Top 10 DeFi-nitions

1. DEX

The acronym DEX stands for ‘decentralized exchange’. When the first exchanges for trading tokens were launched, you had to send your crypto to a wallet that someone else controlled and simply hope that the code was bug-free and the exchange admins were honest.

2. Automated market maker

Automated market makers are the protocols that allow DEXs to exist. Centralized exchanges use matching engines to match buy and sell orders and execute them at the best price, while market makers (either companies or individuals) add liquidity to the market by quoting both a buy and a sell price.

3. Liquidity pools

A liquidity pool is a collection of assets locked in a smart contract. Pairs of assets are matched in a liquidity pool and the Automated Market Maker determines how they are priced against each other.

4. Liquidity mining

Adding your tokens to a liquidity pool carries a certain amount of risk. Even though the risk of hacking or fraud is mitigated by the AMM code being open source, so anyone can scrutinise it, there have still been instances of DEXs being hacked. Additionally, while your tokens are in a liquidity pool, you are foregoing the chance of making money on them elsewhere — for example, by trading or using them as collateral. For this reason, liquidity providers are rewarded with a share of the fees generated by trading.

5. Collateralized loan

The anonymous (or at least, pseudonymous) nature of DeFi means that no one will lend money to you… unless they can access some kind of collateral in case you default on the loan. The constantly shifting exchange rate between Ether, the US dollar and various other cryptocurrencies provides attractive opportunities to make money — and most loans within DeFi are used within the DeFi system to do exactly this.

6. Synthetic assets

Synthetic tokens in crypto have the same function as derivatives in TradFi: they allow traders to benefit from price movements of a particular asset without actually having to own it.

7. TVL

TVL stands for Total Value Locked. Most DeFi protocols involve asset owners committing their tokens to a smart contract, which is known as ‘locking’.

8. Yield farming

As we have seen, there are different ways to make money from your crypt assets in DeFi — whether this is committing assets to be lent out to borrowers, staking, depositing in liquidity pools or even staking the liquidity pool tokens you have received.

9. APY and APR

APY stands for Annual Percentage Rate and refers to the percentage reward you can make by locking up your tokens in different DeFi pools or protocols. In reality, this notion can be slightly misleading, as the highest APRs (often multiples of 100%) rarely last for very long, let alone a full year.

10. Impermanent Loss

If you are depositing liquidity in a pool, it is also important to understand the concept of impermanent loss, which can entirely wipe out even a high APY and can mean you end up with less dollar value than you started with.

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Rhian Lewis

Rhian Lewis

Technologist, #Ruby, #blockchain & #cryptocurrency. Co-developer #altcoin portfolio tracker CountMyCrypto. Author of The Cryptocurrency Revolution