11 DeFi lending terms you need to know

DeFi lending terms can be overwhelming to anyone new to the decentralized finance world. With words and concepts like tokenization, dApps, self-paying loans, and smart contracts, it can almost feel like you’re learning an entirely new language. 

If you’re looking to take advantage of some DeFi lending services, or just want to familiarize yourself with the lingo used in the industry, check out these 11 important terms you need to know.

What is DeFi lending?

DeFi lending works much the same way as regular lending in the traditional financial world, except that it is decentralized, meaning there is no one institution or company in control. Instead, DeFi lending works via smart contract technology and dApps. 

This comes with several advantages for those in need of a loan as well as those looking to earn passive income by lending out their crypto. 

For example, instead of a borrower going to a bank and needing to meet certain criteria to qualify for a loan, they can use a lending dApp to almost instantly receive a loan regardless of their financial status, as long as they have enough crypto to deposit as collateral.

DeFi lending also serves as a way for crypto investors to make passive income from their crypto by lending it out to institutional investors. 

In this situation, an investor opens an account with a firm or company, such as BlockFi, and then deposits some crypto. The firm uses the deposit for investment purposes and then distributes the gains into the user’s account. 

It almost functions like a savings account with a bank, except the amount earned in reward is much higher than traditional interest rates.

11 DeFi terms you need to know

1. Crypto-backed loan

Definition: A crypto-backed loan is a type of secured loan where cryptocurrency is used as collateral. It functions similar to a savings account with a bank: an investor opens an account, deposits their crypto, and is able to earn interest at rates much higher than a traditional savings account. 

These firms lend the deposits to other institutions to make their own trades, which results in rewards for the investor who loaned out their crypto. This is a great way to earn some income from crypto especially for those who don’t want to sell it.

While you don’t need a credit check or other criteria to get a crypto-backed loan, you do need to keep in mind that the crypto you use for collateral will still be subject to changes in market prices. Some types of crypto loans can even be self-paying.

Example sentence: I used my BTC as collateral in a crypto-backed loan in exchange for fiat currency that I used towards purchasing a new home.

2. Decentralized/trustless

Definition: When something is decentralized, it means that no one individual or company has absolute control over it. Instead, the control is distributed among a group of people who all have equal influence. 

In the crypto world, decentralization is a central feature of any blockchain. Another word for decentralized is “trustless.” This is because in traditional, centralized financial systems, you have to trust a middleman to handle things properly. 

For example, trusting the government not to inflate the currency, or trusting your bank to send your money to another account. In a trustless (or decentralized) system, there is no need for an intermediary, because you have direct control over your own assets and there is no central authority.

Example sentence: Bitcoin is the first decentralized cryptocurrency because it runs on a proof-of-work blockchain that is distributed among a vast network of computers.

 3. DeFi tokenization protocol

Definition: A DeFi tokenization protocol refers to a set of standards or rules that help govern the creation of tokens. 

Much the same way that “HTTPS” is a protocol used by a majority of websites on the internet, dApps and other decentralized services run on their own protocols, some of which even have their own native coins that can be purchased and staked to have a voice in the future development of the protocol. 

There are DeFi protocols written for various sectors of the DeFi world, including lending, but tokenization protocols focus specifically on the process of tokenization. These rules are written into autonomous software programs, all of which are interoperable and can be used by anyone to create a tokenization service or dApp. 

Example sentence: The developer integrated the Synthetix protocol into a new dApp to help tokenize real-world assets in the real estate industry.

4. dApp

Definition: dApp stands for decentralized application. A decentralized application is a smart contract-based software program that runs on a blockchain network. 

They function just like any other app you might use on your phone, but with the difference that no central authority or company is controlling them.

Instead, these apps are open source and run on a network of peer-to-peer computers, ensuring that it remains decentralized. Dapps can be used for a variety of purposes like gaming, social media, finance, and video streaming.

Example sentence: Check out this cool token swapping dApp I found on the Ethereum network; it lets you compare different decentralized exchanges so you can find the best trading prices.

5. Future yield

Definition: Future yield is a general investing term that refers to the return that an investor can expect to earn on their investment by holding it over a certain period. The same concept translates to the world of DeFi lending when evaluating the future yield an investor can expect from their crypto assets.

Example sentence: The future yield from holding my AVAX tokens for a year will be 20%. 

6. Self-repaying loan

Definition: A self-repaying loan is a type of self-paying loan that borrows against the future yield of an investment. So as your crypto holdings increase in value, you can use those earnings to pay off your debts, without having to sell off your crypto completely.

Example sentence: As the value of my BTC investment grew, I was able to use the earnings as a self-paying loan to help pay off my mortgage.

7. Smart contract

Definition: A smart contract is a type of computer program that acts as a self-executing, digital contract. The terms of the contract are written in the program’s code, and the contract runs on a blockchain, so it is decentralized, trackable, and unchangeable. 

Smart contracts remove the need for any middlemen in a transaction, because the computer tracks the terms of the contract, and as soon as they are met, it automatically allows the outcome to occur. Smart contracts are the programs used to create dApps.

Example sentence: Once I made the payment, the smart contract was executed and I automatically received the asset in my account.

8. Synthetic asset

Definition: A synthetic asset is a tokenized version of an original asset. The tokenized asset derives its value from the original asset, so it’s worth the same. 

In the DeFi world, synthetic assets may be preferred over non-synthetic ones because they are very liquid, easy to trade across borders, and there are fewer barriers to entry for gaining a synthetic asset compared to the original version.

Example sentence: Instead of buying actual gold, I was able to buy a synthetic asset that represented gold, which made it much easier for me to trade.

9. Synthetic stablecoin

Definition: A stablecoin is a type of cryptocurrency that is attached to the value of the U.S. dollar, so that one stablecoin is equal to the value of $1. A synthetic stablecoin, on the other hand, is the result of a crypto company creating its own version of a stablecoin. 

The company intends for these coins to also represent the value of the dollar. The purpose is typically to make it easier for users to trade on the platform.

Example sentence: Because of its stable value, I converted some of my crypto holdings to Gemini dollar (GUSD) so that I could take out a crypto-backed loan.

10. Transmute

Definition: Transmutation means changing one thing into another. In the context of DeFi lending, it can refer to exchanging one crypto for another. Someone may want to do that if one crypto has more widespread use than the other.

Example sentence: I was able to transmute my UNI tokens to BTC so that I could use them to make a purchase.

11. Yield tokenization protocol

Definition: A yield protocol refers to a set of rules or standards used by a dApp or service to help users tokenize their future yields on an asset. Tokenizing future yields has the benefit of “locking in” a user’s current interest rate so that it becomes fixed.

Yield tokenization is also beneficial for those who wish to participate in yield speculation but don’t have a large amount of capital to do so.

Example sentence: The Superposition app on the Solana network uses a yield tokenization protocol to help users tokenize and trade the future yield on their assets.

Why you should learn DeFi lending terms

It’s important to have a solid understanding of the terms and concepts in any industry before participating, but especially so when it comes to decentralized finance. By taking the time to learn the lingo of the DeFi lending world, you can better understand how these types of crypto-backed loan services work. When you have that knowledge, you’ll be able to make wiser financial decisions about how to use your crypto.