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DeFi and its vocabulary

The DeFi world is so rich and varied that a whole new vocabulary of terms, expressions and concepts has emerged over time.

Anyone approaching this world for the first time encounters a barrage of information which often takes for granted the knowledge of this ‘Slang’.

Today we would like to lay down a reference guide for a quick understanding of the most commonly used terms in DeFi.

DeFi vocabulary from A to Z

AMM (Automated Market Maker)

The innovative concept of Automated Market Makers has breathed new life into the DeFi industry and, in particular, decentralized exchanges (DEX). 

The problem that has long plagued DEXs is the lack of orders in the order book. 

AMMs solve this problem brilliantly by allowing users to trade cryptocurrencies transparently, using Liquidity Pools provided by other users, who will receive fees for the service. In other words, the old order-book of traditional exchanges is replaced by a smart-contract, which cleverly uses the liquidity pools to calculate the exchange value of the pair autonomously.

APY (Annual Percentage Yield)

The percentage of annual interest received on an investment.

CDP (Collateralized Debt Position)

A CDP is a position created by locking a cryptocurrency on a smart-contract against a loan in a stable-coin. A borrower locks a cryptocurrency in their possession on a smart-contract as collateral for the loan. The counterparty, who lends liquidity in exchange for interest, will have a 100% guarantee of repayment thanks to the collateralization and the smart-contract.

DAICO (Decentralized Autonomous Initial Coin Offerings)

DAICOs represent the combination of ICOs with DAOs. This is an approach based on an idea by Vitalik Buterin proposed in 2018, which improves on the concept of ICOs by managing via smart-contract the funds raised through the DAO. Liquidity is locked on a smart-contract. Investors through voting (DAO), will unlock the funds from time to time, during the various stages of project development. This has the enormous advantage of preventing SCAM and Vaporware, while maintaining a high degree of decentralization.

DAO (Decentralized Autonomous Organization)

They represent a new approach to the management of decentralized crypto projects. All token holders of a project, managed via DAO, can propose improvements to the project and vote for the proposals of other users, thus becoming to all intents and purposes pro-active contributors to the project.

DeFi (Decentralized Finance)

Decentralized finance is a new branch of application for cryptocurrencies, which replaces most traditional financial services, typically plagued by the presence of one or more intermediaries, who impose fees at each stage. 

With DeFi, through the clever use of Smart-Contracts and the Blockchain, intermediaries and most of the costs associated with them are completely eliminated. A typical example of application are collateralized loans

DEX (Decentralized Exchange)

They are the decentralized answer to CEXs (centralized exchanges). DEXs manage transactions through smart-contracts; hence without intermediaries and without any requirement for registration and verification policies such as AML (Anti-Money Laundering) and KYC (Know Your Customer).

FEE (Commission)

A fee that the user of a service has to pay for using the service.

ICO (Initial Coin Offering)

Initial Coin Offerings (ICOs), which were very popular in 2016 and 2017, are no longer used. They allowed the creators of crypto projects to raise the necessary funds for the development of the project by selling part of the tokens representing the project.

IEO (Initial Exchange Offering)

Initial exchange offerings have replaced ICOs. The creators of a crypto project submit their whitepaper to a centralized exchange (CEX) for evaluation, and if the evaluation team finds it valid, the coin will be included among those that can be traded on the exchange. 

This new approach, compared to ICOs, has several advantages for all actors involved: project creators do not have to invest in marketing, as they already receive a huge audience of interested users, investors are protected from SCAMs and bad projects, and exchanges earn on the trading fees of listed tokens.

Impermanent Loss

The so-called impermanent loss is a typical feature of the process of recalculating the exchange prices of pairs in liquidity pools

It represents the temporary loss of part of the funds of the liquidity providers, due to moments of high volatility of one of the tokens of the pair. When the price of one of the two tokens moves rapidly, a price difference is created between the spot market and the liquidity pool; this opens up large arbitrage opportunities. This results in the final value of the pair held in the liquidity pool being lower than if the 2 tokens had simply been held.

Liquidity Pools

Liquidity pools are used in DeFi mainly to make trading on DEXs more efficient. 

Users who have cryptocurrencies and wish to generate income from their savings, lock their holdings, usually in pairs, into smart contracts, which provide the liquidity needed for transactions between users via decentralized exchanges. In return for this service, those who trade pay a fee, which is distributed proportionally to all liquidity providers.

NFT (Non Fungible Token)

These are tokens on the blockchain which have the characteristic of being unique. Their field of application is growing rapidly, ranging from collectables to virtual objects in the gaming world.

Oracles

One of the main limitations of the Blockchain is the possibility to interact only with information within it. 

The solution to the need for the blockchain to communicate with the outside world is solved by so-called oracles

They are in charge of retrieving, validating and providing smart-contracts with the information they need, which resides outside the blockchain, on which the smart-contract is implemented.

SCAM

In the crypto world, this is the classic definition of a fraud, which finds its most lucrative application in so-called exit-scams. This is the common practice of running away with the money after a substantial fundraising.

Shilling

The enthusiastic promotion of a coin/token and/or its fundraising (ICO, IEO, etc.).

Smart Contract

These are protocols, generally applied to the blockchain, which allow, free of intermediaries, the execution of a contract when certain predefined conditions are met.

Solidity

A programming language used for smart-contract development on certain blockchains, the most famous of which is Ethereum.

Stablecoin

A token which, through various mechanisms, ensures that its value is always almost equal to that of another currency or asset on the traditional market.

STO (Security Token Offering)

The offering of security tokens differs from the ICO, mainly in what represents the token issued and the resulting legal and regulatory implications. 

To simplify, a security token can be thought of as a share in a company that will give real rights to the company, such as profit sharing, voting on the board of directors or other.

Tokenomics (Economy of the token)

A fundamental aspect, usually dealt with in whitepapers, which describes the economics of tokens. How many will be issued in total, how many and when they will be sold in the various stages of fundraising and how it will be sustainable over time.

Whitepaper

This is a document written by the creators of a project, detailing the technical information and road-map of the project. It is usually used to present the idea to potential investors.

Yield Farming

This is the practice of investing one’s cryptocurrencies in DeFi in order to earn interest (crypto lending, liquidity pools, etc.). This process often involves earning, besides interest, a governance token of the protocol used. This process means that profits are maximised, as the token received can usually be traded on the market generating a higher annual interest (APY).

 

Giorgio Sanfilippo
Giorgio Sanfilippo
At the age of 8 and at the time of the Commodore 64, Giorgio fell in love with programming when for the first time, he manages to fix a bug in a game that didn't want to start. Graduated in Computer Science at the University of Pisa, today he works as a freelance Full Stack Developer. Blockchain technology expert and of course Bitcoin enthusiast.
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