Mastering DeFi.pdf

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THE ULTIMATE BEGINNER’S GUIDE TO
DECENTRALIZED FINANCE
VERSION: 1.0.0
LAST UPDATED: April 22nd, 2021
Marko Mihajlović
Index
Index
Introduction
Quick Glossary
What is DeFi?
How does DeFi work?
Blockchain
Ethereum & Smart Contracts
The DeFi Ecosystem: Use Cases
Decentralized exchanges (trading)
Lending
Derivatives
Yield Farming
Insurance
Stablecoins
Governance
How governance works in practice
The Future of DeFi
Introduction
DeFi has grown at an unprecedented rate. In fact, the speed at which new concepts and
innovations arrive is so dramatic that veterans and beginners alike fail with keeping up and
understanding its ever-growing importance. As with any other subject, information overload is
very likely unless we approach the right data in a structured, intuitive, and progressive way.
Mastering DeFi is a book written for beginners who are familiar with basic blockchain and crypto
concepts but have not yet dared to tread into the world of decentralized finance. This book
carefully explains every facet of DeFi, while placing a major emphasis on its use cases,
features, and platforms.
While we initially provide you with an abstract understanding of DeFi’s significance in not only
the blockchain industry but in the real world as well, a major portion of the book revolves around
comprehending specific and popular use cases as a way of gaining understanding decentralized
finance through practical knowledge. By covering decentralized exchanges, yield farming,
lending, derivatives, stablecoins, insurance, and other topics, the reader becomes capable of
knowing how DeFi works at the level of an experienced user.
Before venturing further, we recommend our readers to glance through the quick glossary and
explore fundamental DeFi words and concepts.Although crypto is known for its slang, there are
indeed technical terms which must be understood before exploring a sector as complex as
decentralized finance.
We would also like to note that the first edition of Mastering DeFi was written in April 2021 and
that some of the information presented here might change with time. Most of the fundamental
concepts will likely remain the same while various data points of financial nature will change.
Quick Glossary
Audit
Refers to a project's code being reviewed for soundness by a party outside of the organization.
Typically, a DeFi protocol project will have a professional third party evaluate the code for
feedback on weak points, allowing them to implement patches (if necessary) before going
public.
APY
Short for Annual Percentage Yield, APY is one of the most important concepts in DeFi. It refers
to the return on investment you can expect from an asset in a one-year period. APY rates tend
to fluctuate wildly in DeFi; therefore, they are best used as approximate measures.
AMM
Automated Market Maker is a smart contract that holds liquidity reserves in the form of crypto
assets. Users interact with the AMM when offering liquidity or trading cryptocurrencies.
Essentially, an AMM is an alternative used in DeFi markets that removes the need for order
books, which are traditionally employed by centralized exchanges.
CeFi
Centralized finance, commonly used as a reference to projects like Celsius, Nexo, and BlockFi
that operate like normal centralized organizations within the DeFi space.
TradFi
Refers to traditional finance or centralized finance institutions like banks and other legacy
institutions.
CEX
Short for centralized exchange. CEXs include Coinbase, Binance, Huobi, Gemini, and Kraken.
DEX
Short for decentralized exchange. DEXs include Uniswap, Curve, SushiSwap, 1inch Exchange,
Synthetix, and Balancer.
Collateral
Assets deposited and used to back a loan. Depositing collateral on crypto lending platforms like
Compound and Aave is typically done to stake and receive APY while simultaneously borrowing
more crypto.
Derivatives
Financial products deriving their value from an underlying asset are known as derivatives.
ERC-20
Ethereum-standard cryptocurrency assets are built and issued using the ERC-20 protocol. Any
cryptocurrency token issued on Ethereum is an ERC-20 by design.
Flash loan
A flash loan is an instant cryptocurrency loan that does not require collateral, KYC checks, or
any other form of upfront investment from the borrower.
Governance & governance tokens
Governance refers to the maintenance, enforcement, and regulation of a decentralized protocol
by token holders. Usually, when a DeFi protocol is released, it does so with a native asset which
is used to participate in the decision-making process.
Impermanent loss
Impermanent loss refers to the loss of assets deposited while yield farming during extreme price
swings.
KYC
Know Your Customer (KYC) is a basic identity check required by centralized financial
institutions.
Liquidity
The amount of circulating supply for a given token paired with trading volume, exchange
availability, and other trade factors determine how liquid or illiquid a token is.
Liquidity pool
Liquidity pools are smart contracts that hold onto a protocol’s liquidity and distribute them to
users.
Liquidity provider
DeFi participants who deposit their tokens into liquidity pools.
LP token
When a liquidity provider deposits tokens into a liquidity pool, their stake is represented by a
minted LP token. The LP token represents the staked asset(s) and can yield farm other DeFi
platforms or be exchanged back for the original assets.
Decentralized Oracle
Decentralized oracles provide both on and off-chain price data to blockchains / DeFi protocols.
Slippage
Slippage refers to the gap in price that exists between what you're willing to pay for an asset
and the seller's best price.

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