Good question. All of these loans are over collateralized with other volatile forms of volatile cryptocurrency. The amount of over collateralization varies from platform to platform.

Most people use it to go leveraged long. To go leveraged long, one would need to lock an approved volatile coin in the smart contract, then draw out a smaller amount of stablecoins out as debt. Then you would buy more volatile coins with that debt and lock them in the smart contract as well. Rinse repeat until you've reached your desired amount of leverage. I don't do this though, because it's essentially gambling.

So, if something terrible happens, like all of the volatile coins drop -50% in a day and they shut down the smart contract so no new loans can be made. You as a stablecoin lender would at least have access to your fair share of volatile coins backing up the system. It's an important risk I should have listed in my other comment, so thanks for asking.

The interest rate they pay you for lending fluctuates based on how much demand there is for loans. So right now, it's around 8%. Earlier this year when people were insanely bullish on their volatile coins, it was 16% for a few days. 7-9% is probably where the average has been so far this year.

The overall goal is to make a more efficient form of banking that requires seconds to send money instead of days. These lending contracts I've linked follow the same principals as fractional reserve banks. The only difference is that you are exposed to a few additional risks:

1. The smart contract could get hacked and you lose everything

2. You are not lending US dollars. You would be lending either DAI or USDC. DAI is a stablecoin soft pegged to the dollar which is backed at least 1.5:1 ETH:DAI. Currently it is backed 3.36:1 (https://mkr.tools/). USDC is a stablecoin that is backed 1:1 US dollars:USDC. These stablecoins pose an additional risk of failing/getting hacked, so there is more risk that you take on when you use them over the traditional banking system.

3. Instead of using a normal bank account, you will use an public/private key pair on ethereum to make transactions to the network. This poses another risk you are taking on in case of a hack/you losing your private key.

So, to wrap it up, this is very different than normal banking. This form of lending is much riskier than a traditional savings account at your bank, but in return for that risk you are paid more of a reward. I would suggest you read more about these risks to further understand what you're getting yourself into before buying some stablecoins and depositing them into dydx/compound smart contracts, as I've only listed the 3 most obvious differences.

Yep, a stablecoin is required for leveraged longs on ETH, BTC, or whatever volatile thing you like. Stablecoins also enable you to enter a leveraged short position if you borrow the volatile asset and sell it. You could even use your crypto as collateral for a loan in the traditional fiat world if you went through a centralized exchange connected to your bank. The rates would be high, but you could do it. Good luck getting any bank to directly accept your shitcoins as collateral backing a loan!

DeFi is attempting to improve upon (better, faster, cheaper) the more conservative, traditional markets. So yep it's pretty much a crypto based version. There are some nuanced differences, and there is a lot more risk in its current stage, but the goals and customers are similar.

I will continue to add things here as they come up. This space has grown quickly this year and new projects seem to pop up all the time so it should be interesting to see where it goes.