If you are new to the cryptocurrency world or are not familiar with all that is behind it, you have certainly heard of centralised finance tools, including exchanges such as Coinbase, Binance and KuCoin, to name a few. However, what is now capturing the interest of millions of investors is undoubtedly decentralised finance, more commonly referred to as DeFi.
While centralised finance already contains terminology that is a bit complicated for those new to the industry, such as exchange, exchange, volume, pump, dump, scalping, drop, short-term, long-term, futures, margin and so on, DeFi's terms are "slightly" more technical and difficult, especially for those unfamiliar with these instruments and the logic behind the blockchain.
But don't worry, this guide to DeFi terminology is designed for all those who want to delve into this profitable and risky, yet interesting and innovative, sector. Let's see them together!
DeFi. Introduction and basic terms
Although we have already published a detailed guide to decentralised finance, it is appropriate to make a small introduction to DeFi and its basic terms, so as to also provide some clarity before moving on to the more technical ones.
DeFi refers to all those financial services that run on blockchain and that, unlike centralised instruments, in which there are major entities such as companies or private companies, operate without any intermediary. This is possible thanks to the use of smart-contracts, which are real smart contracts that stipulate the acceptance of certain conditions in a completely automatic way, recording all data on the network.
So, when you enter any DeFi protocol, be it Uniswap, PancakeSwap, SushiSwap or any other of your preference, you should remember that there will be no one else but yourself. Precisely for this reason, many users do not use DeFi due to a lack of technical skills, or simply because they do not want to learn by themselves how to use these tools, which, although they may seem complicated, are really efficient.
In particular, on DeFi's platforms, called protocols, it is possible to access different options for lending funds, deposits with fixed or flexible interest, and many other ''passive'' earning solutions with much higher remunerations than a bank. In fact, if the solutions of centralised finance are already remunerative, those of decentralised finance are in most cases even higher.
Once you enter any DeFi protocol, the terms you will notice most often are:
AMM (Automated Market Maker)
While before the existence of automated market makers there were major difficulties in managing the order books of decentralised exchanges, which often experienced a great shortage of orders, the invention of AMMs has undoubtedly revolutionised the industry. The invention of AMMs has undoubtedly revolutionized the industry. Thanks to AMMs, DeFi has almost been reborn, allowing investors to trade their assets through liquidity pools.
The problem was that there was often not enough liquidity in the market to cover the order. Now, however, some investors provide liquidity (earning commissions as we will see later on), and the others can close their orders as there is enough liquidity to do so. in this sense, the AMM manages all the processes behind this logic in a fully automated way, calculating the counter value in real-time.
APY o APR
Both APY and APR refer to the interest rate on one's investment. However, the main difference is that APY also takes capitalisation into account, whereas APR does not. Thus, the APY works as a compound interest, which yields more on average than the APR.
ICO e IDO
ICOs are generally referred to as Initial Coin Offerings, i.e. the initial price of a coin at the time of its launch. This, however, is mainly used for centralised exchanges, which launch their own IEOs (Initial Exchange Offering). In DeFi, however, we speak of IDO, or Initial Dex Offering, which represents the initial price of a token that is launched on the decentralised market. The DEX, in fact, is none other than the Decentralised Exchange.
One of the best known protocols for IDOs is certainly Polkastarter.
Fee
Fees are nothing more than the commissions you have to pay when you make an exchange, a purchase, a sale, or accept any service via smart-contract. If you are on the Ethereum network, you will hear about Gas Limit and Gas Price. The Limit is the maximum amount of Gas (fees) you are willing to pay for a transaction, while the Price is the maximum price of a unit of Gas, measured in Gwei (satoshi equivalent for Bitcoin).
Impermanent Loss e Liquidity Pool
As mentioned above, Liquidity Pools offer the ability to lock in liquidity in order to provide it to the exchange and facilitate liquidity. Those who block their assets in the pools select an exchange pair (e.g. ETH/USDT) and each time investors trade on that pair, the person who offered the liquidity will receive a commission based on the amount of money deposited.
Although it sounds very simple and profitable, the Liquidity Pool service can, in the worst-case scenario, lead to an Impermanent Loss. This happens at times when the price of one of the two assets is very volatile. In such cases, the current value of your tokens will be less than it would have been if you had simply held them (Hold: holding tokens without making any transactions).
Rug Pull
Since we are already familiar with IDOs, it is appropriate to illustrate the incidents of Scam and Rug Pull as well. Scam, a term also used in other areas, is nothing more than a scam. Rug Pull, on the other hand, is specific to the DeFi sector. Rug Pull refers to episodes where, after an IDO, often followed by a sharp rise in the initial price, the developers themselves sell all their tokens (which in most cases represent a huge proportion of the total number of tokens in circulation) causing the price to plummet and, consequently, investors to lose large amounts of capital.
Below is an example chart of a Rug Pull. Be careful not to confuse this with Panic Sells, which are mass sales due to a small, sudden drop in the token price, often due to liquidation by one or more whales. In fact, a panic sell can often undermine the long-term performance of a currency.
Tokenomics e Whitepaper
Tokenomics and Whitepaper are two very important aspects that should always be observed before investing in any DeFi protocol. Tokenomics is how the tokens will be managed, i.e. the total distribution, the number of coins in circulation, how much commission is paid for each transaction, and everything else that represents their use.
Tokenomics can always be found in the Whitepaper, the official document that explains a project in full. Usually, DeFi is famous for making project Whitepapers public, offering maximum transparency to investors.
New Metrics
Like everything else, DeFi evolves very quickly, and new terms are coined all the time that can sometimes make things more complicated. In addition to social jargon terms like FOMO and FUD (Fear Of Missing Out/Fear, Uncertainty, Doubt), new terms have been coined that go hand in hand with the release of new updates and features.
DAO
DAO stands for Decentralised Autonomous Organization, and represents a decentralised organisation that runs on the blockchain, and therefore does not need any central body. The decisions and the future of the DAO are based on governance models, i.e. choices made by the entire community through voting or consensus through the nodes of the network.
Inflation rate
The inflation rate determines the percentage of inflation of a given token. Every token, regardless of whether it is circulating in the DeFi market or not, has a total circulating supply, i.e. a total amount of tokens in circulation. However, new ones are often created. If we look at bitcoin, for example, its inflation rate is only 1.76%, because only 1.76% more tokens are created per year and demand is very high.
If, in fact, demand were to be lower than the number of new coins being created, the inflation rate could go way up, and thus cause the value of the asset to drop dramatically. Before investing in a protocol, therefore, it is advisable to assess this aspect as well. However, there is always the exception: Ethereum, for example, does not have a Max Supply (maximum tokens created), but demand remains high anyway, so the price does not fall.
NFT (Non-fungible-token)
NFTs are all the rage at the moment and you've certainly heard of them. They are ''digital works of art'' such as images, social media posts, or any other non-fungible, i.e. one-of-a-kind, object that is created through cryptography on a blockchain network. Their characteristic is that they are unique pieces, exchangeable through dedicated marketplaces that work with a system of auctions and bids.
Oracle
Since the blockchain can only communicate within it, when information needs to be retrieved from outside, oracles are used, allowing smart-contracts to be retrieved and validated using information from 'outside'.
Total Value Locked (TVL)
Each DeFi protocol has a certain amount of blocked funds, which is referred to by the acronym TVL. This is often found on lending platforms (borrowing and lending), where it is indicated to allow borrowers to know how many funds are available. Furthermore, the TVL can be used to understand how much a platform grows over time and, by adding up the TVL of each protocol, one can know how many blocked funds there are on the entire DeFi market.
Obviously, the TVL varies as the price of the cryptocurrencies used by the platforms as collateral changes, so it can be very volatile. Collateral is nothing more than the type of asset used as collateral.
Market Cap to TVL ratio
The Market cap to TVL ratio is simply the ratio of market capitalisation to the TVL we have just seen. The Market Cap is the total value of all tokens in circulation, so it too can vary with the price. Dividing the Market Cap by the TVL gives an even better understanding of the amount of money in a protocol.
In some cases, platforms like coinmarketcap.com already have these values calculated, so you don't have to do any calculations manually.
Conclusions
And so we come to the end of this guide to DeFi terminology and common terms in decentralised finance.
Of course, there are many other useful terms that you might come across when entering this type of market, but by knowing the ones we've mentioned, you'll definitely be able to get around without too much trouble.
DeFi is one of the most popular sectors at the moment, and getting there before the others can make a real difference if you know how to use it in the right way.
Keeping up to date with new terminology, therefore, can make your life a lot easier.
*This article will be published on theledger.it in the Italian language following our schedule. Check our other articles if you want to support us :)
Bibliography
Learn More
- https://theledger.it/recensioni/aave-il-protocollo-defi-piu-solido-in-termini-di-sicurezza/
- https://theledger.it/recensioni/compound-il-progetto-defi-dei-servizi-bancari/
- https://theledger.it/guide/defi-finanza-decentralizzata/
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