Both those operations are somewhere between less likely and impossible with crypto lending. If an institution lends a bitcoin, they had to acquire the bitcoin from someone else first. And if I borrow the bitcoin then forget my keys that bitcoin it isn't going to come back to them without someone else giving up a bitcoin - no matter what the regulators want to happen.
They can only avoid this by not accounting in bitcoin and working in fiat. Or by using pure credit, like what institutions do now where "your money" is actually something like an individual being a bank creditor. But it is much harder both technically and as a matter of incentives to lend crypto.
Lending protocols rely on overcollateralization of loans instead of contract law. If you want to borrow $100k, you would give over (say) $200k worth of some token that you didn't want to sell. In that example, if the value of that token dropped by 50%, the lender would sell all of your collateral to recoup their $100k, not take you to court or send you to a collection agency.
If on the other hand you eventually return the $100k, you would get your collateral back.
The use case for almost all individual loans in tradfi is getting a loan for more than you have in collateral.
Well, most of the people who have crypto to borrow against would fit the description of "betting crypto will go up."
Tax implications might also play into the consideration of selling vs taking an overcollateralized loan as well.
What do they do if it drops by 90%? You'd still be holding their $100k, on only $20k of collateral.
I don't see how this avoids contract law; overcollateralization has never done so in any economic system in the past, and has historically been a ripe domain for financial fraud (since the incentive is to over-value the collateral).
I'm not super knowledgeable here, but I expect such protocols would tend to only take the top few most liquid tokens like Bitcoin or Ethereum as collateral to somewhat mitigate this issue. Very low liquidity tokens held as collateral could be subject to manipulation to trigger loan liquidations as well.
The ability to liquidate collateral is the the stand-in for both creditworthiness and the mechanism for recouping their principal. They would have no recourse to recover their funds if a crash were so drastic that they could not meaningfully liquidate collateral.