Decentralised Finance Glossary

A boring, informative beginner post to kick things off…

Decentralised Finance (“DeFi”)

Decentralised Finance is a blockchain-based form of finance that does not depend on financial intermediaries such as brokerages, exchanges, or banks to offer financial instruments. DeFi instead utilises smart contracts on blockchains, the most common being Ethereum and revolves around decentralised applications, also known as Dapps. These Dapps can perform financial functions on distributed ledgers called blockchains.

Decentralised applications (“Dapps”)

A decentralised application is effectively a computer application that runs on a decentralised computing system. Dapps have been popularised by distributed ledger technologies (such as Ethereum), where Dapps are often referred to as smart contracts. Because smart contracts, or self-executing software, can interact with Dapps, “administrative” overheads are removed. This makes Dapps one of most attractive features associated with blockchain. Well-known DeFi platforms such as Uniswap,and Aave are examples of Dapps.

Decentralised exchanges (“DEX”)

A decentralised exchange is another use case of blockchain technology. DEXs offer peer-to-peer trading of crypto assets. Unlike centralised exchanges, DEXs are based on smart contracts that make most their processes automatic. In transactions made through DEXs, blockchains replace the role typically played by third-party entities that would normally oversee the security and transfer of assets in traditional finance (e.g. banks and stockbrokers).

In a DEX, liquidity for trades is provided by liquidity providers. These liquidity providers, which can be and often are retail investors, lock their cryptocurrencies into the “liquidity pools”. DEXs generally charge a percentage fee for each transaction executed on the platform. This fee is shared by the liquidity providers in proportion to their liquidity contributions within the respective liquidity pool.

Decentralised autonomous organisation (“DAO”)

DAOs are organisations represented by rules encoded as a transparent computer program, controlled by the organisation members, and not influenced by a central authority. As the rules of the DAO are embedded into the DAO’s code, no “managers” are needed. This therefore can remove obstacles relating to bureaucracy.

DAOs are based on smart contracts that represent the rules of a respective organisation. No one can change the rules unnoticed because a DAOs code is transparent and public. In comparison to traditional companies, DAOs have a democratised organisation. Frequently, all or a majority of the members of a DAO need to vote for any changes to be implemented or actions to be made by the DAO itself.

The funding of DAOs is mainly based on crowdfunding that issues tokens.

DAOs are often organisations that determine the way in which certain Dapps perform activities. For instance, for a line of code to be integrated into a Dapp, that piece of code might need to begin as a proposal and then be voted in by the relevant DAO governance token holders.

Smart Contracts

Smart contracts are programs whose terms are recorded in computer code. They often contain agreements or sets of actions between parties that emulate a traditional legal contract. Smart contracts are automated actions that can be coded and executed once a set of conditions is met.

Yield Farming

Yield farming is an activity undertaken by those seeking to earn return on their crypto-assets — often seeking to maximise returns by varying between different strategies made available by different DeFi protocols or Dapps. When a strategy stops working, a yield farmer will often move their funds between protocols or exchange assets to those that can generate more yield.

Just as a bank takes a deposit from a customer, paying 1% interest, and then loans that same amount out to another customer and charges 5% in interest, a decentralised protocol will do the same thing but with a smart contract. Investors or “yield farmers” are paid in rewards, which is like yield. High yields through yield farming can be reached by algorithms harnessing liquidity mining and leverage.

Liquidity Mining

Liquidity mining is a process within DeFi, often taking place on DEXs, whereby participants supply cryptocurrencies into liquidity pools and are rewarded with fees and tokens based on their share of the total pool liquidity.

The revenue of a liquidity pool stems from the transaction fee that is paid when users interact with the pool making transactions such as borrowing, lending, and exchanging coins. This revenue is then re-distributed to the liquidity providers in accordance with the proportion of the liquidity provided into the pool.

Staking

Staking cryptocurrencies is a process that involves committing crypto-assets to support a blockchain network and confirm transactions. Staking is the way many cryptocurrencies verify their transactions, and it allows participants to earn rewards on their holdings. In this way it can be possible, via staking, to use cryptocurrency holdings to generate passive income.

Staking is possible with cryptocurrencies that use the proof-of-stake model to process payments.

‘Initial Coin Offering (“ICO”)

ICOs are effectively cryptocurrency token sales used as a funding method by cryptocurrency projects. The purpose of ICOs is often to raise capital to create a new coin, app, or service. Oftentimes, interested investors can buy into the offering and receive a new token issued by the company in question which may have some utility in using the product or service the company is offering.

Initial Exchange Offering (“IEO”)

IEOs followed the crowdfunding model of ICOs. However, in an IEO an exchange’s team would usually conduct due diligence prior to a token launch on its platform.

Initial DEX Offering (“IDO”)

In its essence, IDO is a successor to ICOs and IEOs in that it is another fundraising mechanism. However, unlike ICOs and IEOs where the tokens are sold prior to an exchange-listing, with IDOs, a respective token is listed immediately on a decentralised exchange.

Airdrop

An airdrop, often seen as a marketing stunt, involves sending new tokens to users’ wallet addresses, often to promote awareness of a new token. During an airdrop new tokens might be sent to the wallets of active members of a respective blockchain community.

Stablecoin

Stablecoins are essentially cryptocurrencies whose price aims to reference or mirror the price of another asset that is usually a real-world asset (e.g. the US Dollar).

Ethereum

Ethereum is a decentralised, open-source blockchain with smart contract functionality. Ether, or ETH, is the native cryptocurrency of the platform. Amongst cryptocurrencies, Ether is second only to Bitcoin in market capitalisation.

Despite having many competitors offering similar smart contract capabilities for DeFi, most of the largest DeFi platforms are built on the Ethereum network.

Many well-known cryptocurrencies operate as ERC-20 tokens. An ERC-20 token is a standard used for creating and issuing smart contracts on the Ethereum blockchain. ERC-20 tokens have emerged as the dominant technical standard for tokens being used in smart contracts.

“Gas”

Gas is effectively the transaction fee that is spent when conducting a transaction or executing a smart contract on Ethereum (other blockchains also have transaction fees but the term gas is most associated with Ethereum). When it is said that gas prices are extremely high, this suggests that there has been a surge in usage on the Ethereum network which drives up gas prices that are paid to miners.