Lending protocols: Aave, Compound basics

Lending without a bank

Lending protocols are the simplest, most boring corner of DeFi — and that's a compliment. Aave and Compound are the two most established. You deposit a token, it sits in a shared pool, and borrowers come along and take loans against it. They pay interest. You earn most of that interest, the protocol keeps a small slice. No application form, no credit check, and the only paperwork is signing a wallet transaction.

Rates are not set by anyone — they are calculated by a formula based on utilization. Utilization is the % of the deposited pool that is currently being borrowed. When utilization is low (say 30%), borrow rates are cheap, and so supplier earnings are small. When utilization climbs (say 90%), rates spike to encourage more depositors and choke off borrowing. The curve usually has a sharp 'kink' around 80% utilization — below the kink rates climb slowly, above it they go vertical fast.

What you earn as a supplier is the borrow rate × utilization, minus the protocol's reserve factor. Simple example: borrow rate is 6%, utilization is 70%, reserve factor is 10%. Supplier APY ≈ 6% × 70% × 90% = 3.78%. So even when the borrow rate looks tempting, what you actually earn is gated by how much of the pool is currently borrowed. Don't read the borrow rate as your yield.

Some practical guardrails. Stablecoins (USDC, USDT, DAI) tend to be the most active lending markets — predictable, in-asset yield, no price exposure beyond the stablecoin itself. ETH and BTC lending yields are typically lower (1-3%) because most borrowers do not want to short them. New or thinly used assets can look like they offer high yield, but utilization is usually low and the headline rate masks how little you'd actually earn.

On a $500 budget, you almost certainly want to be on an L2 — Arbitrum or Base — where gas costs $0.10-1 instead of $20-100. Mainnet Aave on a $500 deposit can take a week or more of yield just to break even on the gas to enter and exit.

Recap: lending protocols are utilization-priced pools. Supplier APY = borrow rate × utilization × (1 − reserve factor). Stablecoin markets are the cleanest yield. Always do it on a low-gas chain at retail size.