DeFi jargon explained
Emmanuel Chibuzor Precious
Decentralized finance (DeFi) continues to be the hottest topic in crypto space as DeFi Pulse reports that $13.71B in total value is locked in, on different DeFi protocols at the time of writing this article.
Newbies in cryptocurrency and DeFi might be confused with the jargon associated with DeFi and cryptocurrency…
What’s APR? What’s an AMM?
…no need to worry anymore, these terms have simple enough definitions.
This article will explore some of the popular terms and phrases relevant to DeFi and will serve as a good foundation for those interested in researching further into this aspect of cryptocurrency.
First of all, what is DeFi?
DeFi stands for “Decentralized finance.” It simply means a crypto ecosystem that offers all the services available in conventional financial system using decentralized applications built on blockchain
AMM: Automated Market Maker
An automated market maker (AMM) is a protocol used by decentralized exchanges (DEX) to price assets using a mathematical formula instead of the conventional order book used by centralized exchanges (CEX).
In AMMs, the price of assets depend on a pricing algorithm. Different protocols use different mathematical formula to calculate prices, but the simplest is the formula used by Uniswap Protocol.
Uniswap uses x * y = k
Where x represents the amount of one token in the liquidity pool, and y stands for the amount of the other while k is a constant which stands for pool’s total liquidity which must remain the same at all times.
APR: Annual Percentage Rate
Annual percentage rate (APR) refers to the annual rate of interest borrowers pay or investors earn when they lend their assets. APR is normally depicted as a percentage that showcases the real yearly cost, or earnings, of assets over the term of a loan or investment period.
Collateral is an asset used to secure a loan. Just like in the traditional world of finance where one is expected to put up something like a home as collateral to secure a cash loan, DeFi requires that a borrower stakes cryptocurrency tokens as collateral to borrow other tokens.
DeFi Pulse is a website that displays the latest rankings, development and analytics of DeFi Protocols. This is the best site to track the quantity and value of DeFi assets that are locked in DeFi Protocols at any moment.
DApps are decentralized applications which exist like normal applications with similar features, but run on a peer-to-peer, distributed and decentralized network, such as a blockchain. This is unlike normal applications that have a central body that controls them.
You can access many DApps from within your Trust Wallet mobile app.
Etherscan & BSCscan
Etherscan is a block explorer and analytics platform for Ethereum. This explorer offers the opportunity to track cryptocurrency transactions carried out on Ethereum smart contracta. BSCscan is the same, but for analysing smart contracts on Binance Smart Chain.
Liquidity Pools are the ways that decentralized exchanges, that rely on AMMs, replace the function of order books. They serve as a matching engine or market maker. Liquidity pools guarantee liquidity between market participants, without having to rely on people placing orders in an order book.
Liquidity Provider (LP)
A liquidity provider is a decentralized exchange user who supplies funds to a liquidity pool in order to provide liquidity for people wanting to trade on that platform. Liquidity providers receive part of the transaction fees on the pool as an incentive for supporting the exchange.
You can provide liquidity for people who want to trade BNB with TWT on PancakeSwap by becoming a Liquidity Provider for one of their pools. PancakeSwap calls their liquidity pools, farms.
The TWT-BNB pair is currently paying out double rewards.
Slippage is the difference between expected price of trading assets and the actual price the trade was executed. This is very common during the time of high market volatility and with order book-less exchanges. Certain platforms provide lower maximum slippage than others, which means you are more likely to get the price you expect when you make a trade.
Trust Wallet recently integrated UniSwap and PancakeSwap into the wallet, so that users get less slippage when swapping assets directly in the mobile app.
Yield farming is a process by which individuals stake or lock their cryptocurrency for a reward. Yield farming which is also referred to as liquidity mining is when individuals earn tokens as a reward for their participation in DeFi applications. The commonest yield farming method is to provide liquidity to a DeFi project’s application and then earn the project’s native token in return.
Staking is the act of locking cryptocurrencies to receive rewards. In staking, an individual holds cryptocurrency to verify transactions and support the network. In exchange for this service, the individual will receive a reward. Staking gives one the opportunity to earn passive income by holding crypto assets.
Impermanent loss is a feature in staking or yield farming whereby an investor can end up with a lower dollar value, when they exit a liquidity pool, than the initial value of the assets where as when they were originally staked.
This happens when an investor provides liquidity to a liquidity pool, and the price of the deposited assets change dramatically when compared to when they were deposited. The bigger the difference in price of the two assets in the pool, the more one is exposed to impermanent loss.
It is referred to as Impermanent loss because, the loss disappears when price of staked tokens returns to initial ratios when they were staked. We recently explored this in more detail in DApp Journey article specifically about Impermanent Loss.
Stable coins are cryptocurrencies that‘s ’market value are pegged to some external reference. Most common stable coins are pegged to a currency like the U.S. dollar. This means that the value of these stable coins maintains $1 or very close to that at all times. Stable coins can also be pegged to a commodity’s price such as gold.
Proof of Stake (PoS)
Proof of Stake is one of the consensus mechanisms that allows an individual to mine or validate block transactions according to how many coins from that chain that the individual holds. Proof of Stake (PoS) was created as an alternative to Proof of Work (PoW), which is the original consensus algorithm of Bitcoin.
Proof of Work (PoW)
Proof of Work consensus is the original algorithm that Bitcoin technology was built on. PoW involves miners competing with each other to complete a complex computational task which comes with rewards. Miners compete to solve a complex mathematical puzzle and whoever gets the solution, receives the block reward.