How do liquidity lenders provide DeFi loans?

The crypto holdings in your wallet don’t generate any interest if you don’t put them into use. While the long-term value of the assets may appreciate or depreciate, simply holding a digital currency won’t generate any earnings. This is where liquidity lending is useful. In liquidity lending, you lock your assets in a protocol, which lends them to borrowers. In return, you receive newly minted coins native to the protocol, for example, aTokens for Aave, cTokens for Compound, and Dai for MakerDAO.

Users who borrow from a lending protocol must provide over-collateralized collateral – they deposit more than they borrow. This way, they cover unpredicted expenses and avoid forced liquidation and capital gains tax.