The growing number of special terms used in the blockchain space can be dizzying. This glossary – updated on an ongoing basis – is your straightforward reference guide.
A majority of 51% attack is a potential assault on the integrity of a blockchain system, in which an individual or organization gain control of more than half of the total hashing power of the network. The attacker(s) can then potentially override the consensus mechanism of the network and commit malicious acts such as double-spending. It would give the assailant(s) enough mining power to modify the ordering of transactions, prevent transactions from being confirmed (transaction denial of service) and to prevent some or all other miners from mining, leading to a mining monopoly.
The term Airdrop refers to the distribution of digital assets to the public, yet requiring no purchase by the recipient. In other words, the assets are distributed for free. In contrast, during an ICO, the digital asset being offered is typically purchased using an alternate coin or token. Airdrops are often used as marketing instruments to raise awareness of a coin or token. It is also a method of diversifying asset holders.
After the launch of the first cryptocurrency, bitcoin, the alternative coins that followed were referred to as altcoins. Today, the widely used Ethereum cryptocurrency, ether, is generally not considered an altcoin, and the term is mainly used in reference to recently launched digital currencies.
Digital assets that are backed by reserves of real-world assets, such as company shares, real estate, diamonds or commodities are termed asset-backed tokens. They fall into a subcategory of security tokens and represent digital titles of ownership to shares in a physical and tangible asset. Asset-backed tokens are equivalent to IOUs that must be collateralized.
Based on smart contracts, an atomic swap is a technology that enables the exchange of different cryptocurrencies on a peer-to-peer basis with no need for a centralized exchange or other intermediaries. Also known as atomic cross-chain trading, atomic swaps allow trading even if the cryptocurrencies are running in different blockchain networks. One advantage of atomic swaps is enhanced security, as users do not provide their private keys at any time. In addition, transaction costs are lower because there is no need for centralized exchanges and there are no deposit, withdrawal or trading fees.
Created in 2009 by an unidentified individual or group operating under the pseudonym Satoshi Nakomoto, the Bitcoin blockchain forms the basis of the first and most well-known cryptocurrency or digital money, the bitcoin. Its technology was originally introduced in a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”
An exchange traded fund or ETF is an investment vehicle linked to the performance of a particular asset or group of assets. Investors use ETFs to diversify their investment portfolios without actually owning the assets tracked by an ETF, making the solution a simpler alternative to buying and selling individual assets. A bitcoin ETF reflects the market price of the digital currency, enabling investors to buy into the ETF without the complicated process of trading bitcoins.
In essence, a blockchain is a distributed ledger, a consensus of replicated, shared and synchronized digital data spread across multiple sites, countries and/or institutions. It is made up of unchangeable, digitally recorded data in packages called blocks. Each time a transaction takes place, the block is linked to the next block by means of a cryptographic signature. A chain of blocks – a blockchain – forms, which serves as a ledger that can be shared and accessed by anyone with the appropriate authorization.
In blockchain applications and cryptocurrencies, bounties originated to combat cybercrimes, rewarding users with bounties for locating hackers or recovering a hacked account. Today, bounty programs serve mainly marketing and promotional purposes. There are also bounties for reporting bugs and improving software. The bounty is paid in bitcoins or native tokens that can be exchanged for bitcoins or fiat money on a trading platform.
A mechanism used in computer and blockchain systems to establish agreement on a data value or state of a network, the consensus mechanism is used in cryptocurrencies and in areas like record-keeping. In centralized systems like databases for administrative information, e.g. about driver’s licenses, a central administrator has the authority to maintain and update the database. Public blockchains, in contrast, operate as decentralized, self-regulating systems on a global scale without central authority. Hundreds of thousands of participants contribute by working to verify and authenticate transactions occurring on a given blockchain.
As digital money, cryptocurrencies have no physical form, yet can be traded as legal tender. They use digital encryption to regulate generation of units of currency and verify the transfer of funds. Cryptocurrencies can operate independently of a central bank.
The user’s blockchain or cryptocurrency address functions as a secure identifier. In combination with the public and private keys, it enables transactions between different users within the blockchain network. The address is generated based on the public key, a long and unwieldy string of characters that is easy to mistype. To create the more practical address, the cryptocurrency wallet runs the public key through a number of cryptographic algorithms. The resulting address is equipped with a checksum, a value indicating the number of bits in the transmission. Should the checksum and actual number of bits not match, an error is detected and the transaction rejected.
The process of verifying cryptocurrency transactions by solving complex computational math problems with high-powered computers is called mining. The computer operators earn “block rewards” in form of cryptocurrency for their mining efforts. Their highly demanding computations result in 64-digit codes termed “hashes” that are used to add blocks to the blockchain and, in so doing, verify transactions. Working alone or in groups, miners compete to be first to calculate the correct hash, which must be less than or equal to the target hash. The odds of this happening by chance are currently lower than one in six trillion. This, coupled with the fact that these verification computations take place within a decentralized blockchain network, is what makes cryptocurrencies virtually impossible to duplicate.
The term DeFi, short for decentralized finance, encompasses a number of blockchain-powered platforms. These enable individuals to forego traditional banks and take control of financial transactions like borrowing, lending, making payments, buying insurance or trading derivatives. To make this possible, DeFi platforms use smart contract technology, in most cases operating on the Ethereum blockchain. Because they are based on a blockchain, DeFi platforms are controlled by peer-to-peer (P2P) computer networks, rather than by central authorities. Most use open-source protocols or modular frameworks for creating and issuing digital assets. This is why DeFi is resistant to censorship as well as being more widely and easily accessible than traditional financial services. The financial services and instruments currently offered by DeFi platforms include lending protocols, issuance platforms, decentralized prediction markets and exchanges.
As an open blockchain-based software platform, Ethereum enables developers to build and run decentralized apps (termed dapps). The public blockchain network has its own cryptocurrency, ether.
Fiat to crypto
The process of converting cash into digital money can be summed up in the term fiat to crypto. Purchasing cryptocurrencies with state-issued fiat currency is subject to strict regulations. Exchanges that enable such fiat-crypto transactions, termed on-ramps and off-ramps, require special licenses, which are time-consuming and costly to acquire. An easier fiat-to-crypto option is to accept cryptocurrency as payment for services rendered. For this, the user needs a cryptocurrency wallet and address as well as public and private keys, but little else.
Initial coin offering (ICO)
An ICO is a fundraising event for a cryptocurrency or decentralized finance application (dapp). Generally, it requires a white paper to explain the new concept, how it works and the reason for its potential value, as well as a Website to make it accessible to the public, but little else. Investors purchase the digital asset in hope that it will become widely circulated and increase in value. Given sufficient demand, the asset can then be freely sold and traded on cryptocurrency exchanges.
Initial exchange offering (IEO)
A fundraising event administered by an exchange, an IEO allows users to purchase digital assets via an established third-party entity (the exchange). In contrast, an initial coin offering (ICO) is a fundraising event run by the project team itself. In an IEO, users make purchases with funds from their own exchange wallets, which requires them to open an account on the exchange and deposit some funds. The benefit to users is that they don’t need different wallets for transactions on different blockchains via the exchange. In addition, since the exchange’s reputation depends on the legitimacy of the projects on its platform, established IEOs tend to inspire trust.
The electronic devices that make up a blockchain network are termed nodes. Various devices including computers, Smartphones and even printers can function as nodes, provided they are connected to the Internet and have an IP address. Nodes support the network by recording, and in some cases processing, transactions within a given blockchain. There are different types of nodes, including mining nodes that add blocks to the blockchain and are rewarded for these efforts in cryptocurrency.
On-ramps and off-ramps
To deposit and withdraw value from cryptocurrency exchanges, users can take advantage of special exchanges termed on-ramps and off-ramps. An on-ramp allows deposits of conventional (fiat) currency, which it converts into cryptocurrency, facilitating entry into the crypto trading space. Conversely, an off-ramp enables crypto traders to convert their digital assets back into products, services or fiat currency. On- and off-ramp exchanges generally charge transaction fees, which are paid in crypto. To prevent misuse and ensure compliance with international anti-money-laundering (AML) regulations, on- and off-ramps have strict know-your-customer (KYC) procedures to verify the identity of users.
Peer-to-peer (P2P) network
One of the cornerstones of blockchain technology is the peer-to-peer (P2P) network, in which participants utilize a distributed and decentralized network of Internet-connected electronic devices and, in the process, verify the legitimacy of the network. Each device, or node, is considered equal, yet can play different roles within the blockchain ecosystem. The essence of the P2P setup is that, rather than being verified by a central authority, transactions on the blockchain are recorded and legitimized by vast numbers of interconnected players. With no central point of storage or dominant authority, it is virtually impossible for a single party to censor transactions or otherwise pursue an individual agenda.
Private and public keys
Cryptocurrencies rely on public-key and private-key cryptography to verify the identity of users and authorize transactions. Three pieces of information come into play: a public key that is visible to all, a private key, which the user keeps secret, and the address, a shorter, representative form of the public key. The public key and address allow others to transfer funds to the wallet. Transfers from the user’s wallet to another wallet are possible only with the user’s private key. This encryption “signs” the transaction and indicates to the entire network that the transaction is authorized, yet without disclosing the private key. The system owes its security to the strict separation of these three codes: there is no way to derive the public or private key from the address, and the public key offers no indication of the private key.
Traditional securities are tradable financial assets. Although their precise definition varies between jurisdictions, securities usually derive their value from external, tradable assets, and can be divided into three main groups: debt securities (banknotes, bonds, debentures), equity securities (common stocks) and derivatives (forwards, futures, options and swaps). A security token is a digital asset representing one of these traditional securities, but in a tokenized, digital form. To qualify as a security, a token must represent a financial investment in a common enterprise or group of enterprises with an expectation to profit from the work of those third parties. Tokens that do not qualify as securities are generally called utility tokens.
As a computer protocol recorded on a blockchain, a smart contract can verify transactions transparently and reliably. Smart contracts digitally facilitate or enforce a contract, allowing the performance of credible transactions without third parties. As a blockchain is a decentralized system that exists between all permitted parties, they are virtually impossible to falsify and are deemed trustless, in that there is no need to establish trust between transacting parties.
A cryptocurrency that is backed by a reserve of external assets, a stablecoin seeks to offer the stability of a conventional (fiat) currency combined with the instant processing and cross-border trading of digital currencies. To achieve this, most stablecoins are collateralized by means of asset reserves. These can be holdings in a fiat currency like the US dollar or commodities such as precious metals or oil. Alternatively, a stablecoin can be backed by deposits of other cryptocurrencies. A fourth variant is the non-collateralized stablecoin, which uses algorithms to make ongoing adjustments in a manner similar to a central bank. The dollar-pegged Basecoin, for example, uses a consensus mechanism to decrease or increase its supply and stabilize its value.
All blockchains require validation of transactions, and staking achieves this based on consensus. Users lock cryptocurrencies within a wallet to validate a transaction and produce new blocks on the blockchain. As these new blocks are created, stakers receive a share of the rewards. The process works with all cryptocurrencies that use a proof-of-stake (PoS) algorithm.
Digital units of ownership recorded on a blockchain are referred to as tokens. A token serves as an accounting unit proving ownership and providing transparency throughout all transactions. They generally fall into two categories, utility tokens and security tokens. A utility token is issued for a specific purpose, for example, to provide users with a certain product and/or service within a closed system. A security token, on the other hand, represents an investment. To qualify as a security, a token must represent a financial investment in a common enterprise or group of enterprises with an expectation to profit from the work of those third parties. Security tokens usually derive their value from external, tradable assets.
The term tokenization refers to the process of issuing digital tokens representing units of ownership, which are recorded on a blockchain. A token then serves as an accounting unit proving ownership and providing transparency throughout all transactions. Tokenization on a blockchain enables investors to liquefy real-world assets, while retaining their solidity as investments. As it vastly widens the group of potential buyers, eliminates the need for third-party brokers, accelerates the business process and reduces transaction costs, tokenization has the potential to enhance the attractiveness of investment in real-world assets. This in turn can increase the market value of the assets involved.
Digital assets designed to be traded exclusively within a specific blockchain ecosystem are termed utility tokens. These tokens simply provide users with a product and/or service. They are also used to incentivize users, for example, rewarding users who offer data storage space as in the case of Filecoin. Utility tokens are used in a number of special incentive schemes that encourage people to perform specific actions within an ecosystem. For example, there are token incentive models to reward renewable energy use.
A cryptocurrency wallet enables digital transactions, asset management and interaction with various blockchains. Wallets use public and private keys to enable users to send and receive digital currency and monitor their balance. Unlike physical wallets, digital wallets do not store currency, but rather the keys to access it. When users transfer currency via a wallet, they sign over ownership of assets recorded on the blockchain to the address of the recipient’s wallet. Wallets can be divided into three categories: software, hardware and paper. They are designed to run on desktop computers, mobile devices or online. Software wallets can be apps installed on mobile and/or desktop devices or cloud-based solutions that can be accessed from any device. Hardware wallets are dedicated devices developed specifically for a given software solution. Although transactions take place online, hardware wallets store transactions and keys offline. The term paper wallet can refer to a physical copy or printout of the user’s public and private keys or can be to a software solution used to securely generate keys, which are then printed.