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Terminologies Used In DeFi (Decentralized Finance)
If you are new in the crypto space understanding of terminology being used is a must. You need to understand what are those abbreviations mean so you will not be out of place when crypto people talks. Not just that you have to understand it before jumping into an investment because those are your guides, in understanding what type of investment it is.
In crypto, people always say DYOR (do your own research) but when we are noobs we don't know where to start doing our research because there are a lot of terms that are so new and alien to us.
In this article, I will summarize some of the common DeFi terms for those newbies who want to explore DeFi;
DeFi - it is an abbreviation of “decentralized finance” a term for a variety of financial applications in cryptocurrency or blockchain geared in disrupting financial intermediaries.
Most DeFi applications are built on top of the Ethereum blockchain, the world's second-largest cryptocurrency platform. It's because of the smart contracts in Ethereum, that automatically execute transactions if certain conditions are met - offers more flexibility.
DEXs- It stands for Decentralized Exchanges, it's an online exchanger that helps users exchange currencies for other currencies. DEX's are a hot type of exchange, that connects users directly to trade their cryptocurrency with one another without trusting an intermediary.
Yield Farming - This is a term for the process of allowing cryptocurrency holders to lock up their holdings which will provide them with rewards in return. In simple terms, it's a process that lets you earn either fixed or variable interest through investing crypto in the DeFi market.
Liquidity pools - It is one of the foundational technologies behind the DeFi ecosystem currently. It is an essential part of an automated market maker (AMM). It is a collection of funds that will be locked in a smart contract. Liquidity pools are being used to facilitate decentralized trading, lending, and many more.
AMM- Acronym for the automated market maker, which means a type of decentralized exchange (DEX) protocol that relies on a mathematical formula to price the assets. Rather than using an order book like in traditional exchange, the asset is priced based on a pricing algorithm.
Liquidity providers (LP) - Liquidity providers are the users that add an equal value of two tokens in a pool to create a market. In return for providing their funds, they will earn trading fees from the trades that happen in their pools, which is proportional to their share of the total liquidity.
Liquidity Pair - These are the two tokens that will be paired in the same value to create a market. (E.g: CAKE-BNB LP)
Yield farming is a bit complicated process compared to staking.
Yield farming locked their funds in lending pools, wherein other borrowers borrow funds in exchange for an interest. Yield farmers can earn multiple governance tokens in exchange for smaller fees that were generated across various liquidity pools.
Staking works on the Proof-of-Stake or PoS consensus mechanism wherein a validator creates a block via a random selection process and earns rewards that are paid by the investors of the platform. The higher the stake, the higher the rewards.
Farming offers higher APR compare to purely staking but it is riskier because of the impermanent losses.
Impermanent losses - It happens when you provide liquidity in a liquidity pool and the price of your deposited assets changes from the time you deposit them. The bigger the change is, the more you are exposed to the impermanent loss. In this scenario, the loss means less dollar value at the time of withdrawal compared to the time of deposit.
APY - stands for Annual Percentage Yield. It will take into account the interest rate and compounding period giving a single number that will represent how much an investor will earn from that certain investment in one year.
APR- or Annual Percentage Rate, is the annual rate charge in borrowing or earned through an investment. An APR may not reflect the actual cost of borrowing or earnings due to the fees are not included or excluded.
APY takes into account compounding while APR does not. In DeFi, if you stake your tokens or farm your LPs in DEXs, for example in Pancakeswap you have the choice to compound your earnings or to harvest. If you compound it you will have to pay for fees. While if you put your tokens or LPs on a yield optimizer like Beefy Finance, your earnings are automatically compounded. Or just like lending platforms like NEXO, Celcius, and Blockfi, they are auto compounded.
TVL- stands for Total Value Locked, in Defi it serves as a high-level valuation metric in determining the number of assets that are currently staked in the DeFi space as a whole. TVL measures the total value of tokens that are locked within these DApps, that is believed the higher the value locked up in Defi DApps, the better.
Those are the most common terms we heard when we talk about DeFi farming, if you are eager to learn about DeFi and grabbed the opportunity to let your coin/token works for you, then you must understand the terminology for your awareness of what you are trying to enter.
If I missed something, please comment down below and I will add it. Thank you.