With defi you can get a loan for millions of dollars just immediately, maybe for a couple of seconds or milliseconds. Without filling any form asking why you need it. Without even creating any account anywhere except your own machine. It's new "in internet nobody knows you are a dog".
Then the next logical question is: what if I never get my money back? What if I lend it to a "dog" who then buys highly leveraged calls on GME, only to be unable to pay me back. Do I, the lender, just write it off as a loss?
As you suggest, if you can get a loan for millions of dollars just immediately without filling any form asking why you need it or without even creating any account anywhere, then what's stopping me from just taking a bunch of loans in excess of the collateral and just never paying them back? After all, as a borrower, I don't have to worry about any sort of credit rating or rate limiting.
As a lender, how do I know that the borrower on the other end isn't running such a scam?
In this case, you don't need to provide any collateral, but the smart contract is designed so that you cannot avoid repayment. It's just an atomic operation, like with database, where all of the actions happen, including repayment, or nothing at all. You can do that with defi.
It's used for market arbitrage, or maybe to restructure other loans, etc.
For borrowers that ostensibly need liquidity, it would be impossible for them to put down collateral equivalent to the loan amount, else they wouldn't need liquidity. If you do have access to collateral, why take a loan in the first place? It's just extra steps (and interest) to end up with the same amount of money that you already have. Is the collateral some lower amount? If so, a bad actor could always put down a lower collateral amount than the original loan amount and then never pay back, resulting in the lender losing {original loan amount - collateral} worth of money.
How is this fraud prevented? Is the interest rate baked into the collateral? If I'm borrowing on this platform, do I need to put down more money than what I seek to borrow in collateral? Who would ever want to do that? How many lenders actually receive, on the net, 10-20% APY successfully?
At least with high yield junk bonds, there are some safeguards built into the system in the form of credit ratings, KYC, and institutional friction (which functions as a rate limiter). How does any of this work in the DeFi world?
Now you might ask, if I already all that money, why the hell am I borrowing it? Because your asset is going to appreciate in value (like a ton of appreciation) whereas your debt is only going to go up 4%. So you want to hold on to your asset, yet you need cash to spend. Also you want to avoid capital gains taxes which happen when you sell the asset.
It's overcollateralized, but that's okay because you actually want to continue holding the asset to realize appreciation.
To your point about avoiding capital gains tax, at some point you would have to repay the full loan, at which point you'd have to pay capital gains tax anyway. I guess, at best, you could always guarantee that you pay the lower long-term capital gains tax rate rather than the higher short-term capital gains tax rate. What's the repayment schedule?
Technically, with a very simplistic math, if your asset appreciates let's say 20%, your cost for borrowing is 4% and you don't spend more than the 20-4=16% in any given year, you technically have a credit line that's worth 16% of your collateral every year, you can live off of, never have to pay your debt. You just need to make sure to never fall below 150% collateral then you'd get liquidated. Of course, there's potential bugs in the smart contract, etc, so don't put more than you can afford to lose, yadi yada.
edit: I highly recommend trying it or watching a Youtube video which shows you the UI and the process, it'll all makes sense and click.