When Bitcoin first launched in 2009, the blockchain sector was simplistic and limited to only what the original whitepaper offered. Newcomers had the chance to learn about Proof of Work, timestamping, hashing, Merkle trees, and other various keystones of blockchain technology.
As the years passed, the market increased in its complexity. Developers introduced new features, customer demand led to innovative products, and crypto as a whole became much more than just Bitcoin.
Despite being merely a subsegment of crypto, DeFi still succeeded in mirroring the same behavior. We went from farming pools and liquidity to highly technical services like flash loans, smart contracts, coverage, and so on.
Those who took part in DeFi from the very start have, as time went on, adjusted to the metric ton of novel concepts. However, users who are only now exploring decentralized finance may find it hard to navigate around as mastering a large number of definitions and words can potentially be too much - even for crypto enthusiasts.
As a result, we intend to start our DeFi course with a lesson that introduces our dear readers to key concepts through the use of a glossary written in alphabetical order. We suggest keeping this tab open while researching DeFi since we do not recommend memorizing all of the words and nor do we expect you to complete the lesson in one go.
For now, it is enough to gain a sense of what the terminology stands for in order to, later on, get a grasp on decentralized finance as a whole.
Refers to a project's code being reviewed for soundness by a party outside of the organization. Typically, a DeFi protocol project will have a professional third party evaluate the code for feedback on weak points, allowing them to implement patches (if necessary) before going public.
Short for Annual Percentage Yield, APY is one of the most important concepts in DeFi. It refers to the return on investment you can expect from an asset in a one-year period. APY rates tend to fluctuate wildly in DeFi, therefore, they are best used as approximate measures.
Decentralized aggregators like Balancer, 1inch Exchange, and Yearn Finance search for the best swap rates when buying tokens as well as the highest yields when farming.
Anti-Money Laundering (AML) regulations are aimed at preventing criminal enterprise within the cryptocurrency landscape. In practice, AML regulations are what require crypto exchanges to gather your identity documents for verification measures.
Automated Market Maker is a pool of cryptocurrencies offering liquidity between trading pairs to buyers and sellers. In practice, an AMM works a lot like a centralized exchange's order book, except they aren't maintained by a central authority and depend on participants to provide liquidity (see: Liquidity Providers).
All-Time High is the highest price a cryptocurrency asset, portfolio, or value has reached against another asset. ATHs can occur against BTC, ETH, and fiat pairs but tend to be recognized against USDT pairs on major exchanges like Coinbase and Binance.
Aave tokens that represent the deposited or underlying asset. For instance, depositing LINK into Aave mints aLINK.
Bonding curves are equations used to create a smooth cause and effect relationship between a cryptocurrency's price and circulating supply. Bonding curves are most often employed in the DeFi space during token launch and distribution — the more users buy the token, the higher the price goes for everyone. However, the opposite is also true.
Centralized finance, commonly used as a reference to projects like Celsius, Nexo, and BlockFi that operate like normal centralized organizations within the DeFi space.
Refers to traditional finance or centralized finance institutions like banks and other legacy institutions. Sometimes used as a derogatory term on Crypto Twitter.
Short for centralized exchange. CEXs include Coinbase, Binance, Huobi, Gemini, and Kraken.
Short for decentralized exchange. DEXs include Uniswap, Curve, SushiSwap, 1inch Exchange, Synthetix, and Balancer.
Assets that are deposited and used to back a loan. Depositing collateral on crypto lending platforms like Compound and Aave is typically done to stake and receive APY while simultaneously borrowing more crypto.
DeFi products, protocols, and blockchains that function as close to seamless as possible with other products and protocols have high composability. The quality of being composable means a DeFi product or protocol integrates easily with others and is, therefore, more useful and efficient.
When you deposit an interest-generating asset in a DeFi platform, protocol, or exchange, rewards are sometimes reinvested into your original stake. This, in turn, increases (or compounds) your yield. Therefore, compound interest allows you to see greater and greater gains by simple reinvestment.
Decentralized exchanges like Uniswap are managed by liquidity providers rather than centralized hosts (order books). This allows anyone to create and deposit tokens to make them available for trading. In turn, scammers often create imitation tokens that resemble more popular assets. To verify that you are trading a real token (and not a fake), always enter the contract address in etherscan.io to verify the token's legitimacy.
A loose term for the crypto community present on Twitter that is made up of developers, influencers, investors, and traders.
Refers to Compound tokens. Depositing tokens into the Compound Finance app mints their Compound equivalent (e.g., USDT —> cUSDT).
Decentralized Autonomous Organizations are created by and adhere to a set of smart contract encoded rules that are fair and transparent. The purpose of a DAO is to govern a distributed network effectively without relying on a central chain of command.
Financial products deriving their value from an underlying asset are known as derivatives. Popular derivatives within cryptocurrency trading include Bitcoin perpetuals and Ethereum futures. However, DeFi has created novel derivatives on protocols like Compound, Synthetix, and Aave, such as cUSDT, sUSD, and aBTC.
Ethereum-standard cryptocurrency assets are built and issued using the ERC-20 protocol. Any cryptocurrency token issued on Ethereum is an ERC-20 by design.
A DeFi project launched without VC, angel, or a third-party investment of any kind. In a fair launch, all tokens are sold to the community and none are held back for a team or founder allocation. Recently, fair launches have come under fire for not providing enough team incentives, forcing popular fair launch projects like Yearn Finance to mint more tokens.
A flash loan is an instant cryptocurrency loan that doesn't require collateral, KYC checks, or any other form of upfront investment from the borrower. However, what it does require is that the loan is repaid within the same transaction block as the loan itself. In practice, this means the loaned funds can only be used on-chain to trigger smart contract actions. If a flash loan isn't repaid in the time it takes for the initial transaction block to confirm, the transaction is rejected and the issuer retains the funds.
An emerging field in the mathematics world is dedicated to the study of game theory, or the way competitors interact and create outcomes using strategies. In DeFi, game theory is especially relevant as market participants each try to capture value to their benefit.
Ethereum gas fees are the transaction fees paid to network miners who validate and confirm transactions in the background. Gas fees accompany every transaction interacting with smart contracts, such as when depositing, withdrawing, or transferring assets between decentralized exchanges, wallets, and DeFi pools. Ethereum gas fees are paid in ETH and become expensive during periods of high network congestion. For this reason, your wallet always needs to contain a bit of ETH for paying gas fees.
Governance refers to the maintenance, enforcement, and regulation of a decentralized protocol by token holders. Usually, when a DeFi protocol is released, it does so with a native asset such as COMP (for Compound Finance), AAVE (for Aave), and UNI (for Uniswap). Anyone who holds the protocol's native token can participate in governance decision-making and propose governance measures themselves.
The currency unit used to denominate Ethereum gas fees. Gwei, or gas, is paid in Ether (ETH).
When providing liquidity to DeFi AMMs, impermanent loss refers to the loss of your deposited assets during price swings. Since AMMs like Uniswap don't use order books, prices are maintained by the ratios between assets inside liquidity pools. Therefore, if you deposit two assets and the price of one or both changes, you might withdraw less of your assets than deposited. However, trading fees garnered from the LP often more than make up for impermanent losses.
Know Your Customer (KYC) is a basic verification check required by centralized finance exchanges, CeFi platforms (such as Celsius), and others. DeFi platforms typically reject KYC measures as they are decentralized protocols.
The amount of circulating supply for a given token paired with trading volume, exchange availability, and other trade factors determine how liquid or illiquid a token is. In practice, the more liquid a token is, the more it can absorb large volume price action.
Liquidity mining refers to depositing tokens into a DeFi protocol to provide liquidity while being rewarded for the deposit stake. Rewards are usually paid out in the protocol's native asset. However, some LM events are paid in kind.
Decentralized exchanges depend on liquidity pools to provide liquidity between assets and make trades possible. In centralized exchanges, order books handle this task. However, a DEX replaces the order book by effectively crowdsourcing liquidity. To incentivize liquidity providers, DEXs and AMMs provide rewards (shares of LP transaction fees or native token APY).
DeFi participants who deposit their tokens into liquidity pools such as those on Uniswap and Curve Finance are known as liquidity providers.
When a liquidity provider deposits tokens into a liquidity pool, their stake is represented by a minted LP token. The LP token represents the staked asset(s) and can yield farm other DeFi platforms or exchange back for the original assets.
Metamask is an ERC-20 Ethereum-based cryptocurrency wallet required for interacting with most DeFi platforms.
Decentralized oracles provide both on and off-chain price data to blockchains / DeFi protocols.
Return on investment is a way to calculate your profits or losses from an investment in a DeFi platform.
Slippage refers to the gap in price that exists between what you're willing to pay for an asset and the seller's best price. Slippage typically ranges anywhere between 0.5%-2%, but in extreme cases can go as high as 3% or more for particularly illiquid tokens.
A blockchain-based, lightweight, programmable structure of code that executes functions as determined by the author. In practice, smart contracts run like autonomous programs that replace intermediaries and guarantee outcomes.
Tokens with value backed by underlying assets or pegged to the value of another asset. Dollar-pegged stablecoins such as USDT, USDC, and GUSD are endowed 1:1 with real dollar reserves, while other stablecoins use rebasing to arrive at a stable valuation.
Depositing cryptocurrency assets in a DeFi protocol to generate a yield (measured in APY) is known as staking.
Synthetics are blockchain-based derivative trading products representative of other assets. Synthetics, or synths, are often backed directly by the underlying asset, but this is not always necessary. Some synths are built by a basket of assets made to resemble and track the original asset. As an example, think of trading a plastic banana in place of a real banana.
Short for token economics, tokenomics refers to token design and includes factors such as circulating/max token supply, token emission rates, and vesting schedules.
Total value locked (TVL) refers to the total amount of value deposited (or staked) in a given DeFi platform. Higher TVL means greater liquidity and confidence in a DeFi exchange. Examples of high TVL DeFi protocols include Uniswap, Curve Finance, Aave, and Compound Finance.
Financial derivatives such as perpetuals, synthetics, and LP tokens (aLINK, wBTC, cUSDT) all derive their value from underlying assets (the original assets they track or represent).
Yield is the amount earned by depositing, or staking, an asset in a DeFi platform such as Yearn Finance, Compound, Aave, Curve Finance, or Synthetix.
Yield farming is the act of depositing, or staking, tokens, across DeFi platforms offering rewards for liquidity providers. Farming your tokens enables you to generate additional value from your assets by having them work for you.