Defi for dummies

Defi? Wtf? Welcome to the wonderful world of decentralized finance (DeFi).

First of all, what is Defi?

Defi is short for decentralized finance. It is essentially just conventional financial tools built on a blockchain — specifically the Ethereum blockchain. These tools can be lending, borrowing, trading, investing, gearing, portfolio managemenet or asset management, and the tools are mostly built with open-source code. First of all, this means that anyone can access any financial product or service, that are both cheaper and faster than old finance. It also means that any developer can build a new service that is based on (gets necessary data or information from) any other service or protocol. It’s kind of like building with Lego. Lastly, while old finance relies on courts and the written law to solve conflicts, decentralized finance relies on what is written in code. 

What do all the terms in Defi mean?

Ether (ETH)

Ether is the native cryptocurrency on the Ethereum blockchain, and the fuel that makes the whole system run. If you want to submit data to the Ethereum blockchain, you pay transaction fees. Transaction fees (called “gas”) are normally paid with ETH. ETH is the second most traded cryptocurrency after Bitcoin. 

Stablecoin

A stablecoin is a cryptocurrency which does not fluctuate in value. Therefore it is easier to use it as a means of payment, just like USD. Stablecoins are backed by some digital asset, like normal money, cryptocurrency or even gold. There are hundreds of stablecoin projects.

DAI

Dai is an example of a stablecoin. It is the first decentralized stablecoin on the Ethereum blockchain, which means it’s not controlled or managed by one single party. Its value is soft-pegged 1:1 to the US Dollar. The peg is maintained by clever incentive mechanisms in the Dai system. The Dai system is governed by owners of the MKR token. 

MKR is the governance token for the Dai Credit System. MKR owners have the important responsibility of making decisions that will impact the future of the Dai system, such as its long term interest rate (called the “stability fee”). 

The DAI stablecoin is created using a CDP. This is done by sending collateral (ETH) to a locked account, which you can loan DAI against. A CDP always needs 150% collateral. For example, for 150 dollars worth of ETH, you can loan max 100 DAI. If the price of ETH falls below 150 dollars, your collateral is auctioned off. 

Peer-to-peer

Usually when people send things to eachother over the internet, it travels via one or several servers (for example, when you send an email, it probably travels through Google’s servers). Peer-to-peer means that that email goes directly from you to the recipient, without going through a server. 

Fiat

Fiat is what crypto people call normal money. US Dollar, British Pounds, Japanese Yen, Chinese Yuan and Indian rupi are all fiat money. The opposite of fiat money is crypto.  

Wei

Similar to the various small-value coins that are in circulation for real-world fiat currency like the nickel, dime and penny, Wei is the denomination to refer to the fractional value of Ether (ETH). Wei is the smallest denomination of Ether. 

1 Ether =  1,000,000,000,000,000,000 Wei (one billion billion Wei). 

1,000,000,000 Wei = 1 GWei 

Gas

Gas is transaction fees on the Ethereum blockchain. 

Compound Finance

Compound Finance is a system for borrowing and lending crypto assets. You can lend out your assets through Compound and earn interest, or you can borrow assets (e.g. for gearing investments) and pay interest. When you lend an assets to Compound, it is put into a “liquidity pool”. 

Liquidity pool

Compound is the first “liquidity pool” — instead of lending assets directly to another user, you supply liquidity to a market, and other users borrow from that market. Such a market is called a liquidity pool, and there are many examples of similar liquidity pools.

A cToken represents a crypto asset which gives you interest. A cToken is what you get back if you lend your crypto asset on Compound. For example, cETH is ETH that is lent on Compound and accrues interest. 

cDAI

cDAI is a stablecoin that is loaned out on Compound and therefore gives the holder interest. 

rDAI

rDAI is similar to cDAI. However, instead of getting the interest payment to your own wallet directly, you can choose to give the interest to some other wallet which is not yours. You could give it to charity, or you can “stream” payments to a service you’re using. 

Uniswap is a protocol and program on the Ethereum blockchain where you can swap tokens with a few clicks. Uniswap is also a liquidity pool. 

Kyberswap is, just like Unswap, a swapping service on Ethereum. Kyberswap gets liquidity from several external sources, where Uniswap is one of these. 

Using Sets removes the need to manually manage multiple assets and rebalance your portfolio. Sets automatically rebalance to make executing any portfolio strategy (e.g. range bound trading) simple by holding a single asset. 

Wrapped token

There are many different blockchains. Most of these blockchain have a native token in their system. For Ethereum this is Ether. For the Bitcoin blockchain it is Bitcoin. By using some clever math, you can make these other native tokens available on Ethereum by “wrapping” them. For example is wrapped Bitcoin (WBTC) the first token on Ethereum backed 1:1 with Bitcoin.

Staking

In blockchains you need a mechanism to make sure that each new block of transactions added to the chain is valid. Staking is a mechanism where you volunteer to check if new blocks are valid, and in return get a monetary reward for your effort. To make sure that you don’t do anything evil, you need to register something valuable that can be removed if you act maliciously. This is your “stake”. On Ethereum you have to stake 32 ETH to become a so-called validator; a person who checks and validates new blocks.