Just like in traditional banks, DeFi borrowing and lending opportunities come with terms about how interest rates and collateral will be calculated.
In the case DeFi interest rates, there are several factors to consider when deciding where and how long to engage in a loan.
For borrowers, taking out a loan with low interest rates and a reasonable repayment plan is usually the most attractive choice. You obviously want to pay back your borrowed amount, but also have the time to come up with the interest payments. In crypto, some DeFi loan servicers (e.g. Aave) will offer a fixed interest rate; most, however, adjust interest rates with each new block on the blockchain. These variable interest rate loans can quickly change depending on current market conditions.
For lenders, and those who want to earn yield while they loan out their crypto, incentives for the most in-demand assets mean the highest returns in interest earned. Participants in DeFi who wish to earn yield by loaning their assets will naturally choose the opportunities that incentivize them; that is, the ones with the best Annual Percentage Yield (APY). Compounded interest rates may advertise an estimated APY but again, these variable interest rates and incentives may not last long as more and more users deposit their assets to take advantage of a good yield. Study the protocols you wish to use and ask yourself if the yield is sustainable before you proceed.
Should you choose to engage in borrowing and lending cryptocurrency, you must remain attentive to the pace at which variable rates change, and in turn current market conditions. With innovation presented by DeFi interest rates, many may take on greater risk in the hopes of higher returns than what can be achieved with centralized banking.