Decentralized finance (DeFi) is the future of cryptocurrencies. Protocols are growing significantly, and there has also been a noticeable growth in investments.
Admittedly, it will most likely take a while for DeFi to catch on. Protocols are still confusing for beginners to work with, and there are a lot of regulatory hurdles to work through. But, it won’t hurt for crypto fans to understand. Here are some major DeFi terms for you to keep in mind:
DAO is short for “Decentralized Autonomous Organization.” Traditional companies need some staff and managers. But, a DAO doesn’t need any of that. Everything that happens in a DAO happens automatically.
A DAO operates based on open-source computer programming. Anyone can view the code and see how it works, and a DAO is also resistant to censorship since it runs on the blockchain. All decisions on a DAO must be made following a consensus. This means that even if there’s an error in the DAO’s code, the majority of the DAO’s users will need to vote to have it fixed before a fix can be implemented.
dApp is short for “decentralized application.” Like a DAO, a dApp is an application that runs with minimal human effort. There are no middlemen or managers, and the app runs automatically. Users can transfer funds between themselves and operate the app on a completely peer-to-peer basis if they like.
Most of the dApps available - as well as DeFi protocols - run on the Ethereum blockchain. But, other blockchains - including EOS and TRON - have smart contracts that allow customers to build dApps.
Cryptocurrency exchanges are divided broadly into centralized exchanges (CEX) and decentralized exchanges (DEX). Both exchanges allow customers to buy and sell coins - and even trade. But, they work quite differently.
Unlike a CEX, a DEX operates autonomously. It is run by smart contracts - a type of code that is built on some blockchains that outlines the rules for specific functionality. DEXs allow customers to use them without the need for any middlemen or companies running them.
In some cases, DEXs don’t even require things like identity verification and other security processes. This is a contrast to CEXs, which are run by companies and will require elaborate security protocols.
Popular CEXs include Binance, Coinbaase, and Kraken. Popular DEXs include Uniswap, Kyber, and SushiSwap. DEXs tend to be more expensive than DEXs, but DEX users tend to have more of a say in what happens to the platform.
Gas fees are very important to DeFi protocols. They are fees that Ethereum miners charge for processing transactions on the Etheruem blockchain. Remember that most of the DeFi protocols and dApps run on the Ethereum blockchain. For all transactions that run, the blockchain has a say.
In order to run transactions, miners charge gas fees. The higher the congestion on the blockchain, the higher the gas fees. These fees are levied in ETH, but they’re usually broken down into small portions known as “Gwei.”
Due to the possibility of gas fees rising, smaller trades can be less cost-effective than larger ones. In some cases, people who make small transactions end up paying even higher in gas fees than the transactions they’re sending.
Also known as yield farming, liquidity mining is a feature in DeFi that allows customers to deposit a cryptocurrency into a dApp or a DEX. This action is known as staking, and the coins are locked for a period. When the period elapses, the user gets interest as well as additional tokens as rewards.
Some liquidity mining platforms reward their users with some other tokens that can be staked on some other dApp or DEX. And so on, and so on.
Liquidity mining is especially attractive because each token pays a yield, and you will also be able to chase higher yields through the staking process. Think of it like putting cash in a deposit across several banks - just that you need individual tokens from each bank before being able to deposit at another bank in order to get a higher yield.
A liquidity pool is a feature of DEXs that brings people together for the purpose of trading. There are no middlemen or operating companies, with the DEXs running by smart contracts. The smart contracts also keep the pools balanced, ensuring that there is a healthy mix of cryptocurrencies and trading pairs.
Most times, liquidity pool users get rewarded for putting their coins into the pools. They can also get transaction fees that the platform generates.
TVL is an acronym for “Total Volume Locked.” In DeFi, this is used to mean the amount of money that is in a single platform - could be a DeFi protocol, a dApp, or a DEX. In some cases, it can also be called Total Locked Value (TVL).
In the early years of DeFi, a protocol having a TVL running into millions of dollars was considered a big one. Today, the entire DeFi ecosystem has a TVL that runs into billions of dollars. Of course, while TVL tells a lot about a DeFi protocol’s state, it doesn’t tell the full story.