Decentralized Finance (DeFi) and Tokenization Flashcards

What is impermanent loss in the context of DeFi liquidity provision?

Answer: The temporary value difference between holding assets vs. providing them as liquidity when prices diverge

Impermanent loss occurs when the price ratio of assets in a liquidity pool changes from the deposit time, causing the LP position to be worth less than simply holding those assets would have been.

What is a Decentralized Exchange (DEX)?

Answer: A blockchain-based peer-to-peer exchange enabling token swaps without a central intermediary

A DEX is a peer-to-peer exchange built on blockchain smart contracts that enables token swaps without requiring users to trust or hand custody of funds to a centralized party.

What is slippage in the context of DeFi trading on an AMM?

Answer: The difference between the expected trade price and the actual executed price due to liquidity depth

Slippage is the difference between the expected price of a trade and the actual execution price, occurring due to price movements or insufficient pool liquidity during transaction processing.

What is the primary function of a governance token in a DeFi protocol?

Answer: To grant holders voting rights over protocol parameter changes and treasury decisions

Governance tokens grant holders the right to vote on protocol changes, fee structures, treasury allocations, and other decisions, enabling decentralized collective governance of the protocol.

What is a wrapped token such as Wrapped Bitcoin (WBTC)?

Answer: A tokenized 1:1 representation of another asset enabling it to be used on a different blockchain's ecosystem

A wrapped token is a tokenized 1:1 representation of another cryptocurrency, enabling it to be used on blockchains with different native standards (e.g., WBTC brings Bitcoin's value to Ethereum's DeFi ecosystem).

In DeFi, what defines a Decentralized Autonomous Organization (DAO)?

Answer: An organization governed by smart contract rules and token holder votes rather than centralized management

A DAO is an organization whose operational rules are encoded in blockchain smart contracts, with governance decisions executed automatically based on token holder voting outcomes.

What is the primary risk that distinguishes custodial wallets from non-custodial wallets in DeFi?

Answer: Custodial wallets give a third party control over private keys, introducing counterparty and insolvency risk

With custodial wallets, a third party holds the private keys, creating counterparty risk — if the custodian is hacked, freezes withdrawals, or becomes insolvent, users may permanently lose access to their assets.