C4 C4 DeFi & Smart Contracts 1 — Questions and Answers
Question 1: What is decentralized finance (DeFi)?
- A government-backed digital currency system
- A financial ecosystem built on public blockchains that provides financial services without centralized intermediaries (Correct answer)
- A consortium of crypto-friendly banks
- A regulatory framework for cryptocurrency exchanges
Correct answer: A financial ecosystem built on public blockchains that provides financial services without centralized intermediaries
DeFi refers to open, permissionless financial protocols built on smart contract platforms (primarily Ethereum) that replicate and extend traditional financial services without banks or brokers.
Question 2: What is a smart contract?
- A legally binding digital agreement stored in a corporate database
- Self-executing code deployed on a blockchain that automatically enforces predefined rules when conditions are met (Correct answer)
- An encrypted PDF contract signed with a private key
- A smart routing algorithm used by decentralized exchanges
Correct answer: Self-executing code deployed on a blockchain that automatically enforces predefined rules when conditions are met
A smart contract is immutable, self-executing code on a blockchain that automatically enforces terms without the need for intermediaries.
Question 3: What is an Automated Market Maker (AMM) in DeFi?
- A bot that places orders on centralized exchanges
- A smart contract protocol that uses liquidity pools and a pricing formula to enable permissionless token swaps (Correct answer)
- A market surveillance tool used by regulators
- An algorithm that automates portfolio rebalancing
Correct answer: A smart contract protocol that uses liquidity pools and a pricing formula to enable permissionless token swaps
AMMs like Uniswap use liquidity pools and formulas (e.g., x*y=k) to price and execute token swaps without an order book or central counterparty.
Question 4: What is a liquidity pool in a DeFi protocol?
- A reserve fund held by a centralized exchange
- A smart contract holding reserves of two or more tokens contributed by liquidity providers to facilitate trading (Correct answer)
- A mining pool that aggregates hash power
- A pool of stablecoins used to back a CBDC
Correct answer: A smart contract holding reserves of two or more tokens contributed by liquidity providers to facilitate trading
A liquidity pool is a smart contract that holds token reserves deposited by liquidity providers, enabling decentralized trading and earning fees for providers.
Question 5: What is impermanent loss in the context of providing liquidity to an AMM?
- A permanent loss due to a smart contract hack
- The temporary reduction in value a liquidity provider experiences compared to simply holding tokens, caused by price divergence between pooled assets (Correct answer)
- Interest charged for borrowing from a lending protocol
- Slippage incurred during a large token swap
Correct answer: The temporary reduction in value a liquidity provider experiences compared to simply holding tokens, caused by price divergence between pooled assets
Impermanent loss occurs when the price ratio of pooled assets changes from deposit time, leaving the LP with less dollar value than if they had just held the tokens.
Question 6: What is a governance token in a DeFi protocol?
- A token issued by a government to represent digital fiat
- A token that grants holders voting rights over protocol parameters, upgrades, and treasury decisions (Correct answer)
- A token used only to pay gas fees on a blockchain
- A non-fungible token representing identity on a DeFi platform
Correct answer: A token that grants holders voting rights over protocol parameters, upgrades, and treasury decisions
Governance tokens (e.g., UNI, COMP) allow holders to propose and vote on changes to the protocol's rules, fee structures, and smart contract upgrades.
C4 C4 DeFi & Smart Contracts 1
What is decentralized finance (DeFi)?