How do DeFi loans work?

TL;DR. A DeFi (decentralized finance) loan is a loan that a smart contract, a program on a public blockchain, makes and enforces instead of a bank. In the common version you lock crypto in a shared pool as collateral worth more than you borrow, pay a floating rate, have no due date, and lose that collateral to liquidation, a forced sale, if its value falls too far. In a peer-to-peer or crowd loan, specific lenders fund your request at a fixed rate with a fixed repayment date, sometimes with little or no collateral. DeFi loans differ on three points: where the money comes from, what secures it, and whether there is a due date.

What is a DeFi loan?

A DeFi loan, short for decentralized finance loan, is a loan made and enforced by a smart contract, a program stored on a public blockchain such as Ethereum, instead of by a bank. The contract holds the lender's money, releases it to the borrower when its conditions are met, counts the interest, and applies the consequences if the debt is not repaid. A lending protocol is a set of such contracts.

Most DeFi loans are over-collateralized: the borrower first locks collateral, an asset the contract can sell if the debt goes bad, worth more than the amount borrowed. What is borrowed is often a stablecoin, a token designed to track a currency, most often the US dollar.

At Unlloo we have written lending contracts in both main shapes, a shared pool and an escrow per loan (a contract that holds one loan's funds until its conditions release them), so this page describes each by what the code can guarantee and what it cannot.

This page is general education, not financial, legal or tax advice. Rules vary by jurisdiction.

Where does the money in a DeFi loan come from: a shared pool or a specific person?

The money in a DeFi loan comes either from a shared pool or from specific lenders. In a pool loan, many lenders deposit into one contract and borrowers draw from it without being matched to anyone; in a peer-to-peer loan, specific lenders fund one borrower's loan on agreed terms, and when many lenders each fund a slice of the same loan, we call it a crowd loan.

Pools became the common design because they remove the wait. Aave's January 2020 whitepaper, describing its shift from peer-to-peer loans to a pool, says pooled loans do not need to be matched one by one, which makes them instant.

Inside the contract, the difference is bookkeeping. A pool keeps one running total of deposits and one of debt, and one formula prices every borrower. A per-loan escrow keeps a ledger per loan: who offered what, at which rate, what was accepted and what has been repaid. A default in one loan cannot reach another loan's lenders, and no other loan's interest cushions the loss.

What do you need to get a DeFi loan: collateral, reputation, or both?

For almost every DeFi loan you need collateral worth more than the loan, because a smart contract cannot check your income or take you to court, so the only repayment it can guarantee is the collateral it already holds. A small number of protocols offer an under-collateralized loan, one with collateral worth less than the amount borrowed or none at all, and rely instead on what is known about the borrower: on-chain reputation (a score built from a wallet's public history), verified identity or a legal agreement.

A Bank for International Settlements bulletin explained in June 2022 why collateral dominates: borrowers are anonymous, so lenders fall back on collateral, and credit then reaches only people who already hold assets.

The claim that unsecured DeFi loans do not exist is out of date, though the segment was small when DL Research measured it in June 2025: $134 million in active loans at the three largest uncollateralized protocols (Wildcat, Clearpool and TrueFi), against $19.8 billion at Aave, Morpho and SparkLend. The main approaches:

• Institutional credit. On Wildcat, per the full report (PDF), only borrowers approved by its team could open markets as of June 2025, most participants were institutional lenders and trading firms, and borrowers could attach legally enforceable off-chain agreements.
• Reputation-based crowd loans. Lenders judge each borrower by an on-chain reputation score, which also draws on third-party identity checks. This is our approach; a separate post covers the score.
• Flash loans. A flash loan needs no collateral only because, per Aave's documentation, the amount and a fee must be returned before the same transaction ends.

See also: getting a crypto loan without collateral.

How does borrowing from a DeFi lending pool work, step by step?

To borrow from a DeFi lending pool, you deposit collateral, borrow up to that asset's loan-to-value (LTV) limit, the largest share of the collateral's value the protocol lets you borrow, and interest starts accruing on your debt immediately. Nobody has to approve the loan; the one ongoing requirement is that your collateral stays valuable enough relative to what you owe.

1. Connect a wallet, the software that holds your keys.
2. Supply collateral, for example ETH, Ethereum's native asset, into the pool contract.
3. Borrow up to the LTV limit.
4. Watch the health factor, a single number for the safety of the position.
5. Repay any amount at any time.
6. Withdraw the collateral once the debt is cleared.

The health factor is the collateral's value times the liquidation threshold, divided by the debt, as Aave's help page defines it. The liquidation threshold is the share of the collateral's value that the protocol counts as cover for the debt. Below a health factor of 1, the position can be liquidated: collateral is sold off to cover the debt.

A hypothetical example: you supply ETH worth $10,000 where the liquidation threshold is 83%, and borrow 5,000 USDC, a dollar stablecoin. The health factor is 10,000 × 0.83 / 5,000 = 1.66. If ETH falls 40%, it becomes 6,000 × 0.83 / 5,000 = 0.996, below 1, so the position can be liquidated.

How does a peer-to-peer or crowd loan work, step by step?

In a peer-to-peer or crowd loan, the borrower posts a request with an amount, a maximum rate and a repayment date, lenders lock offers in an escrow contract, and the borrower accepts the offers they want. The loan then runs until it is repaid or the due date passes, and offers that were not accepted stay refundable to their lenders.

Acceptance is the commitment point: an accepted offer is part of the loan until repayment. This is the model we are building at Unlloo, and the same shape exists elsewhere with collateral: on NFTfi, as TechCrunch described in November 2021, lenders make offers against an NFT (a unique token), the borrower picks one, and the lender receives the NFT if the loan is not repaid in time. Without collateral, the lifecycle is the same until the due date; after it, the lenders have nothing to claim, and the borrower's wallet carries a public default that every later lender can see.

A hypothetical request: 1,000 USDC for 90 days, maximum rate 15% a year. Lenders offer 400 at 10%, 300 at 12%, 300 at 14% and 200 at 15%. The borrower accepts the first three, and the fourth lender withdraws from escrow. The blended rate is (400 × 10% + 300 × 12% + 300 × 14%) / 1,000 = 11.8%. With simple interest (charged only on the amount borrowed) and no fees, the borrower owes interest of 1,000 × 0.118 × 90 / 365 = $29.10.

What happens when offers fall short of the requested amount differs by protocol; for crowd loans, see the crowd loan glossary entry.

Who decides the interest rate on a DeFi loan?

In a DeFi lending pool, a formula decides the interest rate: it rises and falls with utilization, the share of deposited funds that is currently borrowed, so the rate floats for every borrower at once. In a peer-to-peer or crowd loan, the borrower and the lenders agree the rate when the loan starts, and it normally stays fixed until the loan ends.

Compound III's documentation defines utilization as total borrows divided by total supply and describes a kink, a level above which the rate climbs faster.

A fixed rate gives the borrower a known cost, provided lenders will offer it. Our earlier post shows the kinked curve. See also: how DeFi interest rates are set.

Do DeFi loans have a due date, and how do you repay one?

DeFi pool loans usually have no due date and can be repaid in full or in part at any time, while peer-to-peer and crowd loans usually have a fixed repayment date by which the amount borrowed and the interest are owed. Aave's FAQ says of its pool loans, "There is no fixed time period to pay back the borrow position," whereas in a fixed-term loan, missing the date counts as default.

Open-ended does not mean free. The debt keeps growing whether or not anyone is watching it.

The same FAQ answer warns that accrued interest grows and lowers the health factor, the ratio of counted collateral to debt; below 1, a position can be liquidated. In Compound III interest accrues every second. A pool position can therefore drift into liquidation with no price move.

Fixed-term loans differ on what you owe if you repay early. A 2023 guide by a co-founder of the peer-to-peer lending platform Gondi notes that some protocols charge interest only while the loan is outstanding, others for the full agreed duration. For a hypothetical 1,000 USDC over 90 days at 12% a year, simple interest:

The loan's terms say which rule applies.

What happens if you do not repay a DeFi loan?

If you do not repay a collateralized DeFi loan, the protocol does not send a collector or go to court: once your debt is too large relative to your collateral, anyone may repay part of it and take your collateral at a discount, which is called liquidation. If a DeFi loan has little or no collateral, the contract can only record the default in public; the lenders bear the loss, and the consequences for the borrower are reputational and, depending on any off-chain agreement and the jurisdiction, possibly legal.

Aave's help page on liquidations gives the rule for its pools: once the health factor, the ratio of counted collateral to debt, is below 1, a liquidator can repay some or all of the debt and receive collateral of equal value plus a bonus. How much can be repaid at once differs by protocol and version.

In a collateralized fixed-term loan the trigger is the calendar: after the due date the lender takes the collateral, as TechCrunch described for loans against NFTs (unique tokens) on NFTfi. With no collateral there is nothing to seize. The borrower's cost is the record: the default stays public on the wallet, and later lenders can decline or charge more because of it. The lender's protection is the choice of whom to fund, at what rate and for how much.

What a lender can do off-chain depends on the agreement and the jurisdiction. See also: what happens if you don't repay a crypto loan.

What can go wrong with a DeFi loan besides the price of your collateral?

Besides the price of your collateral, three things outside your control can go wrong with a DeFi loan: a bug in the contract, a wrong price from the oracle (the data feed that tells the contract what your collateral is worth), and a dollar stablecoin that stops trading at one dollar. All three have happened to large protocols or stablecoins, and in a loan without collateral the main risk is simpler still: the borrower may not pay.

• Contract bug. On 13 March 2023 Euler Finance lost an estimated $197 million in a flash-loan attack, The Block reported; Chainalysis traced it to a contract function that destroyed deposit tokens without destroying the matching debt tokens. By 4 April 2023 the attacker had returned more than $177 million.
• Oracle error. On 10 March 2026 a misconfigured price cap made the oracle used by Aave value wstETH, a wrapped form of staked ETH, about 2.85% too low. Per the Chaos Labs post-mortem and The Block, about 10,938 wstETH was liquidated, roughly $26 million, with no bad debt (uncovered debt) for the protocol and a compensation plan for the users. The market had not moved against those borrowers.
• Stablecoin depeg. On 11 March 2023 USDC traded as low as $0.88 after Circle, its issuer, disclosed $3.3 billion of reserves at the failed Silicon Valley Bank, per The Block. It was back near $1 by 13 March.

A fixed-term loan with no price trigger does not depend on an oracle, but the request may never fill and the protocol's operator may hold powers over the contracts, so it matters who can pause or upgrade them. For the lender's side, see is it safe to lend crypto.

How is a DeFi loan different from a bank loan?

A bank decides whether to lend by examining who you are and enforces a bank loan through contracts and courts, while a typical DeFi lending pool does not ask who you are and enforces a DeFi loan through collateral and code. Pool loans are therefore fast and, at the contract level, open to any wallet, though access through a given website can vary by jurisdiction, and they are mostly useful to people who already hold assets.

The bank column below uses United States sources; other countries differ. The Federal Reserve's G.19 release of 5 June 2026 reports an average rate of 11.40% on 24-month personal loans at commercial banks for the first quarter of 2026, and 21.00% on credit card plans across all accounts.

A bank loan needs no crypto and comes with consumer-protection rules that vary by country; neither DeFi design has an equivalent built into its contracts.

Which kind of DeFi loan fits which situation: a pool or a peer-to-peer loan?

A pool loan fits when you already hold crypto you do not want to sell and want funds within minutes at a floating rate with no end date. A peer-to-peer or crowd loan fits when you want a fixed rate and a fixed term, or when you lack the collateral and need lenders to judge you instead of your assets, and you accept that it takes longer and may not fill.

For borrowing against liquid crypto, pools are the better tool. For lenders, a pool suits staying passive and able to withdraw; a peer-to-peer or crowd loan suits choosing each borrower and rate, at the price of lock-up and default risk.

None of this is a recommendation for your situation; it describes what each design is built to do. For the terms used on this page, see the glossary.

Sources

1. Aave, "FAQ", undated reference page. No fixed repayment period for borrow positions; accrued interest lowers the health factor.
2. Aave Help, "Health Factor & Liquidations", page dated 9 August 2024. Health factor formula, liquidation below a health factor of 1, and what a liquidator repays and receives.
3. Aave Help, "Repay Tokens", page dated 9 August 2024. Repayments can be full or partial.
4. Aave Docs, "Flash Loans", undated documentation for Aave v3. Definition of a flash loan.
5. Aave, "Protocol Whitepaper V1.0", January 2020 (file version committed on 28 January 2020). Aave's shift from peer-to-peer loans to a pool.
6. Compound III Docs, "Interest Rates", undated documentation. Utilization, the kink, and interest accruing every second.
7. Bank for International Settlements, "DeFi lending: intermediation without information?" (BIS Bulletin No 57), 14 June 2022. Why over-collateralization is pervasive and whom it excludes.
8. DL Research, "The Return of Uncollateralised Lending in Crypto: A Sector of Risk and Reward" (summary page), 17 June 2025. Active-loan figures for uncollateralized and collateralized protocols.
9. DL Research, "The Return of Uncollateralised Lending in Crypto: A Sector of Risk and Reward" (full report, PDF hosted by DefiLlama), 17 June 2025. The description of Wildcat.
10. TechCrunch, "South Africa's NFTfi raises $5M so people can use their NFTs as collateral for loans", 16 November 2021. How offers and repayment work in a collateralized peer-to-peer loan, and what the lender receives on default.
11. CryptoSlate, "The savvy holder's guide to NFT lending" (guest post by a Gondi co-founder), 2 September 2023. The two early-repayment interest rules.
12. The Block, "Euler Finance flash-loan attacked for an estimated $197 million", 13 March 2023. Smart contract risk example.
13. Chainalysis, "$197 Million Stolen: Euler Finance Flash Loan Attack Explained", 15 March 2023, updated 6 April 2023. The contract flaw behind the Euler attack.
14. The Block, "Euler hacker returns $31 million, marking end to 'recoverable funds' in DeFi exploit", 4 April 2023. Funds returned after the Euler attack.
15. Chaos Labs on the Aave governance forum, "Post-Mortem: Exchange Rate Misallignment on wstETH Core and Prime Instances", 10 March 2026. Cause, size and compensation plan of the wstETH liquidations.
16. The Block, "Aave suffers oracle glitch, triggering $26 million in unfair wstETH liquidations", 10 March 2026. Independent report of the same incident.
17. The Block, "USDC remains at about $0.90 following Circle's disclosure of funds at SVB", 11 March 2023. USDC price low and the $3.3 billion disclosure.
18. Forkast, "Circle's USDC stablecoin regains parity as regulators act to stop bank run risk", 13 March 2023. USDC recovery.
19. Federal Reserve, "Consumer Credit - G.19", release of 5 June 2026. Bank rates on 24-month personal loans and credit card plans for the first quarter of 2026.
20. Consumer Financial Protection Bureau, "What is a credit report?", last reviewed 29 January 2024. How US lenders use credit reports and what they contain.
21. Consumer Financial Protection Bureau, "What should I do if I'm sued by a debt collector or creditor?", last reviewed 2 August 2023. What a creditor may do after a court judgment.