Learn the essential steps and concepts for providing digital assets to a decentralized lending protocol to earn yield and enhance market liquidity.
LABS
Guides
How to Supply Assets to a Lending Protocol
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core-concepts
Core Mechanics of Supplying
01
Asset Deposit
Asset Deposit is the initial act of transferring your crypto holdings into the protocol's smart contract. This action converts your tokens into a protocol-specific representation, like a cToken or aToken, which accrues interest over time.
- Process: You approve the contract and execute a deposit transaction from your wallet.
- Example: Depositing 10 ETH to receive 10 cETH, which automatically grows in quantity as interest is paid.
- Importance: This is the foundational step to start earning a passive yield on idle assets, with the protocol managing the underlying lending.
02
Interest Accrual
Interest Accrual refers to the continuous earning of yield on supplied assets, typically calculated per block and derived from borrower interest payments.
- Mechanism: Interest is compounded, often automatically, increasing your balance of the protocol token (e.g., your cETH balance grows).
- Example: With a 5% APY, your supplied 1000 DAI could earn approximately 50 DAI in interest over a year, visible as more aDAI in your wallet.
- Significance: This provides a transparent, automated return without requiring active management, making it a core incentive for suppliers.
03
Liquidity Provision
Liquidity Provision is the act of supplying assets to create a pool that borrowers can access, which is crucial for the protocol's operation.
- Role: Your deposited funds become part of a collective liquidity pool that facilitates loans.
- Use Case: Supplying stablecoins like USDC helps ensure borrowers can reliably obtain loans, especially during high demand.
- User Impact: By providing liquidity, you earn interest but also accept the risk of the underlying protocol, as your capital is utilized for generating yield.
04
Collateral & Safety
Collateral & Safety mechanisms protect suppliers by ensuring loans are over-collateralized and managing risks like insolvency.
- Feature: Protocols require borrowers to post more collateral than the loan value, creating a safety buffer.
- Example: A borrower might deposit $150 worth of ETH as collateral to borrow $100 in DAI, protecting suppliers if ETH's price drops.
- Why it Matters: These features, along with reserve factors and governance, aim to safeguard supplier funds, making the process less risky than uncollateralized lending.
05
Withdrawal Process
The Withdrawal Process allows suppliers to redeem their protocol tokens (e.g., cTokens) for the underlying asset plus accrued interest, subject to protocol liquidity.
- Mechanism: You exchange your interest-bearing token back to the original asset via a smart contract call.
- Real Scenario: Redeeming 10.5 cDAI after a year might return 10.5 DAI, representing your principal and earned interest.
- User Consideration: Withdrawals are typically instant if sufficient liquidity exists, but some protocols may have timelocks or require exiting a specific market.
06
Yield & Incentives
Yield & Incentives encompass the total return for suppliers, including base interest and often additional rewards like governance tokens.
- Components: Yield comes from borrower interest payments and may be supplemented by liquidity mining programs.
- Use Case: Supplying to a new protocol might earn you 3% base APY in the asset plus an additional 5% APY in the protocol's native token.
- Importance: These incentives attract capital, bootstrap liquidity, and align user participation with the protocol's long-term growth and governance.
The Supply Transaction Lifecycle
A detailed walkthrough of the process for supplying digital assets to a decentralized lending protocol to earn yield.
1
Step 1: Connect Wallet & Approve Protocol
Initialize connection and grant token spending permissions.
Detailed Instructions
First, you must connect your Web3 wallet (like MetaMask) to the lending protocol's front-end interface. This allows the dApp to interact with your wallet address. The most critical action in this step is granting token approval. This is a one-time transaction that authorizes the protocol's smart contract to move a specific amount of the asset you intend to supply from your wallet. You are not sending funds yet; you are only setting a spending limit.
- Sub-step 1: Navigate to the protocol's app and click "Connect Wallet." Select your wallet provider and confirm the connection in your wallet pop-up.
- Sub-step 2: Choose the asset to supply (e.g., USDC). The interface will prompt you to "Approve USDC" or "Enable" the asset. This triggers a transaction.
- Sub-step 3: In your wallet, review the approval transaction. It will be a call to the
approvefunction on the USDC token contract, specifying the protocol's lending pool contract address (e.g.,0x7d2768dE...for Aave V2 on Ethereum) as thespenderand anamount(often set to a very large number like2**256 - 1for unlimited approval).
Tip: While unlimited approval is convenient, for enhanced security, you can approve a specific amount you plan to supply. Always verify the contract address you are approving is the official protocol contract.
javascript// Example ERC-20 approve transaction data const data = tokenContract.methods.approve( '0x7d2768dE32b0b80b7a3454c06BdAc94A69DDc7A9', // Lending Pool Address '115792089237316195423570985008687907853269984665640564039457584007913129639935' // Max uint256 ).encodeABI();
2
Step 2: Initiate the Supply Transaction
Execute the transaction to deposit assets into the protocol.
Detailed Instructions
After approval, you can execute the supply transaction. This action transfers your tokens from your wallet into the protocol's liquidity pool. In return, you receive protocol-specific tokens, often called aTokens (Aave) or cTokens (Compound), which represent your supplied balance and accrue interest in real-time. These tokens are your proof of deposit and can be transferred or used as collateral.
- Sub-step 1: On the interface, enter the amount of the approved asset you wish to supply (e.g., 1000 USDC).
- Sub-step 2: Review the projected metrics, such as the Supply APY (Annual Percentage Yield) and your updated health factor if using the asset as collateral.
- Sub-step 3: Click "Supply" or "Deposit." Your wallet will prompt you to confirm a transaction. This calls the
depositorsupplyfunction on the lending pool contract.
Tip: Pay close attention to the gas fees. Supply transactions are more complex than simple transfers and may cost more. The transaction will mint an equivalent amount of interest-bearing tokens to your wallet address.
solidity// Simplified view of the contract interaction AaveLendingPool.deposit( USDC_Contract_Address, // The asset being supplied 1000000000, // Amount in base units (e.g., 1000 USDC = 1000 * 10^6) yourWalletAddress, // The address receiving the aTokens 0 // Referral code (often 0) );
3
Step 3: Receive & Manage Interest-Bearing Tokens
Understand and interact with the tokens representing your supplied position.
Detailed Instructions
Upon successful transaction confirmation, your supplied balance is no longer held as the base asset. Instead, you hold interest-bearing tokens (e.g., aUSDC). The balance of these tokens in your wallet increases continuously as interest accrues, directly reflecting your growing share of the pool. You can view your balance in the protocol's dashboard or by checking your wallet. These tokens are ERC-20 compliant and can be freely transferred, sold, or used in other DeFi protocols.
- Sub-step 1: Verify the receipt of aTokens in your wallet. Add the token contract address (e.g.,
0xBcca60bB...for aUSDC) to your wallet to see the balance. - Sub-step 2: Monitor your earned interest. The aToken balance increases every block. You can calculate accrued interest by subtracting your initial deposit amount from the current aToken balance, converted to the underlying asset.
- Sub-step 3: Consider using your aTokens as collateral to borrow other assets, or provide liquidity in other protocols that accept them.
Tip: The exchange rate between the aToken and the underlying asset constantly increases. To check your actual underlying balance, query the aToken contract's
balanceOfand the pool'sgetReserveDatafor the current liquidity index.
javascript// Query your aUSDC balance and the underlying value const aTokenBalance = await aUSDCToken.methods.balanceOf(userAddress).call(); const reserveData = await lendingPool.methods.getReserveData(USDC_address).call(); const liquidityIndex = reserveData.liquidityIndex; // A growing index const underlyingBalance = aTokenBalance * liquidityIndex / 10**27; // Example calculation
4
Step 4: Withdraw or Adjust Position
Redeem your supplied assets or modify your position parameters.
Detailed Instructions
The final phase involves managing your exit or adjusting your risk. To reclaim your underlying assets plus all accrued interest, you must redeem your interest-bearing tokens. This is done via a withdraw transaction, which burns your aTokens and sends the underlying asset back to your wallet. You can withdraw a partial or full amount. If your assets are used as collateral, you may need to repay outstanding borrows or adjust your health factor above the liquidation threshold before a full withdrawal.
- Sub-step 1: Navigate to the "Withdraw" section of the protocol's dashboard. Select the asset and the amount (or "Max").
- Sub-step 2: If the asset is enabled as collateral, the interface will show the impact on your health factor. Ensure it remains safe (e.g., >1.0) to avoid liquidation risk.
- Sub-step 3: Confirm the withdrawal transaction. This calls the
withdrawfunction on the lending pool, specifying the asset address and the amount.
Tip: Withdrawal transactions also incur gas fees. The amount you receive will be precisely the current underlying value of the aTokens you burn. Always perform a test transaction with a small amount first if you are unfamiliar with the process.
solidity// Calling the withdraw function AaveLendingPool.withdraw( USDC_Contract_Address, // The asset to withdraw 500000000, // Amount in underlying units (e.g., 500 USDC) yourWalletAddress // The destination for the withdrawn funds ); // This burns the corresponding amount of aUSDC from your wallet.
Major Lending Protocols: Supply-Side Features
Comparison overview of how to supply assets to a lending protocol
| Protocol | Primary Deposit Method | Supported Assets (Examples) | Native Token Integration | Yield Accrual Method |
|---|---|---|---|---|
Aave V3 | Direct wallet deposit via UI/contract | USDC, ETH, wBTC, LINK, DAI | StkAAVE rewards for safety module stakers | aTokens (balance increases in real-time) |
Compound V3 | Direct wallet deposit via UI/contract | USDC, ETH, WBTC | COMP governance token distribution to suppliers | cTokens (balance increases per block) |
MakerDAO | Open Vault & lock collateral (e.g., ETH-B) | ETH, wBTC, LINK, UNI | MKR governance from stability fees & auctions | Generates DAI debt, not direct supply yield |
Lido Finance | Stake ETH for stETH via contract | ETH only (liquid staking) | LDO governance for fee distribution | Rebasing stETH balance increases daily |
Yearn Finance | Deposit into yield-bearing vault (e.g., yvUSDC) | USDC, DAI, ETH via vault strategies | YFI governance for strategy fees | Share price appreciation of vault token |
Curve Finance | Provide liquidity to stablecoin pools (e.g., 3pool) | DAI, USDC, USDT, other stables | CRV emissions to liquidity providers | LP token accrues trading fees & CRV |
Risk Analysis for Suppliers
Understanding Your Role as a Supplier
Supplying assets to a lending protocol like Aave or Compound means you are providing liquidity to a pool in exchange for earning interest. Your supplied assets are used by borrowers, and you receive supply APY (Annual Percentage Yield) as a reward. However, your capital is not risk-free.
Key Risks to Consider
- Smart Contract Risk: The protocol's code could have vulnerabilities. For example, a bug in the smart contract could lead to a hack, as seen in the early days of some DeFi protocols.
- Impermanent Loss (for LP tokens): If you supply liquidity provider (LP) tokens from a DEX like Uniswap, their value can change relative to holding the assets separately if the underlying asset prices diverge.
- Protocol Insolvency Risk: If too many borrowers default and the collateral value drops below the loan value, the protocol may become undercollateralized, potentially affecting your ability to withdraw funds.
Practical Example
When you supply USDC to Aave, you receive aTokens (interest-bearing tokens) representing your deposit. You earn interest automatically, but you must monitor the health factor of the protocol and the overall market conditions to assess risk.
yield-strategies
Advanced Yield Strategies
Explore sophisticated methods to supply assets to lending protocols, maximizing returns while managing risk through strategic asset selection, protocol diversification, and leveraging DeFi mechanisms.
01
Single-Asset Supplying
Direct deposit involves supplying a single cryptocurrency like ETH or USDC to a lending protocol's liquidity pool. This is the foundational yield strategy.
- Earn supply APY from borrowers' interest payments.
- Maintain full custody and can withdraw assets at any time.
- Example: Supplying DAI to Aave to earn a variable yield while it's lent to traders and other users.
- This provides a straightforward, low-complexity entry point for generating passive income on idle holdings.
02
Liquidity Provision with LP Tokens
Supply liquidity provider (LP) tokens from decentralized exchanges (e.g., Uniswap) to lending protocols to earn double rewards.
- Earn trading fees from the DEX pool PLUS lending interest from the protocol.
- Protocols like Compound accept tokens like UNI-V2 for borrowing against.
- Example: Providing a USDC/ETH LP token to Compound to earn COMP rewards and fees while your capital remains productive.
- This strategy compounds yields but introduces impermanent loss as an additional risk factor.
03
Cross-Protocol Yield Optimization
Employ yield aggregators or vaults that automatically move supplied assets between protocols to chase the highest available yield.
- Uses algorithms to find the best supply rates across Aave, Compound, and others.
- Automatically compounds earned interest to boost APY through auto-compounding.
- Example: Using Yearn Finance vaults, which deposit your USDC into the most profitable lending market and reinvest earnings.
- This maximizes returns passively but adds smart contract risk from the aggregator.
04
Collateralized Borrowing Loops
A leveraged strategy where supplied assets are used as collateral to borrow a stablecoin, which is then re-supplied to create a recursive yield position.
- Amplifies the base supply APY through leverage, but increases liquidation risk.
- Requires active monitoring of health factor or collateral ratio.
- Example: Supplying ETH to Aave, borrowing USDC against it, and supplying that USDC back to Aave to earn yield on both the original and borrowed amount.
- This is an advanced tactic for experienced users comfortable with significant risk.
05
Stablecoin Yield Arbitrage
Capitalize on differing interest rates for the same stablecoin across multiple lending protocols by supplying to the highest-yielding platform.
- Involves monitoring rates for USDC, DAI, or USDT on platforms like Aave, Compound, and Euler.
- May involve moving funds as rates change to optimize returns.
- Example: Supplying DAI to Compound when its supply APY is 4% instead of Aave's 3%, then shifting if the rates flip.
- This strategy requires active management but exploits inefficiencies in the DeFi market for extra yield.
06
Insured or Protected Supplying
Supply assets through platforms that offer deposit insurance or use risk tranching to provide a safer yield environment.
- Protocols like BarnBridge or Nexus Mutual offer products that mitigate smart contract or default risk.
- Can involve supplying to a senior tranche for lower, but protected, yield.
- Example: Using a yield tokenizer that separates principal protection from yield generation, allowing conservative suppliers to prioritize safety.
- This strategy is crucial for institutional or risk-averse capital seeking DeFi exposure.
Technical FAQs for Suppliers
The process involves a smart contract interaction where you approve and deposit your assets. First, you must grant the protocol's contract an allowance to move your tokens via an approve transaction. Then, you call the supply or mint function, which transfers your tokens to the protocol's liquidity pool and issues you a receipt token (like a cToken or aToken) representing your share. This token accrues interest over time and can be redeemed later. For example, supplying 100 DAI might mint you 100 cDAI, which grows to 105 cDAI after a year at 5% APY. Always verify contract addresses on the protocol's official documentation, such as Compound Docs.