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PHY is an abbreviation for the physical layer of the OSI model and refers to the circuitry required to implement physical layer functions. A PHY connects a link layer device (often called MAC as an abbreviation for media access control) to a physical medium such as an optical fiber or copper cable.
More specifically, the Ethernet PHY is a chip that implements the hardware send and receive function of Ethernet frames; it interfaces between the analog domain of Ethernet's line modulation and the digital domain of link-layer packet signaling.