Crypto Jargon: What is DeFi?
DeFi stands for Decentralized Finance. It is some sort of an umbrella to describe financial applications running on blockchain. Decentralization in this case means not relying on traditional financial institutions to invest, lend and borrow for instance.
This generated a whole new world where people can lend and borrow by paying (lower or earning) interest fees that are usually better than the ones practiced by the traditional market because you don’t intermediaries. DEX (Decentralized Exchanges) rely on this type of operations to provide market with liquidity for instance. In order to do so, a new jargon must be explained: AMM.
AMM are Automated Market Makers, something not new that was born in 90’s first implemented by Shearson Lehman Brothers and ATD. AMMs today represent a set of protocols designed to boost DEX performance through liquidity pools.
Without sufficient liquidity to back trading volumes, exchanges become unstable and subject to slippage and wild price swings. This applies for both traditional exchanges (CEX – Centralized Exchange) or DEX. By being a liquidity provider – you can put your money into a liquidity pool and earn commissions based on conversions (e.g. trading ETH for USDT) performed by other users – this become a perfect scheme that fosters both decentralization and anonymity.
In addition to that, AMMs bring to the DEX a model where the asset pricing is pegged to specific mathematical formulas rather than traditional transactional agreements which automates and again decentralizes the whole business model, making it more transparent to the end user.