An essential guide to understanding the key terms and concepts in decentralized finance. This guide is designed to help newcomers get up to speed with the basic terminology and foundational concepts in the world of DeFi.
NOTE: Regular updates to this repository should be anticipated, as additional terms and concepts will be continuously added over time.
- Decentralized Exchanges (DEXs): Platforms for trading digital assets directly between users without a central authority.
- Derivatives Market: Where financial contracts like futures, options, and synthetic assets derive their value from underlying digital assets.
- Lending and Borrowing Platforms: Where users can lend or borrow digital assets in a decentralized manner.
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Smart Contracts:
- Definition: Smart contracts are digital contracts stored on a blockchain that are executed when predetermined terms and conditions are met.
- Usage: Automate financial transactions, lending, borrowing, trading, and more without intermediaries.
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Decentralized Exchanges (DEXs):
- Definition: Platforms for trading digital assets directly between users without a central authority.
- Examples: Uniswap, SushiSwap, Balancer.
- Mechanism: Utilize Automated Market Makers (AMMs) or order book systems to facilitate trades.
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Automated Market Makers (AMMs):
- Definition: Protocols that provide liquidity and facilitate trading using liquidity pools.
- Examples: Uniswap, Curve.
- Mechanism: Users provide liquidity to pools and earn fees; prices are determined by mathematical formulas (e.g., constant product formula).
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Liquidity Pools:
- Definition: Pools of tokens locked in a smart contract to provide liquidity for trading.
- Providers: Users who deposit tokens and earn a share of trading fees and possibly governance tokens.
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Yield Farming:
- Definition: Earning rewards by staking or lending digital assets in DeFi protocols.
- Mechanism: Users provide liquidity or participate in lending platforms and earn interest, fees, or additional tokens.
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Staking:
- Definition: Locking up tokens in a network to support operations (e.g., validating transactions) and earning rewards.
- Types: Direct staking in proof-of-stake (PoS) networks or staking in liquidity pools.
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Decentralized Lending and Borrowing:
- Definition: Platforms allowing users to lend and borrow assets without intermediaries.
- Examples: Aave, Compound.
- Mechanism: Users can supply assets to earn interest and borrow against their collateral.
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Governance Tokens:
- Definition: Tokens that grant holders voting rights on protocol changes and governance decisions.
- Usage: Decentralized governance allows token holders to influence the development and operations of DeFi protocols.
- Market Order: Buy or sell immediately at the current market price.
- Limit Order: Buy or sell at a specific price or better.
- Stop Order: Buy or sell when the price reaches a specified point.
- Stop-Limit Order: A combination of a stop order and a limit order.
- Long Position:
- Definition: Buying a digital asset with the expectation that its price will rise.
- Example: Buying ETH expecting its value to increase.
- Short Position:
- Definition: Selling a digital asset you do not own, with the expectation that its price will fall, and then buying it back at a lower price.
- Example: Using synthetic assets or derivatives to short BTC.
- Leverage:
- Definition: Using borrowed funds to increase the potential return of an investment.
- Example: If you have $1,000 and use leverage at a ratio of 10:1, you can control $10,000 worth of assets on a DeFi platform.
- Margin:
- Definition: The amount of capital required to open and maintain a leveraged position.
- Initial Margin: The amount of money needed to open a leveraged position.
- Maintenance Margin: The minimum amount of equity required to keep a position open.
- Liquidation:
- Definition: Automatically selling an investor’s assets to meet margin requirements.
- When It Occurs: If the investor fails to meet the margin call, the DeFi protocol may liquidate positions to cover the shortfall.
- Bid Price: The price at which buyers are willing to purchase a digital asset.
- Ask Price: The price at which sellers are willing to sell a digital asset.
- Spread: The difference between the bid and ask prices.
- Volume: The number of tokens or contracts traded in a digital asset or market.
- Liquidity: The ease with which a digital asset can be bought or sold in the market without affecting its price.
- Liquidity Pools: Pools of tokens locked in a smart contract to provide liquidity for trading on DEXs.
- Yield Farming: Earning rewards by staking or lending digital assets in DeFi protocols.
- Governance Tokens: Tokens that grant holders voting rights on protocol changes and governance decisions.
- Trading Account: A wallet or account where digital assets are managed and traded.
- Collateral: Digital assets pledged to secure a loan or margin position.
- Unrealized PnL: Profit or loss on open positions that have not yet been realized by closing the positions.
- Mark Price: The fair value of a derivative or asset, typically used to prevent manipulation in DeFi protocols.