It’s no exaggeration to say that Decentralized Finance and DeFi are almost one of the most exciting things this century. Instead of handing over cash to bankers and investment managers, people can now save, invest and borrow using cryptocurrencies through digital “smart contracts” fully automated in DeFi.
It sounds crazy, but it’s actually not that complicated. Just as various technologies have changed our lives, DeFi is also changing the way we make money. Unlike the traditional centralized finance (“CeFi”) model, we can still save and invest now, but we can save the fees that were charged by middlemen.
The best part is that everything in DeFi is done through the blockchain: a decentralised ledger that cannot be corrupted, clearly recording every transaction. Of course, this does not mean that DeFi has no risks. We will introduce it in detail in the follow-up articles of this popular science. Let’s start with some of the most important DeFi terms in this issue!
Collateral
On many DeFi platforms, users can stake one cryptocurrency or token in order to borrow another, such as DAI using ether (ETH). It’s a bit like using your house as collateral for a loan from a bank. Typically, you have to provide a larger percentage of your cryptocurrency or token as collateral for a DeFi loan, such as using $100 in ETH to borrow $70 DAI (i.e. 140% LTV, or a loan-to-value). This helps support the stability of the system.
NO.2
DAO
DAOs are autonomously contributed to the community by decentralized individuals. In short, like a company without any HR managers or employees, everything that happens in the organization is fully automated based on “open source” code that anyone can view and use. Both DAO and DeFi run on the blockchain, so it is also immutable and does not need to be audited.
NO.3
dApp (Decentralized Application)
dApps refer to decentralized applications and are the foundation of all DeFi. Like DAOs, dApps are essentially self-running applications without managers or middlemen, allowing users to transfer funds between programs. The Ethereum blockchain is like a dApp library where most DeFi dApps live, while other blockchains such as Tron and EOS also allow developers to code applications.
NO.4
DEX/CEX (Centralized Exchange/Decentralized Exchange)
DEX is a decentralized exchange, and CEX is a centralized exchange, both of which can buy and sell cryptocurrencies and tokens. Just like the difference between DeFi (centralized finance) and CeFi (decentralized finance), DEXs are automated and run by algorithms and smart contracts, while CEXs are run by companies with human governance. Well-known DEXs include Uniswap, Sushiswap and Kyber, etc. There are countless well-known CEXs, such as Coinbase, Binance, etc. In operation, CEXs may be cheaper than DEXs, but users may have little knowledge of how they operate, and the same is true of DEXs.
NO.5
Ethereum
Ethereum is perhaps the most important blockchain currently after Bitcoin, and the “birthplace” of DeFi. It acts like the project library of most dApps in the DeFi world, building the underlying foundation that makes everything possible at present. Ethereum is often confused with Ether (i.e. ETH), which is Ethereum’s native token but is not the same as the Ethereum blockchain itself.
NO.6
Gas fees
Miner fees are the fees incurred by Ethereum “miners” when processing transactions on the blockchain (which can also be understood as transaction fees in the blockchain network). The miner’s fee is charged by ETH, the native token of Ethereum, which is generally calculated using Gwei, the most basic unit in the Ethereum code. The more transactions that go through Ethereum, the higher the miner fee, which may make smaller transactions less cost-effective (more on “high miner fees” later in this series).
NO.7
Liquidity mining
Liquidity mining (aka yield farming) is a key feature of DeFi that allows people to earn rewards by depositing (or “staking”) a cryptocurrency or token on a DEX or dApp. Some platforms reward users with another token that can then be staked on the same or another DEX or dApp without limit. Even more attractive is that each cryptocurrency or token can earn yields (such as interest on savings), and can earn (that is, “mine“) higher yields through the staking process. This is similar to depositing cash into different banks; the difference is that you need to get separate tokens from each bank before you can deposit at the next bank for a higher yield.
NO.8
Liquidity pools
Liquidity pools are a feature of DEXs that enable transactions between investors without any intermediaries. Smart contracts govern the work of liquidity pools, keeping them balanced between pairs/groups of different cryptocurrencies and tokens traded. Users can earn money by placing tokens in the DEX into these pools to provide liquidity and facilitate transactions.
NO.9
NFT (Non-Fungible Token)
NFTs are a major innovation in the token world. Unlike other tokens on Ethereum, NFTs are completely unique and not interchangeable with other tokens. As such, they are often used to buy and sell unique art and collectibles, and have some interesting test cases in more complex financial products. There are two main NFT standards currently in use on the market: the original and unique ERC 721 token, and the hybrid version based on the ERC 1155 protocol used in the game.
NO.10
Pump and dump
The term “pump and dump” refers to the simultaneous entry of buyers into a virtual currency or token, inflating its price and then dumping it all at once, causing the price to plummet. This is common in newly minted tokens, with hype and private pre-sales allowing prices to soar before crashing. Since not every investor can get out at the same time, this operation has unfortunately resulted in huge losses for many buyers.
NO.11
Smart contract
We have mentioned smart contracts many times, because without smart contracts there is no DeFi, and the importance is self-evident. The code in smart contracts can determine exactly how dApps and other blockchain protocols work. Unlike traditional contracts, once written and published, these contracts cannot be changed. Bugs in a smart contract can make it vulnerable to hackers, which is why most legitimate projects go through rigorous vetting before launching.
NO.12
Stablecoins
The core pillar of DeFi is stablecoins, which can be compared to “fiat” or traditional currencies in tokens. There are two types of stablecoins: one is algorithmic stablecoins, which do not require traditional fiat currency to be backed (or mortgaged) in a 1:1 ratio, while centralized stablecoins need to be pegged to fiat currencies. For example, DAI belongs to the former, while Tether (USDT) and USDC belong to the latter. Since users do not have to worry about price fluctuations, stablecoins account for the majority of transactions in DeFi.
NO.13
Tokenomics (Token model/Token economics)
Tokenomics is somewhat similar to the prospectus for investors of a public company in the stock market, and it describes the key functions of the new line token and its vision for the future. This may include how many tokens will be issued, how the tokens will be distributed, and what effects the tokens will have. This is the key to know before buying tokens, especially during the pre-sale phase.
NO.14
Tokens
Tokens (aka tokens) are often confused with cryptocurrencies like Bitcoin and Ethereum. Tokens are more like company shares on the stock market, which can be traded for profit, but “stocks” are not dollars and euros after all. Also, not all tokens have value. The most common tokens are ERC-20 tokens, which run on the Ethereum blockchain and form the bulk of DeFi. Some tokens grant holders the right to vote on how an issuing DAO, DEX or dApp operates, also known as “governance tokens”.
NO.15
TVL/TLV (total lock-up volume )
TVL stands for Total Locked Value, and in the DeFi world, this means the amount of funds held by a single DEX, dApp, or the entire ecosystem, also known as Total Locked Value (TLV). Although 2017 has seen an early version of DeFi, the year of real DeFi harvest is 2020, with the value of TVL rising from $662 million in January to over $11 billion in November. TVL is often used as a measure of DeFi success, but it doesn’t tell the whole story.
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