One of the key innovations in blockchain technology is DeFi. By disrupting intermediaries, DeFi revolutionizes the financial system’s foundations and redefines traditional financial services, such as trading, investing, payment, insurance, lending, brokerage, investments, and more.
DeFi gains wider adoption. The TVL, total Value Locked, is growing at 10x per year since May 2020. It now amounts to $172 Billion across all DeFi applications.
While DeFi offers a plethora of opportunities to crypto investors, some of them might be overwhelmed by the unfamiliar DeFi terminology. So, if you’re among them, we got you covered.
Continue reading for a brief DeFi glossary that explains the DeFi ecosystem in detail.
Let’s get right to it!
Decentralized finance is a term that refers to a range of financial products that rely on smart contract and blockchains for peer-to-peer financial services. Smart contracts enable the development of protocols to replicate financial services in an efficient, transparent, interoperable and transparent manner.
DeFi makes financial transactions permissionless by using DApps (and distributed ledger tech (DLT). This includes banking, loans and insurance as well as payments and mortgages. It also allows for asset trading and margin trading. DeFi’s goal is to decentralize finance, replacing central institutions with peer to-peer relationships. This empowers anyone who has an internet connection and can access all financial services.
Annual Percentage Yield
The annual percentage yield or APY, is your compounded annual return on an investment. The compounded returns include the interest from your initial deposit and the interest earned.
For crypto investors, the APY is key to helping them compare their returns on DeFi platforms and other cryptocurrencies. You can either earn APY through yield farming or by taking cryptocurrencies.
Automated market maker (AMM).
Automated Market Maker (AMM) is a distributed exchange protocol which uses algorithms to establish the prices of traded assets. It’s different from central exchanges that use an order book. Uniswap and PancakeSwap are some of the most popular examples of AMM.
AMMs use smart contracts to create their own liquidity pools, and they allow users to automatically and in a permissionless way trade against these liquidity pools.
DEX means decentralized exchange. This is a place where you can buy, sell, and swap cryptocurrencies with no central authority. Unlike a centralized cryptocurrency exchange, DEXs don’t offer a custodial wallet, leaving your assets totally under your control. DEXs don’t charge an exchange commission or a transaction fee.
Decentralized Autonomous Organizations (DAOs) are community-led entities that have no central leadership. It’s fully autonomous, transparent, and governed entirely by community members who collectively make decisions about the project’s technical upgrades, treasury allocations, etc.
Smart contracts lay a DAO’s foundational rules, execute the decisions, etc. The blockchain is open to all public auditing, including voting and proposals.
Decentralized apps are applications that use a distributed peer-to-peer network to support them. DApps can execute transactions and process data via distributed networks using smart contracts that are stored on the blockchain. DApps have no central authority or a single point of ownership, and once a developer has released a DApp’s codebase, others can build on top of it.
DApps are always accessible and don’t have a single point of failure. The DApps are able to be used for a range of purposes, such as decentralized finance and gaming.
Flash Loans are uncollateralized loans that allow you to borrow any available amount of assets, as long as the liquidity is returned to the protocol within one block transaction. The interest rate and the loan’s conditions are coded into the smart contract governing the flash loan.
If the borrower doesn’t repay the total amount of the loan before the completion of the transaction, the transaction is reversed by the smart contract, and the loan is nullified.
The DeFi platform has a liquidity pool, which is an accumulation of cryptocurrency tokens that are secured by smart contracts. Anyone can use smart contracts to deposit tokens into the liquidity pools. In return, they will receive trading fees and native tokens. The liquidity providers refer to users who have their assets locked up in liquidity pools.
Lending platforms and DEXs are two examples of DeFi platforms that make use liquidity pools.
If a crypto token is locked in a liquidity fund to earn interest and provide liquidity, an impermanent loss occurs.
Stablecoins refer to cryptocurrencies that are pegged at another currency like fiat currency, commodity or financial instrument. USDT and USDC are some of the most widely used stablecoins.
DeFi staking is a rewards-type system that involves locking crypto assets in your cryptocurrency wallet for a specific period to verify blockchain transactions, contribute to the blockchain network’s performance and safety, and earn rewards in the form of additional coins or tokens. Only blockchain networks that use the Proof-of-Stake consensus mechanism (PoS), in which DeFi staking is used for validation of transactions, can be defi staking. Participant nodes are assigned the responsibility of maintaining the public ledger in the Proof-ofStake scheme. Users are algorithmically granted the right to verify transactions. Staking is the act of locking crypto assets in order to verify transactions and receive staking rewards.
Validators are those who stake digital assets on a PoS Blockchain for a set period of time to earn passive income. PoS validateators add value to the network. They are chosen based upon the highest number of staked assets.
Total Value locked (TVL), is the sum of all crypto assets held in smart contracts within a DeFi platform. This is a measure of funds that are available to various DeFi platforms in order to lend, borrow, or transact on them. TVL was created to evaluate the DeFi ecosystem and decentralized protocols. TVLs that are higher indicate that DeFi platforms are healthy and highly in demand.
Yield farming refers to the lending and/or staking of cryptocurrency tokens within DeFi protocols for return on investment or other benefits. Yield farming is where crypto owners deposit their funds into liquidity pools in order to supply liquidity to others. Yield farmers determine their return in terms annual percentage yields (APY).
DeFi protocol codes are code or programs that can be written on the blockchain to create DApps. DApps can be used to provide peer-to–peer financial services. The DeFi protocol is an autonomous program that addresses setbacks within the traditional financial industry.
Smart contracts, which are self-executing agreements that represent the buyer-seller contract terms and conditions in code form, can be written directly to lines of code. The code and agreement operate on the blockchain and control the contract’s automatic execution once predetermined requirements are met. Smart contracts ensure that transactions, such as DeFi lending, borrowing, etc., are trackable and irreversible and happen in a trustless manner, without any intermediary’s involvement or time loss.
A derivative is an agreement that involves two or more financial parties and derives its worth from an underlying asset. This could be stocks, commodities, tokens, etc. Crypto derivative contracts don’t have direct value, instead, their value is solely based on the future price movements of the underlying token.
Slippage is the difference between the expected price of an order and the actual price when the order executes. The volatile nature of cryptocurrency means that its prices can change, moving up or downward, and slippage can either be positive or negative.
These fees cover the costs of transacting on a Blockchain network. These fees, paid in a blockchain’s native currency, are designed to compensate miners in exchange for the computational power they use to verify the transaction.
A blockchain network’s gas fees aren’t fixed. Instead, they can fluctuate depending on many factors like demand and supply, transaction throughput, etc.
A token’s contract address is the address location of the token contract or the location of a smart contract that manages the balance of all token holders.
Crypto loans are secured loans where the borrowers pledge their crypto assets. The lender will give them back the collateral they have provided as security for the loan. In return, the borrower can get liquidity. You can get crypto loans ranging from 50% to 90% of your crypto’s values. If the price of the tokens you’ve put as collateral decreases during the loan period, you might need to deposit more collateral.
Aggregators are DeFi protocols that look through multiple DeFi lending platforms and liquidity pools to bring the very best APY into one place helping users optimize their trades. By bringing trades across various DeFi platforms into one location, a DeFi aggregator saves investors’ time and increases the crypto trading efficiency. Agregators are able to automatically invest your cryptocurrency on the highest yielding protocol in order to obtain the best rates.