DeFi Key Terms

Key terms in DeFi

• AMM: Automated Market Makers (AMMs) have disrupted the traditional way that buyers and sellers come together. They allow digital assets to be traded in a permissionless and automatic way by using liquidity pools rather than a traditional market of buyers and sellers. AMM users supply liquidity pools with crypto tokens, whose prices are determined by a constant mathematical formula. So, instead of two parties coming to an agreement, traders can instead interact directly with a smart contract and execute the trade

• APR: APR represents the annual rate charged for earning or borrowing money. APR does not take into account the compounding of interest within a specific year. It is calculated by multiplying the periodic interest rate by the number of periods in a year in which the periodic rate is applied. It does not indicate how many times the rate is applied to the balance

APR is calculated as follows:

APR = Periodic Rate x Number of Periods in a Year

• APY: APR also represents the rate charged for earning or borrowing money but does take into account the frequency with which the interest is applied—the effects of intra-year compounding. 

Here’s how APY is calculated:

APY = (1 + Periodic Rate)Number of periods – 1

• Borrowing Rate : This is the rate a borrower will pay to borrow tokens. The Borrowing rate will always be higher than the Lending rate.

• CEX: Centralized Exchange. Even though these exchanges cater to decentralized digitized assets, they act as centralized authorities and take custody of a user’s funds on deposit.  Binance and Coinbase are examples of CEXs. 

• Collateral: This is an asset used to secure a loan. In the traditional world of finance, one might put up their home as collateral to secure a cash loan. In DeFi, one puts up cryptocurrency tokens as collateral to borrow other tokens.

• cTokens: These are Compound’s native tokens. When a user supplies assets to the Compound protocol, they receive cTokens. These, in turn, represent claims on the asset pool.

• Deflationary Token: Tokens are “deflationary” if a percentage is permanently removed from the marketplace over time. Buy-backs and burns are popular ways of destroying tokens. This causes scarcity which hopefully makes the price rise

• dApps: Decentralized applications. These are digital apps that run on a blockchain outside the control of a central authority.

• DEX: A DEX, or decentralized exchange, is a type of cryptocurrency exchange. It operates like a stock exchange, except smart contracts run it. These smart contracts enforce rules and execute trades. Unlike a Centralized Exchange (CEX), a DEX does not take custody of a user’s funds.  

• ETH: ETH stands for Ethereum tokens. These are digital assets built on the Ethereum blockchain.

• Flash Loan: Flash Loans are futuristic and next-generation DeFi and native to the crypto space. A borrower can take out a flash loan with no collateral. However, it must be repaid within the same block, or the entire transaction is canceled. 

• Flash Swaps: Similar to Flash Loans. A user can withdraw a token and use it before paying for it.

• Gas: Gas is used to calculate fees on the Ethereum network. Every smart contract execution on the Ethereum network requires gas. When the network is more congested, gas prices are higher.