DeFi is redefining the standards of what we anticipate from finance, and for beginners, grasping the entire lexicon of DeFi terms may be rather difficult. To make it easier, we have simplified them down into simple terms.
What is DeFi?
DeFi is a developing industry that enables participants to conduct financial transactions without using a middleman.
Decentralized finance is a subset of the crypto sector that focuses on turning standard financial instruments into decentralized products and services.
Regulations, constraints, intermediaries, KYC requirements, and other policies that are common in the banking industry are not applicable to DeFi Users.
The core tenet of DeFi is that any end user, regardless of location or educational background, can access advanced investment tools.
DeFi presents users with a wide range of innovative opportunities, but it is also rife with novel terms that may be unfamiliar to those entering the field. In this article, we have prepared this DeFi glossary to help you grasp the industry, and take your first steps into the new possibilities it offers.
DeFi glossary: Most popular terms you should know in DeFi
An audit is a thorough internal or external examination of a theory, system, procedure, business, or product. The structure, vulnerabilities, and strengths of the entity or process being inspected are all carefully and in-depth examined in a comprehensive audit. A DeFi protocol project will typically have a qualified outsider assess the code to find any flaws and provide feedback, allowing them to incorporate modifications (if necessary) before going public.
Abbreviation for Annual Percent Yield. It speaks about the return on investment you may anticipate from a given asset over the course of a year. Since APY rates in DeFi can fluctuate greatly, it is better to use them as approximations. The Return On Investment (ROI) on an asset is measured using the annual percentage yield, which is time-based.
Arbitrage happens when a security is purchased in one market and simultaneously sold for a greater price in another market.
Automated yield farming in DeFi employs algorithmic arbitrage techniques to boost investment returns. One or more digital assets may be purchased, sold, lent to, or provided with liquidity using these arbitrage tactics, frequently all on the same day.
Aggregators are DeFi protocols that automatically invest your coins in the protocol with the greatest yield after searching for the best APY across a number of sites.
Anti-money laundering (AML) refers to the network of laws, rules, and protocols designed to expose attempts to pass off illicit cash as legitimate earnings. Anti-Money Laundering (AML) laws are designed to stop criminal activity in the bitcoin industry. In reality, it is AML regulations that mandate that crypto exchanges collect your identity documents for security checks.
An automated market maker is a group of cryptocurrencies that provides buyers and sellers with access to liquidity between trading pairs. AMMs (automated market makers) use liquidity pools in place of a traditional market of buyers and sellers to enable the automatic and unrestricted trading of digital assets. An AMM functions practically very similarly to a centralized exchange’s order book, with the exception that members are responsible for maintaining liquidity rather than a central authority.
The All-Time High is the highest price a crypto asset, portfolio, or value has ever been against another asset.
A market is said to be in a bear market when prices continue to drop over time. Typically, it refers to a scenario in which widespread pessimism and unfavorable investor sentiment cause securities values to decline by 20% or more from recent highs.
Bonding curves are mathematical formulas that provide a smooth cause-and-effect connection between the price and available supply of a cryptocurrency. When a token is launched and distributed in the DeFi space, bonding curves are frequently used. As more people purchase a token, its price increases for everyone. But the inverse is also accurate.
A financial market is said to be in a bull market when prices are rising or are anticipated to rise. a time frame in which investors are generally optimistic about a particular asset or class of assets.
CeFi is represented by centralized cryptocurrency exchanges, companies, or groups that have a physical location and typically have a corporate structure. These CeFi companies must abide by all applicable laws, rules, and regulations in each country, state, or region where they operate.
A CEX is a central exchange that has a physical location, a corporate structure, and is governed by the laws, ethical standards, and rules of the countries in which it conducts business.
a type of digital currency primarily used for transfers of value or asset storage. Encryption algorithms protect coins. This coin or token may stand for a portion of the ownership and/or control of a coin, token, protocol, business, or project, together with all potential advantages that may result from such a position.
A distributed exchange is a DEX. A DEX is a particular kind of cryptocurrency exchange in DeFi that enables secure online peer-to-peer cryptocurrency transactions without the need for a middleman.
Collateral is the term used in DeFi to describe the offering of one cryptocurrency or token as “collateral” to guarantee the borrowing of another cryptocurrency or token. They are deposited assets that are used to support loans.
It evaluates how well a DeFi or crypto product may be utilized as a building block (or “money lego”) to create additional goods or domains. A DeFi product or protocol that is composable interacts well with other systems and is therefore more practical and effective.
It may be compared to a savings account where you could collect interest without entrusting your money to a third party. It enables lenders to grant loans to borrowers in exchange for access to their Compound protocol-locked cryptocurrency holdings.
Refers to Compound tokens. The main way to engage with the Compound Protocol is through cTokens; whenever a user mints, redeems, borrows, pays back, liquidates, or transfers cTokens, user does so using the cToken contract.
A DAO is a blockchain-governed, collectively-owned company with a shared objective. Decentralized Autonomous Organizations are established by and abide by a set of fair and open rules that are written in smart contracts. A DAO’s main objective is to efficiently manage a distributed network without relying on a centralized command structure.
dApp (decentralized application)
Similar to DAO, decentralized applications (dApps) are computer programs that carry out specified activities and aren’t under the control of one person.
A security with a price that is based on or derived from one or more underlying assets is referred to as a derivative. Changes in the underlying asset’s value affect its value.
Ethereum Request for Comment 20 (ERC-20) is the established standard for fungible tokens issued on the Ethereum blockchain. By design, any cryptocurrency token released on Ethereum is an ERC-20.
It is a DeFi initiative that wasn’t funded by angel, VC, or any other type of outside financing. All tokens are offered to the public during a fair launch; none are kept back for team or founder allocations.
A flash loan is an immediate cryptocurrency loan that doesn’t require the borrower to make any upfront investments, KYC checks, or collateral. It does, however, demand that the loan is paid back within the same transaction block as the original loan. In actuality, this limits the use of the borrowed money to on-chain smart contract actions. The transaction is denied and the issuer keeps the money if a flash loan isn’t paid back within the time it takes for the first transaction block to confirm.
Fear Of Missing Out (FOMO) is the impression that everyone else is becoming rich, benefiting, or having a good time without you. When it comes to investing, it’s the perception that your present portfolio isn’t performing well enough in comparison to newer, “shinier” investment options and choices.
Gas (Ethereum Gas Fees)
Transaction fees paid to network miners, who validate and confirm transactions in the background, are known as Ethereum gas fees. Every interaction with a smart contract involves gas fees, including deposits, withdrawals, and transfers of assets across wallets, DeFi pools, and decentralized exchanges.
Governance & Governance Tokens
The term “governance” describes how token holders uphold, enforce, and control a decentralized system. Anyone who owns the protocol’s native token is eligible to vote on governance issues and suggest new regulations.
The unit of currency used to represent Ethereum gas charges. Gas is paid for in Gwei, or ether (ETH).
The term “HODL” originated as a typographical error for the word “hold” and quickly caught on among early adopters of Bitcoin and Ethereum as an inside joke. HODLing refers to the decision to endure volatility and hang onto one’s cryptocurrency investments during bull and bear markets. A HODLer is someone who hoards.
The term impermanent loss refers to the loss of deposited assets during price fluctuations.
Know Your Customer is the acronym for this term. It is the practice of organizations verifying the identity of their clients in order to comply with legal requirements and current laws and regulations such as AML, GDPR, and eIDAS. Centralized finance exchanges, CeFi platforms (like Celsius), and others all require the Know Your Customer (KYC) basic verification check. Due to the decentralized nature of KYC methods, DeFi platforms often reject them.
Leverage in CeFi refers to borrowing money or utilizing multipliers, like margin functions, to boost trading profits. In DeFi, it more explicitly relates to the usage of multipliers on exchanges. Leveraged trades can dramatically multiply gains, but they can also amplify losses on losing transactions by the same amount or more.
A token’s liquidity is determined by its circulating supply, trading activity, accessibility to exchanges, and other market considerations. In reality, a token’s ability to withstand sharp price fluctuations increases with its level of liquidity.
Depositing tokens into a DeFi network to provide liquidity while receiving payment for the deposit stake is known as liquidity mining. Typically, rewards are given in the protocol’s native asset. Some LM events, nevertheless, do receive payment in kind.
A Liquidity Pool (LP) is a collection of depository funds with the purpose of supplying liquidity to a network, smart contract, or currency. Those that offer liquidity to LPs typically receive planned incentives or rewards. Liquidity pools are necessary for decentralized exchanges to provide liquidity between assets and enable trades.
Liquidity providers are DeFi players who deposit their tokens into liquidity pools like those on Uniswap and Curve Finance.
A minted LP token serves as the representation of a liquidity provider’s investment when they deposit tokens into a liquidity pool. The staked asset(s) are represented by the LP token, which can yield farm on other DeFi platforms or be exchanged for the original assets.
Metamask is an ERC-20 Ethereum-based cryptocurrency wallet that is necessary to interface with the majority of DeFi services.
Market Capitalization. The total amount of money invested in a company or project. The market capitalization of a coin, business, or project can be determined by dividing the asset’s unit cost by the total coins in circulation.
The process of forcing liquidation or having a liquidity event when a trader or investor is unable to pay debt commitments on leveraged trade positions. Rapidly shifting market conditions and excessive volatility, which cause Liquidation Events for some leveraged traders on exchanges and markets, might result in margin calls.
a group of cryptocurrency miners that offers mining services to a network of digital currencies. A coin or token’s programmed mining incentives are an incentive for mining pool operators and contributors to enable transactions and offer liquidity on a currency’s network.
It is a reliable source of data, such as current market pricing for an asset or assets, that gives users confidence that the information is up-to-date, accurate, and unaltered. Oracles give blockchains and DeFi protocols access to both on-chain and off-chain price data.
Pump and Dump
The term “pump and dump” refers to customers rushing into a cryptocurrency or token to inflate its price and then selling it all at once, causing the price to plummet. Pump and dump schemes are frequently forbidden in CeFi.
a set of created guidelines or requirements that describe the specs, features, limits, and potential restrictions of a high-tech project or product. Technology protocols like TCP/IP and ERC-20 are well-known.
Return on investment(ROI) is a method of calculating your earnings or losses from a DeFi platform investment.
Slippage is the difference in price between your willingness to pay and the seller’s best price for an asset. Slippage may cause the asset’s ultimate sale price to be more or lower than the specified transaction amount.
It is a programmable, lightweight, blockchain-based structure of code that performs author-specified functions. Simply put, smart contracts are blockchain-based algorithms that execute when certain criteria are met. Smart contracts replace middlemen and ensure results in real life by functioning like independent programs.
Stablecoins are digital currencies whose value is based on the price of a reliable asset. Although they can be anchored to other assets such as gold or a basket of cryptocurrencies, stablecoins are most frequently tied to the US dollar. While other stablecoins use rebasing to achieve a stable valuation, dollar-pegged stablecoins like USDT, USDC, and GUSD are endowed 1:1 with real dollar reserves.
the act of adding a cryptocurrency coin or token to a yield farming project or protocol, regardless of how one accesses the project (via CeFi or DeFi). Staking is the process of adding cryptocurrency assets to a DeFi protocol in order to provide a yield (expressed in APY).
Synthetics are derivative trading products for the blockchain that serves as a proxy for other assets. Although it is not always essential, synthetics, also known as synths, are frequently backed directly by the underlying asset. Some synths are composed of a collection of elements that are designed to look like and track the original asset.
A network used for testing new coins, projects, or products as well as prospective upgrades to already-existing ones. Newcomers can “practice” things like trading and staking on a testnet.
Similar to a coin, but with significantly more functionality. Like coins, tokens can also be used as a form of payment, but unlike coins, they are better suited to other use cases, such as the democratic management of a protocol or system, or the creation of liquidity tokens using underlying coins from coin deposits.
Tokenomics, short for token economics, is a term used to describe the design of a token and includes elements like the maximum/circulating token supply, the token emission rates, and vesting schedules.
The total amount of value deposited (or staked) in a specific DeFi platform is known as total value locked (TVL). A DeFi exchange will have more liquidity and confidence if its TVL is higher. The Total Value Locked (TVL), also known as Total Locked Value (TLV), is a dollar amount that represents all investor deposits made in coins or tokens that have been locked into a platform, protocol, lending program, yield farming program, or insurance liquidity pool.
The financial assets on which a derivative’s pricing is based are known as underlying assets. Perpetual, synthetic, and LP tokens (aLINK, wBTC, cUSDT) are financial derivatives whose value is derived from underlying assets (the original assets they track or represent).
A wallet is a type of non-custodial storage for cryptocurrency holdings. They are non-custodial, so only those who have the private key or seed phrase, which functions as a password, can access your money. A cryptocurrency wallet is a software application or hardware device that can store several coins.
A person who HODLs a large amount of cryptocurrency or cryptocurrencies.
The return on an asset staked in a DeFi platform like Yearn Finance, Compound, Aave, Curve Finance, or Synthetix is referred to as yield.
Yield farming is the practice of staking or depositing tokens across DeFi platforms that pay liquidity providers. By making your assets work for you, farming your tokens enables you to extract more value from your holdings.