DeFi Glossary (Important!)

Audit

An audit is either an internal or independent comprehensive analysis of a concept, system, processes, company, and/or product. A comprehensive audit includes a thoughtful and in-depth look at the structure, strengths, weaknesses, and vulnerabilities of the thing or processes being audited.

Audits may be either informal or formal, they might include the full scope analysis or part of a product/process.

Automated Market Maker (AMM)

An automated market maker (AMM) is a type of decentralized exchange (DEX) protocol that relies on a mathematical formula to price assets. Instead of using an order book like a traditional exchange, assets are priced according to a pricing algorithm. More details here.

APR (Annual Percentage Rate)

The term annual percentage rate (APR) represents the annual rate charged for earning or borrowing money. APR is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan or income earned on an investment.

This includes any fees or additional costs associated with the transaction, but it does not take compounding into account.

APY (Annual Percentage Yield)

The annual percentage yield (APY) is the real rate of return earned on a savings deposit or investment taking into account the effect of compounding interest. APY is the actual rate of return that will be earned in one year if the interest is compounded.

The more often interest is compounded, the better the return will be.

Beta code/Beta version

A release of software that is given out to a large group of users to try under real conditions. Beta versions have gone through alpha testing in-house and are generally fairly close in look, feel and function to the final product; however, design changes often occur as a result.

Compound Interest

Compounding is the process in which an asset's earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. This growth, calculated using exponential functions, occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods.

Compounding can be seen as interest on interest.

Fair Launch Token/Coin

A concept where a dev team decides to not seek outside investment and does not pre-mine, pre-sale or hold back a share of a coin or token's launch for themselves or others. This is considered to be much fairer to early participants as their share of ownership of a coin or token is not diluted by pre-investors or founders/founding teams. The first Fair Launch token was YFI, which was launched in 2020 by Developer Andre Cronje. $FRIES were launched using exactly the same Fair Launch principle.

Impermanent Loss

Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. The bigger this change is, the more you are exposed to impermanent loss. In this case, the loss means less dollar value at the time of withdrawal than at the time of deposit.

Pools that contain assets that remain in a relatively small price range will be less exposed to impermanent loss. Stablecoins or different wrapped versions of a coin, for example, will stay in a relatively contained price range. In this case, there’s a smaller risk of impermanent loss for liquidity providers (LPs). More information here.

Liquidity Pools

Liquidity pools are pools of tokens that are locked in a smart contract. They are used to facilitate trading by providing liquidity and are extensively used by some DEXes. A single liquidity pool holds 2 tokens and each pool creates a new market for that particular pair of tokens.

When a new pool is created, the first liquidity provider is the one that sets the initial price of the assets in the pool. The liquidity provider is incentivised to supply an equal value of both tokens to the pool. If the initial price of the tokens in the pool diverges from the current global market price, it creates an instant arbitrage opportunity that can result in lost capital for the liquidity provider. More information here.

Liquidity Provider (LP) Tokens

When liquidity is supplied to a pool, the liquidity provider (LP) receives special tokens called LP tokens in proportion to how much liquidity they supplied to the pool. When a trade is facilitated by the pool a defined fee is proportionally distributed amongst all the LP token holders. If the liquidity provider wants to get their underlying liquidity back, plus any accrued fees, they must burn their LP tokens.

Slippage

Slippage is when there is a price difference from the amount of the original market order and the actual price paid of an asset (token for example). Slippage happens because the bid-ask spread changes from the time the order was placed to the time the order is completed.

Staking (Frying)

The act of staking a cryptocurrency deposit to yield farm an additional cryptocurrency via CeFi or DeFi staking offerings. Staking in the ecosystem of DeFi projects is also referred as farming/liquidity mining.

Subsidized gas

Technically, it is not a performance fee — it's a fee on the some profit-generating transactions that incur high gas costs and are critical to the vault's internal functioning.

Vaults

What are Vaults in DeFi? Vaults are decentralized smart contract powered hedging strategies, that utilize and manage your assets to ensure the best yield. Imagine vaults as community driven robo-advisers, that work with different farming, lending, and yield optimization strategies.