Explanation of 15 basic terms in DeFi
Is it hard to believe? In fact, everything is very simple. Just as technology is changing everything else in our lives, it is changing the way we make money. Now, instead of enriching bankers and CEOs, as in traditional models of centralized financing (CeFi), with DeFi we can save all these fees and fees, and still save and invest our money.
What’s even better, according to the description of the projects on Coinmarketrate.com everything in DeFi is done through the blockchain: an incorruptible ledger (registry) that stores records of every transaction made. Of course, this does not mean that DeFi is risk-free, and we will discuss this further in our articles and manuals. However, first let’s start by explaining the key principles and terms of DeFi, listed in alphabetical order, as you will constantly encounter them.
On many DeFi platforms, users place collateral in a cryptocurrency or token in order to borrow in another cryptocurrency or token: for example, Ethereum (ETH) in DAI. It’s like giving away your house as collateral for a bank loan.
As a rule, you will need to provide a larger percentage of cryptocurrency or token as collateral for a DeFi loan, for example, $100 in ETH as collateral, for example, for $70 DAI (i.e. 140% LTV – loan to loan value ratio). This helps to maintain the stability of the system.
The DAO is a decentralized autonomous organization. Simply put, this is a company in which there are no managers or people. Everything that happens in the organization is fully automated and based on computer software codes with “open source” that can be viewed and used by anyone. Since it runs on the blockchain, like DeFi, the DAO is also immutable and resistant to censorship.
DApp stands for a decentralized application, and is the basis of everything in DeFi. Like the DAO, DApp is an application that, in fact, works by itself, without administrators and intermediaries, allowing users to transfer funds among themselves.
The Ethereum blockchain is like a dApps library, in which most DeFi dApps exist. There are other blockchains, such as Tron and EOS, which also allow developers to create applications.
DEX is a decentralized exchange, and CEX is a centralized exchange, and you can buy and sell cryptocurrencies and tokens on both. Like the difference between DeFi and CeFi, DEX are autonomous and managed by algorithms and smart contracts, while a centralized exchange (CEX) is a human-controlled organization. Examples of reputable DEX are Uniswap and Kyber, and more well-known CEX are Coinbase and Binance. Centralized exchanges can mean lower costs than decentralized ones, but users cannot influence their management, as is the case with some DEX.
Ethereum is perhaps the most important blockchain after Bitcoin and the cradle of DeFi. As mentioned above, it acts as a library for most dApps in the DeFi world, and is the architecture through which everything is currently possible. Ethereum is often confused with Ether (ETH), which is its native currency, but differs from Ethereum’s own blockchain.
A gas fee is a fee that Ethereum miners receive for processing transactions on the blockchain. They are charged in their own ETH token, usually broken down into small increments called Gwei. The more transactions are made through Ethereum, the higher the gwei commission will be, which can make small transactions less profitable (we’ll talk more about this next time).
Liquidity mining, also known as profitable farming
Liquidity mining (or profitable farming) is a key feature of DeFi that allows people to deposit (or place, “delegate”) a cryptocurrency or token into DEX or DApp to receive rewards. Some platforms reward users with another token, which can then be infinitely delegated to the same, or another DEX, or DApp.
The appeal lies in the fact that each coin or token generates income (as a percentage of savings), and you can achieve higher incomes in the process of staking. It’s like depositing cash into different banks, only to get higher returns you need separate tokens from each bank before you can deposit money into the next one.
Liquidity pools are characteristic of DEX, and allow people to trade with each other without intermediaries. Smart contracts manage their work and maintain a balance between different trading pairs or pools of cryptocurrencies and tokens.
Users are often rewarded for placing their coins (or liquidity) in these pools with DEX tokens, which earn commissions for transactions made on each platform.
Non-interchangeable Tokens (NFT) are a major innovation in the token world. Unlike other Ethereum tokens, NFTs are completely unique, and are not interchangeable with other tokens. As such, they are used to buy and sell unique art and collectibles, proof of ownership, etc., with interesting test cases in more complex financial products. They are also available in two different versions: the original and individually unique token ERC 721 and ERC 1155, which is a hybrid version used in video games.
Pump y dump
The English term “pump and dump” means that buyers accumulate a cryptocurrency or token to inflate their price, and then sell everything at once, which leads to a sharp drop in price. This is a fairly common phenomenon when listing new tokens, when hype and private pre-sales cause an initial jump in price, after which it falls. Since not everyone can exit at the same time, many unsuccessful buyers suffer large losses.
We have already mentioned smart contracts several times, and this is because without them DeFi could not exist. The code written in the smart contract determines exactly how dApps and other blockchain protocols work. Unlike traditional contracts, once they are drawn up and put into effect, they cannot be changed. Errors in smart contracts can make them vulnerable to hackers, so most legal projects are now undergoing a thorough audit before launching.
The central element of DeFi is stablecoin, which is a token that is a mirror image of fiat, or traditional fiat currency.
There are two types: algorithmic stablecoins that do not need collateral (or collateral) 1:1 traditional fiat currency, and centralized stablecoins, which are such. Examples are DAI for the first and Tether(USDT) and USDC for the second.
Most transactions on DeFi account for stable cryptocurrencies, since users do not have to worry about price volatility.
Tokenomics or Token Economy
Similar to a prospectus for investors in shares of publicly traded companies, token economics or tokenomics describes the key functions and forecasts of a newly issued token. This may include how many tokens will be issued, how they will be distributed, and what powers they will have. It is very important to understand this before buying a token, especially at the pre-sale stage.
Tokens are often confused with cryptocurrencies such as Bitcoin and Ethereum. Although, in principle, they are, they are more like shares of a company on the stock exchange. Trading them can bring profit, but it’s not dollars or euros.
However, not all tokens have value. The most common are ERC-20 tokens, which work on Ethereum, and make up the bulk of DeFi. Some of them give their owners the right to vote on the management of the issuing DAO, DEX or DApp, and are also known as management tokens.
TVL – total cost blocked in escrow
TVL – Total value locked, which in the world of DeFi means the amount of money that DEX, DApp or the entire ecosystem has inside itself. It is also known simply as the total cost lock.
Although the first iterations of DeFi began in 2017, the launch year for DeFi was 2020, while the cost of TVL increased from US $662 million in January to more than US $11 billion in November – US $11 billion. LTV is often used as a measure of success in DeFi, but it doesn’t always tell the whole story.
Today, the sum of blocked funds in the DeFi ecosystem is 232.4 billion US dollars.