Back in Venice, Bassanio is trying to convince Shylock, a Jewish moneylender, to lend him 3,000 ducats for three months, with Antonio bound to repay the debt. Frustrated by Shylock's stalling, Bassanio demands an answer. Shylock concedes that Antonio is a "good man" (1.3.16)—that is, Shylock believes Antonio will be good for the money that Bassanio wants to borrow. Therefore, after a little more waffling, he accepts the terms that Bassanio has proposed.
Even in this brief exchange, Shylock shows that he interprets the world through a different framework than Bassanio: he understands "good" as meaning "having enough money" whereas Bassanio, in theory, values other "good" qualities in his old friend. (Though Bassanio also, clearly, appreciates Antonio's money.)
Shylock then asks whether he can speak with Antonio himself. Bassanio invites Shylock to dine with them both that night, but Shylock declines. Although he will do business with Christians, he explains, it would go against his religious principles to eat or drink or pray with them.
By coincidence, at this moment, Antonio appears. Although Shylock notices Antonio at once, at first he ignores him, remarking privately that he harbors an "ancient grudge" (1.3.47) towards the "Christian" (1.3.42). Shylock explains to the audience that he hates Antonio because he "lends out money gratis" (1.3.44), or free of interest, thereby bringing down interest rates for professional moneylenders such as himself (who are almost all Jews). More importantly, Antonio has repeatedly insulted the Jewish people in general and Shylock in particular. Shylock is determined to get revenge on Antonio not only for himself, but also for his "tribe" (1.3.51).
Shylock reveals his prejudice against Christians and explains the way in which he has experienced anti-Semitic prejudice himself. Notably, both groups' ideas of the other revolve around ideas of commerce: the Christians believe it is wrong to practice usury (lending money for interest), whereas the Jews—who were forbidden by law from engaging in most other professions—often resorted to usury as a way to make a living. Being treated badly has given Shylock a desire for revenge.
Antonio approaches Shylock, saying that he ordinarily would not take part in a transaction involving interest but that, this one time, he will break his personal principle in order to help his friend. Shylock agrees to lend Bassanio the money.
After stating his "Christian" business principles (and denigrating the Jews' principles), Antonio publicly declares that there are no limits to what he will do for Bassanio.
Shylock then defends his practice of charging interest by citing the Biblical story of Jacob. When Jacob was working as a shepherd for his uncle Laban, Shylock reminds Antonio, he found a clever way to earn interest for his efforts. He cut a deal with Laban in which he got to keep any sheep that were born with a "streaked" color. Then he employed a magic trick to get all the sheep to breed streaked lambs, which he was, by contract, entitled to keep for himself. Shylock defends this kind of behavior, similar to his own, as representing "thrift" (1.3.90) rather than theft.
Citing the Book of Genesis, Shylock shows how different interpretations are the basis of his religious and personal differences with the Christians. The Christians believe that usury is immoral because it is unnatural to breed money from money. But Shylock interprets the Bible to say that charging interest is no different than Jacob's breeding of animals, which Christian law would permit as totally natural.
Outraged that Shylock would cite the Bible in order to defend what Venetian Christians consider to be the sin of usury, Antonio insults Shylock. Shylock, in turn, cites Antonio's previous mistreatment of him: Antonio has publicly abused him many times and even spat upon his clothing. Why, Shylock asks, should he lend to Antonio as freely as he would to a relative or friend? Enraged, Antonio begins to insult Shylock again. There is no need to pretend to be friends, he says: lend money to him as to an enemy.
Shylock reveals the years of abuse he has received from Antonio and other Venetian Christians as the source of his desire for revenge. By noting that Antonio is not his friend, he shows that this abuse has made it clear to him that he is an outsider to the polite society of Venetian friends on display in 1.1. Antonio, for his part, openly declares Shylock to be an enemy.
Teasing Antonio for getting so worked up, Shylock then goes on to propose an unusual compromise. He says that, this time, he will not charge interest on his loan. However, if Antonio defaults on the loan and is unable to pay, Shylock will be entitled to cut one pound of Antonio's flesh from any part of Antonio's body that Shylock chooses.
The contract Shylock proposes is hard for the Christians, and a modern audience or reader, to understand. By trading in flesh, rather than making money "breed" by usury, Shylock is actually adopting the Christians' stated business principles but directing them toward a monstrous end, which mocks those Christian principles in turn.
Antonio agrees, despite Bassanio's nervousness about binding his friend to such a potentially dangerous contract. Talking to himself, Shylock gleefully hints at the fact that he has achieved the first step in his still-mysterious plan for revenge. But Antonio remains unconcerned: he is sure his ships will return, with three times 3000 ducats, at least one month before Shylock's deadline.
For the first time, Bassanio shows some scruples about putting his greed before his friend—who, by agreeing to put a price on his pound of flesh (and his life) has become like an animal headed to slaughter. Antonio will not be held back in his generosity, and by signing the contract agrees to be bound by law. So Shylock's revenge plot starts moving into action.