Author: Stani.eth

Compiled by: Ken, Chaincatcher

On-chain lending began around 2017 as a fringe experiment related to crypto assets. Today, it has grown into a market exceeding $100 billion, primarily driven by stablecoin lending, mainly secured by crypto-native collateral such as Ethereum, Bitcoin, and their derivatives. Borrowers release liquidity through long positions, execute leverage cycles, and engage in yield arbitrage. The key is not creativity, but validation. Behavior over the past few years indicates that automated lending based on smart contracts already possessed genuine demand and a real product-market fit long before institutional attention began.

The crypto market remains volatile. Building lending systems on top of the most dynamic assets in existence forces on-chain lending to address risk management, liquidation, and capital efficiency issues immediately, rather than hiding them behind policy or human discretion. Without crypto-native collateral, it's impossible to see how powerful fully automated on-chain lending truly is. The key is not cryptocurrency as an asset class, but the transformative cost structure brought about by decentralized finance.

Why is on-chain lending cheaper?

On-chain lending is cheaper not because it's a new technology, but because it eliminates layers of financial waste. Borrowers can now acquire stablecoins on-chain at around 5% cost, while centralized crypto lending institutions charge 7% to 12% interest, plus fees, service charges, and various surcharges. When conditions are favorable to borrowers, choosing centralized lending is not only not conservative, but even irrational.

This cost advantage doesn't stem from subsidies, but from the aggregation of capital within an open system. Permissionless markets are structurally superior to closed markets in terms of capital pooling and risk pricing because transparency, composability, and automation drive competition. Capital flows faster, idle liquidity is penalized, and inefficiencies are exposed in real time. Innovation spreads instantly.

When new financial primitives like Ethena's USDe or Pendle emerge, they absorb liquidity across the entire ecosystem and expand the use of existing financial primitives (such as Aave), eliminating the need for sales teams, reconciliation processes, or back-office departments. Code replaces administrative costs. This is not merely an incremental improvement; it's a fundamentally different operating model. All the advantages of this cost structure are passed on to capital allocators, and more importantly, to borrowers.

Every major transformation in modern history follows the same pattern. Asset-heavy systems become asset-light systems. Fixed costs become variable costs. Labor becomes software. Centralized economies of scale replace localized duplication of construction. Excess capacity is transformed into dynamic utilization. These transformations initially seem terrible. They serve non-core users (e.g., cryptocurrency lending, rather than mainstream use cases), compete on price before improving quality, and don't seem serious until they scale up and existing businesses are unable to cope.

On-chain lending fits this model perfectly. Early users were primarily a niche group of cryptocurrency holders. The user experience was poor. Wallets felt foreign. Stablecoins didn't reach bank accounts. But none of that mattered because it was cheaper, faster, and had global access. As everything else improved, it became more accessible.

What will happen next?

During a bear market, declining demand and compressed yields expose a more significant dynamic: capital in on-chain lending is constantly in competition. Liquidity doesn't stagnate due to quarterly committee decisions or balance sheet assumptions. It's constantly repricing in a transparent environment. Few financial systems are as ruthless as it.

On-chain lending doesn't lack capital, but rather collateral. Currently, most on-chain lending simply recycles the same collateral for the same strategies. This isn't a structural limitation, but rather a temporary one.

Cryptocurrencies will continue to generate native assets, productive primitives, and on-chain economic activity, thereby expanding the reach of lending. Ethereum is maturing into a programmable economic resource. Bitcoin is solidifying its role as a store of economic energy. Neither of these is in its final state.

If on-chain lending is to reach billions of users, it must absorb real economic value, not just abstract financial concepts. The future will combine autonomous, crypto-native assets with tokenized real-world rights and obligations, not to replicate traditional finance, but to operate it at extremely low cost. This will be a catalyst for replacing the old financial backend with decentralized finance.

What exactly went wrong with the lending process?

The reason borrowing is so expensive today is not because capital is scarce. Capital is abundant. The liquidation rate for quality capital is 5% to 7%. The liquidation rate for risky capital is 8% to 12%. Borrowers still have to pay high interest rates because everything surrounding capital is inefficient.

The loan disbursement process is bloated by customer acquisition costs and outdated credit models. A binary approval process results in high-quality borrowers paying excessive fees, while low-quality borrowers receive subsidies until default. Service delivery remains manual, compliance-intensive, and slow. Incentive mechanisms at each level are misaligned. Those who price risk rarely actually bear it. Brokers bear no responsibility for defaults. Loan originators immediately sell off risk exposure. Everyone gets paid regardless of the outcome. The flawed feedback mechanism is the true cost of lending.

Lending hasn't been disrupted because trust trumps user experience, regulation stifles innovation, and losses mask inefficiencies before they materialize. The collapse of a lending system is often catastrophic, reinforcing conservatism rather than progress. Therefore, lending still appears to be an industrial-age product forcibly inserted into the digital capital markets.

Breaking the cost structure

Unless loan disbursement, risk assessment, service delivery, and capital allocation are fully software-native and on-chain, borrowers will continue to pay excessive fees, while lenders will continue to justify these fees. The solution is not more regulation or marginal improvements in user experience. It's about breaking down cost structures. Automation replaces processes. Transparency replaces discretion. Certainty replaces reconciliation. This is the disruptive potential of decentralized finance (DeFi) for lending.

When on-chain lending becomes significantly cheaper than traditional lending in end-to-end operations, widespread adoption is not an issue, but an inevitability. Aave was born in this context, serving as the foundational capital layer for a new type of finance, supporting the entire lending sector from fintech companies to institutional lenders and consumers.

Lending will become the most empowering financial product, simply because the cost structure of decentralized finance will allow rapidly flowing capital to flow into the application scenarios that need it most. Abundant capital will create numerous opportunities.