DeFi Glossary
The complete DeFi dictionary with 101+ terms explained. From blockchain basics to advanced Aave features, all with practical examples.
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DeFi Fundamentals8 terms
DeFi (Decentralized Finance)
Financial services built on blockchain without traditional intermediaries like banks. Uses smart contracts to automate lending, trading, and other financial activities.
Aave, Uniswap, and Compound are examples of DeFi protocols.
Smart Contract
Self-executing code on the blockchain that automatically enforces the terms of an agreement. Once deployed, it runs exactly as programmed without human intervention.
When you deposit ETH into Aave, a smart contract automatically tracks your deposit and calculates interest.
Protocol
A set of rules and smart contracts that define how a DeFi application works. Different protocols offer different services (lending, trading, etc.).
Aave is a lending protocol, while Uniswap is a trading protocol.
TVL (Total Value Locked)
The total amount of assets deposited in a DeFi protocol. A key metric for measuring protocol size and user trust.
Aave has $10B TVL, meaning users have deposited $10 billion worth of crypto into the protocol.
dApp (Decentralized Application)
An application that runs on a blockchain network rather than centralized servers. Users interact with dApps through their crypto wallets.
Uniswap, Aave, and OpenSea are popular dApps on Ethereum.
Web3
The vision of a decentralized internet built on blockchain technology, where users own their data and interact peer-to-peer.
Web3 applications let you log in with your crypto wallet instead of username/password.
Permissionless
A system that anyone can access without needing approval. Core principle of DeFi - no KYC or gatekeepers.
Anyone with a crypto wallet can use Aave - no account application or credit check required.
Composability
The ability for DeFi protocols to work together like building blocks. Protocols can integrate with each other to create complex strategies.
Deposit ETH in Aave, use the aETH in Yearn for yield farming - protocols "compose" together.
Lending & Borrowing12 terms
Collateral
Assets you deposit to secure a loan. If you fail to repay or your position becomes undercollateralized, the collateral can be liquidated.
You deposit 10 ETH as collateral to borrow $20,000 USDC.
LTV (Loan-to-Value)
The maximum percentage of collateral value you can borrow. An 80% LTV means you can borrow up to $80 for every $100 of collateral.
ETH has 80% LTV on Aave. With $35,000 ETH collateral, you can borrow up to $28,000.
Liquidation Threshold
The LTV percentage at which your position becomes eligible for liquidation. Higher than max LTV to provide a safety buffer.
ETH has 80% max LTV but 83% liquidation threshold. You can borrow at 80%, but you're liquidated at 83%.
Health Factor
A number indicating your position's safety. Above 1 is safe, below 1 means liquidation. Higher is safer.
With $35,000 collateral (83% threshold) and $20,000 debt: HF = (35000 × 0.83) / 20000 = 1.45
Liquidation
When Health Factor drops below 1, your collateral is sold to repay debt. You lose collateral plus a liquidation penalty (usually 5-10%).
If ETH drops 30% and your HF goes below 1, liquidators can repay your debt and claim your ETH at a discount.
Liquidation Penalty/Bonus
The discount liquidators receive when buying your collateral. It's a penalty for you (you lose extra) and a bonus for them (incentive to liquidate).
A 5% liquidation penalty means liquidators buy your ETH at 5% below market price.
Utilization Rate
Percentage of deposited assets currently being borrowed. Affects interest rates - higher utilization means higher rates.
If $80M USDC is borrowed from $100M deposited, utilization is 80%.
Overcollateralized Loan
A loan where collateral value exceeds the borrowed amount. Standard in DeFi because there's no credit system.
Deposit $1,500 worth of ETH to borrow $1,000 USDC - the loan is 150% collateralized.
Borrowing Power
The maximum amount you can borrow based on your collateral value and the asset's LTV ratio.
With $10,000 ETH at 80% LTV, your borrowing power is $8,000.
Reserve Factor
Percentage of interest payments that go to the protocol treasury. Funds protocol development and safety reserves.
A 10% reserve factor means 10% of all interest paid by borrowers goes to the Aave treasury.
Borrow Cap
Maximum amount of a specific asset that can be borrowed from the protocol. Limits exposure to risky assets.
If GHO has a 35M borrow cap, only 35 million GHO can be borrowed total across all users.
Supply Cap
Maximum amount of an asset that can be deposited into the protocol. Prevents overexposure to single assets.
A supply cap of 200,000 ETH means no more can be deposited once that limit is reached.
Interest & Yield10 terms
APR (Annual Percentage Rate)
The simple annual interest rate without compounding. What you'd earn/pay if interest was calculated once per year.
10% APR on $1,000 = $100 interest after one year (no compounding).
APY (Annual Percentage Yield)
The effective annual rate including compound interest. Always higher than APR when compounding occurs.
10% APR compounded daily ≈ 10.52% APY. On $1,000, you'd earn $105.20 instead of $100.
Variable Rate
Interest rate that changes based on supply and demand. Most DeFi rates are variable.
USDC supply rate might be 5% today and 8% tomorrow if demand increases.
Stable Rate
A semi-fixed interest rate that doesn't change as frequently. Available on some protocols for borrowing.
Aave offers stable rate borrowing which protects you from rate spikes, but starts higher than variable.
Yield Farming
Strategies to maximize returns by moving funds between protocols, leveraging, or earning protocol tokens.
Supplying ETH, borrowing stablecoins, and using them in another protocol to earn additional yield.
Interest Rate Model
An algorithm that determines borrow and supply rates based on utilization. Designed to balance supply and demand.
When utilization hits 80%, rates spike sharply to incentivize deposits and discourage borrowing.
Optimal Utilization
The target utilization rate where interest rates are most efficient. Rates increase sharply above this threshold.
Aave targets 80% optimal utilization for most assets. Rates are stable below 80%, spike above.
Base Rate
The minimum interest rate charged when utilization is zero. Sets the floor for borrowing costs.
A 2% base rate means borrowers pay at least 2% APR even when no one else is borrowing.
Slope 1 / Slope 2
How quickly rates increase below (Slope 1) and above (Slope 2) optimal utilization. Slope 2 is steeper.
Slope 1 of 4% means rates climb slowly up to optimal. Slope 2 of 75% means rates spike quickly above optimal.
Real Yield
Sustainable yield from actual protocol revenue, not token emissions. More reliable long-term.
Aave earns real yield from interest spread - the difference between what borrowers pay and lenders receive.
Trading & Liquidity10 terms
Liquidity Pool
A collection of funds locked in a smart contract. Users deposit tokens to provide liquidity for trading or lending.
When you supply USDC to Aave, it goes into a liquidity pool that borrowers can access.
AMM (Automated Market Maker)
A protocol that uses mathematical formulas to price assets instead of order books. Enables trading without counterparties.
Uniswap uses the x*y=k formula to automatically set prices based on pool ratios.
DEX (Decentralized Exchange)
A cryptocurrency exchange that operates without a central authority. Users trade directly from their wallets.
Uniswap, Curve, and SushiSwap are popular DEXs on Ethereum.
Slippage
The difference between expected and actual trade price due to market movement or low liquidity.
You expect to buy ETH at $3,500 but get filled at $3,520 due to a large order ahead of you.
Price Impact
How much your trade moves the market price. Larger trades have bigger impact, especially in low-liquidity pools.
A $10K swap might have 0.1% price impact, while a $1M swap could have 2% impact.
Impermanent Loss
Loss that occurs when providing liquidity to AMM pools. Happens when token prices diverge from when you deposited.
You provide ETH/USDC liquidity. If ETH price doubles, you'd have been better off just holding ETH.
Liquidity Provider (LP)
Someone who deposits assets into a liquidity pool to enable trading. Earns fees from trades.
LPs on Uniswap earn 0.3% of every trade in their pool, proportional to their share.
LP Token
A token representing your share of a liquidity pool. Can be staked for additional rewards or used as collateral.
Deposit ETH+USDC into Uniswap, receive UNI-V2 LP tokens representing your pool share.
Arbitrage
Profiting from price differences between markets. Arbitrageurs help keep prices consistent across exchanges.
If ETH is $3,500 on Uniswap but $3,520 on Binance, buy on Uniswap, sell on Binance for profit.
MEV (Maximal Extractable Value)
Profit that miners/validators can extract by reordering, inserting, or censoring transactions in a block.
A bot sees your large trade, front-runs it to profit from the price movement you create.
Risk & Security11 terms
Oracle
A service that provides external data (like prices) to smart contracts. Critical for DeFi protocols to function correctly.
Chainlink oracles tell Aave the current ETH price to calculate Health Factors.
Oracle Manipulation
An attack where someone manipulates price feeds to exploit a protocol. Often targets low-liquidity price sources.
Manipulate a DEX price to make bad collateral appear valuable, then borrow against it.
Flash Loan
A loan that must be borrowed and repaid in the same transaction. No collateral needed because it's atomic.
Borrow $1M USDC, arbitrage a price difference, repay $1M + fee - all in one transaction.
Flash Loan Attack
Using flash loans to exploit protocol vulnerabilities. Can manipulate prices or drain funds.
Borrow massive amounts via flash loan to manipulate DEX prices, exploit lending protocol, repay loan.
Rug Pull
A scam where developers abandon a project and steal user funds. Usually happens with unaudited protocols.
Developers drain liquidity pools or mint unlimited tokens, crashing the price.
Smart Contract Audit
Professional security review of smart contract code to identify vulnerabilities before deployment.
Aave has been audited by Trail of Bits, OpenZeppelin, and Certora.
Bug Bounty
Rewards offered by protocols for responsibly disclosing security vulnerabilities.
Aave offers up to $250,000 for critical vulnerability reports through Immunefi.
Multisig (Multi-Signature)
A wallet requiring multiple private keys to authorize transactions. Used for protocol governance and treasury.
A 3-of-5 multisig requires any 3 of 5 keyholders to approve a transaction.
Timelock
A delay between when a governance action is approved and when it executes. Gives users time to exit if needed.
Aave has a 24-hour timelock on governance changes so users can react to controversial updates.
Protocol Risk
The risk that a protocol's smart contracts have bugs or design flaws that could lead to loss of funds.
Even audited protocols can have undiscovered bugs. Never deposit more than you can afford to lose.
Bad Debt
Debt that cannot be repaid because collateral value fell below debt value before liquidation occurred.
During a flash crash, a position went from healthy to bad debt before liquidators could act.
Tokens & Standards10 terms
ERC-20
The standard interface for fungible tokens on Ethereum. Defines how tokens can be transferred and tracked.
USDC, AAVE, and UNI are all ERC-20 tokens that follow the same standard.
Stablecoin
A cryptocurrency designed to maintain a stable value, usually pegged to $1 USD. Used as the "cash" of DeFi.
USDC, USDT, and DAI are popular stablecoins, each with different backing mechanisms.
Algorithmic Stablecoin
A stablecoin that maintains its peg through algorithms and incentives rather than reserves.
UST (Terra) was an algorithmic stablecoin that collapsed when its mechanism failed.
Wrapped Token
A token that represents another asset on a different blockchain. Allows cross-chain compatibility.
WBTC (Wrapped Bitcoin) is an ERC-20 token on Ethereum that represents BTC.
WETH (Wrapped ETH)
An ERC-20 version of ETH. Required because native ETH doesn't follow the ERC-20 standard.
Many DeFi protocols require WETH instead of ETH for technical compatibility.
Governance Token
A token that gives holders voting rights in protocol decisions. Often also used for staking.
AAVE token holders can vote on protocol upgrades and parameter changes.
Receipt Token
A token you receive when depositing assets, representing your claim on the deposited amount plus interest.
Deposit USDC into Aave, receive aUSDC. The aUSDC balance grows as interest accrues.
Rebasing Token
A token whose supply automatically adjusts to maintain a target price or distribute rewards.
aTokens rebase - your balance increases as you earn interest without any transactions.
Liquid Staking Token (LST)
A token representing staked assets that can still be used in DeFi while earning staking rewards.
stETH represents staked ETH - you earn staking rewards while using stETH in Aave.
Liquid Restaking Token (LRT)
A token representing assets that are staked across multiple protocols/layers simultaneously.
Deposit ETH to earn Ethereum staking + EigenLayer restaking rewards in one token.
Blockchain & Gas9 terms
Gas
The fee paid to process transactions on Ethereum. Measured in units of computational work.
A simple transfer costs ~21,000 gas. A complex DeFi transaction might cost 200,000+ gas.
Gas Price (Gwei)
The price per unit of gas, measured in Gwei (1 billionth of ETH). Higher prices = faster confirmation.
At 50 Gwei, a 100,000 gas transaction costs 0.005 ETH (~$17.50 at $3,500 ETH).
Gas Limit
The maximum gas you're willing to spend on a transaction. Protects against unexpectedly expensive operations.
Set gas limit to 150,000. If the transaction needs more, it fails and you only lose gas spent so far.
Layer 1 (L1)
The main blockchain network (Ethereum, Bitcoin, Solana). Provides security and finality.
Ethereum mainnet is a Layer 1. All L2s ultimately settle their transactions on L1.
Layer 2 (L2)
Networks built on top of L1 for faster, cheaper transactions. Inherit security from the main chain.
Arbitrum and Optimism are L2s where Aave transactions cost cents instead of dollars.
Rollup
An L2 scaling solution that bundles many transactions into one L1 transaction. Reduces costs dramatically.
Arbitrum and Optimism use rollups to make DeFi 10-100x cheaper than Ethereum mainnet.
Bridge
A protocol for moving assets between different blockchains or L1/L2 networks.
Use the Arbitrum bridge to move ETH from Ethereum mainnet to Arbitrum for cheaper DeFi.
Block
A batch of transactions confirmed together on the blockchain. New blocks are added every ~12 seconds on Ethereum.
Your transaction enters the mempool, then gets included in a block when confirmed.
Mempool
The waiting area for unconfirmed transactions. Transactions sit here until included in a block.
Your transaction is pending in the mempool. Higher gas price = higher priority to be included.
Wallet & Transactions7 terms
Wallet
Software that stores your private keys and lets you interact with the blockchain. Your gateway to DeFi.
MetaMask, Coinbase Wallet, and Ledger are popular wallet options.
Private Key
A secret number that proves ownership of your crypto. Never share it - whoever has it controls your funds.
Your private key is like your password. Lose it = lose access. Share it = lose funds.
Seed Phrase (Recovery Phrase)
12 or 24 words that can regenerate all your private keys. Write it down, store it safely, never share.
"apple banana cherry..." - these words can restore your entire wallet on any device.
Transaction Hash (Tx Hash)
A unique identifier for a blockchain transaction. Use it to track your transaction's status.
Your tx hash: 0x123...abc. Look it up on Etherscan to see if it confirmed.
Approval (Token Approval)
Permission you grant to a smart contract to spend your tokens. Required before most DeFi interactions.
Before depositing USDC into Aave, you must approve the Aave contract to access your USDC.
Revoke
Removing a token approval you previously granted. Good security practice for unused approvals.
Use revoke.cash to remove old approvals from contracts you no longer use.
Nonce
A sequential number for each transaction from your address. Ensures transactions process in order.
If you have a stuck transaction, you can send a new one with the same nonce to replace it.
DeFi Strategies7 terms
Leverage
Borrowing to amplify your exposure. Multiplies both gains and losses.
Deposit $10K ETH, borrow $7K USDC, buy more ETH. Now you have $17K ETH exposure with $10K capital.
Looping
Repeatedly depositing, borrowing, and redepositing to amplify leverage or earn more rewards.
Deposit ETH → borrow USDC → buy ETH → deposit ETH → repeat for 3x leverage.
Recursive Borrowing
Same as looping - using borrowed funds as collateral to borrow more, building leverage.
Common strategy to maximize AAVE reward emissions by increasing both supply and borrow.
Delta Neutral
A strategy with no exposure to price movements. Profits from yield regardless of market direction.
Long $10K ETH spot + short $10K ETH futures. Price movements cancel out, you collect funding.
Carry Trade
Borrowing a low-rate asset to invest in a higher-rate asset. Profits from the rate differential.
Borrow USDC at 5% APR, lend DAI at 8% APY = 3% profit on the spread.
Stablecoin Farming
Yield farming strategies using only stablecoins. Lower risk than volatile asset farming.
Provide USDC/DAI liquidity on Curve for ~5% APY with minimal price risk.
Yield Aggregator
A protocol that automatically moves your funds to the highest-yielding opportunities.
Yearn Finance automatically shifts your stablecoins to the best lending rates.
Aave-Specific Terms12 terms
aTokens
Interest-bearing tokens received when you deposit into Aave. Your aToken balance increases over time as you earn interest.
Deposit 100 USDC → receive 100 aUSDC. After a year at 5% APY, you have ~105 aUSDC.
Debt Tokens
Tokens representing your debt in Aave. Variable debt tokens change balance as interest accrues.
Borrow 1000 USDC, receive variableDebtUSDC. Balance grows as interest accrues.
E-Mode (Efficiency Mode)
A feature allowing higher LTV when borrowing correlated assets. Reduces capital requirements for safer pairs.
In stablecoin E-Mode, you can borrow USDC at 97% LTV using DAI as collateral (both are ~$1).
Isolation Mode
A risk management feature where certain assets can only be used as collateral in isolation, not mixed with other collateral.
A new, volatile token might be in Isolation Mode with limited borrow capacity.
Siloed Borrowing
Restricts an asset to only be borrowed if it's the only borrowed asset. Prevents mixing risky borrows.
If GHO is siloed, you can borrow GHO or USDC, but not both at the same time.
GHO
Aave's native decentralized stablecoin, minted directly by borrowers against their collateral.
Instead of borrowing USDC, you can mint GHO directly at potentially lower rates.
Facilitator
Entities authorized to mint and burn GHO. Can be protocols or the Aave pool itself.
The Aave V3 pool is a GHO facilitator - users can mint GHO by borrowing against collateral.
Safety Module
Aave's insurance fund where users stake AAVE to protect the protocol. Stakers earn rewards but risk slashing.
Stake AAVE in the Safety Module to earn ~7% APR. If bad debt occurs, up to 30% could be slashed.
stkAAVE
The token received when staking AAVE in the Safety Module. Represents staked position and can vote on governance.
Stake 100 AAVE → receive 100 stkAAVE. Unstaking has a 10-day cooldown period.
Cooldown Period
The waiting period before you can unstake from the Safety Module. Currently 20 days for stkAAVE.
Activate cooldown, wait 20 days, then have a 2-day window to unstake.
Merit Program
Aave's reward program for users who contribute to protocol health through safe borrowing and participation.
Maintain healthy positions and participate in governance to earn Merit rewards.
Credit Delegation
Allowing another address to borrow against your collateral. Enables uncollateralized loans for trusted parties.
Deposit ETH, delegate credit to a friend's address. They can borrow against your collateral.
Governance & DAOs5 terms
DAO (Decentralized Autonomous Organization)
An organization governed by token holders through on-chain voting. No central management.
Aave DAO controls the protocol through proposals and votes by AAVE token holders.
Governance Proposal
A formal suggestion to change protocol parameters or add features. Must pass a vote to execute.
AIP-123 proposes to add a new collateral asset. Token holders vote yes/no.
Quorum
The minimum number of votes required for a proposal to be valid.
A proposal needs 320,000 AAVE voting for quorum. Below that, it fails regardless of yes/no ratio.
Snapshot
A gasless off-chain voting platform. Often used for temperature checks before on-chain votes.
Community votes on Snapshot first to gauge support, then formal proposal goes on-chain.
Treasury
Protocol-owned funds controlled by governance. Used for development, grants, and emergencies.
Aave treasury holds ~$50M in various assets controlled by AAVE holders.