PYMNTS Cryptocurrency Glossary: The Basics

Cryptocurrency is a confusing business with a language all its own, in part because it is a genuinely new way of doing business and in part, because it was created in large part by programmers and cryptographers, who should never be allowed to name anything regular people will use.

Cryptocurrencies have a lot of uses as an investment, as a currency for payments, as a store of value, as well as others. Like any investment, it’s vital to know what you’re talking about and more importantly, what the person trying to sell you something is really saying. And like any other field of finance, industry, art or basically every human endeavor, it has its own lingo, its own acronyms and its own definitions.

In this series of articles, we’re going to create a number of glossaries for various parts of the crypto industry, which we’ll combine into a larger reference tool. Today, we’re talking about the basics of bitcoin and blockchain, but we’ll also be looking at regulatory and legal terms, decentralized finance (DeFi) stablecoins and central bank digital currencies non-fungible tokens (NFTs) and metaverses and more.

Altcoin: Any cryptocurrency other than bitcoin is an altcoin. In practice, it’s less used for Ethereum’s ether token.

Bitcoin: The first cryptocurrency is “a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution,” according to the Bitcoin Whitepaper, which describes both its purpose and the blockchain technology it is built on. The largest and by far the best-known digital asset, it accounts for about 40% of the global market capitalization of all cryptocurrencies as of August 2022. That’s down from more than 50% as recently as last year.

Blockchain: A blockchain is a distributed ledger on which information, once written, cannot be deleted, changed or reordered. In crypto, blocks of transactions are gathered up, validated by mining or staking, and written onto the blockchain on a regular basis — bitcoin is every 10 minutes, Ethereum every 12 seconds and others in a tiny fraction of a second — in exchange for a reward of newly created tokens and transaction fees. Blockchains rely on geographically distributed “nodes” — basically servers with a full copy of the blockchain, which is being added to in real time — that must agree that a block of transactions is valid to keep the transactions honest, accurate and uncensorable.

Cryptocurrency: A digital asset that can be used as a store of value or medium of transaction on a blockchain. The movement of most cryptocurrencies can be tracked on a publicly accessible blockchain, but the identities of their owners are hidden behind cryptographic keys.

Decentralization: The key principle of blockchain is that there is no centralized controlling person or entity making it both secure and free of individual, corporate or government control.

Double Spend: The core problem bitcoin and blockchain solved is to allow payments between two parties without a third, trusted party like a financial institution in the center. Each transaction block is timestamped and a cryptographic “hash” — think a scrambled picture of the data — is used to connect it to the one in front and behind so that changing any data would require changing all hashed transaction blocks before and after it.

Ethereum: The second largest blockchain by market cap and arguably the most important, Ethereum introduced self-executing smart contracts that are responsible for almost every use of blockchain beyond its original purpose as decentralized currency for payments.

Ether: The native token of the Ethereum blockchain, it is known by the exchange symbol ETH and is used to settle all transactions by decentralized apps (DApps) and platforms built on Ethereum. Most supply chains, DeFi, NFTs and pretty much every other use of blockchains either use ether or Ethereum-standard tokens that can be thought of as white-labeled ether.

Fork: When one or more miners or validators disagree with the majority, the minority is expelled and a blockchain is forked. Think of it as adding a second link to one link on a metal chain that moves off in another direction. Whichever one is longer — the one with more mining power behind it is the “official” chain. For example, when Bitcoin Cash (BCH) supporters wanted to increase Bitcoin’s block size — the number of transactions a block can hold — they were outvoted and started a new blockchain with a new block size that shares a past with bitcoin.

Genesis Block: The first block of a blockchain, from which all others follow. Think of it as one end of the chain onto which new transactions cannot be added, like a link embedded in a wall. Bitcoin’s block zero was mined on Jan. 3, 2009 at 1:15 p.m. ET.

Halving: Many blockchains have a limited number of tokens that can be minted — Bitcoin’s is 21 million — to make them noninflationary and to preserve the value of tokens. Halving is a way to decrease the number of crypto tokens a blockchain mints when a new block is added. This extends the time before a chain runs out of new tokens and must rely on transaction fees to reward the miners or validators who secure it.

Layer 2: A Layer 2 is a blockchain that sits on top of another one, metaphorically speaking, to make the bottom layer more scalable, as Lightning Network does for Bitcoin. All of the transaction work made on a Layer 2 blockchain takes place “off-chain” with only the finalized transaction data being sent down “on-chain” to be written onto the blockchain. The makes the blockchain faster and transaction fees lower by freeing up space on the main blockchain.

Mining: The technique used to randomly choose who wins the opportunity to write a new block onto a “proof-of-work” (PoW) blockchain in exchange for a reward. This “consensus mechanism” secures the blockchain by randomizing the validator. Unfortunately, the process, which is essentially a race to solve a math puzzle by guessing potential answers caused an arms race of sorts in Bitcoin and to a somewhat lesser extent Ethereum when the tokens got so valuable. More and more powerful specialized computers were added, and now each of the blockchains uses more energy than whole countries — a pollution problem causing blockchain serious reputational problems.

Private key and public key: Each bitcoin has two key codes. A set public key that identifies it and can be tracked, and a one-time-only private key that is necessary to send it to another digital wallet. A new private key is generated when the cryptocurrency token arrives at a new wallet address. Lose it, and the coin is forever useless as it cannot be transferred.

Proof of work: A PoW consensus mechanism is used in mining (see above).

Proof of Stake: An environmentally friendly consensus mechanism that has essentially replaced PoW mining on virtually all new blockchains, PoS relies on validators who put up “stakes” — essentially bonds for good behavior that are “slashed” or seized for bad behavior.

Quantum computing: This is a potential blockchain bogeyman. If scientists can make quantum computing work, computing power would rise by so many orders of magnitude that the hashing cryptography used to secure blockchains could theoretically be broken.

Smart contract: Smart contracts are essentially “if-A-then-B” programs that can be used to make self-executing contracts that pay out when a pre-determined action or period of time takes place. Invented on Ethereum, one party can lock ether (or other) tokens into a contract that cannot be broken or ended unilaterally (or even by both sides agreeing in many cases). It is essentially a way of making “trustless” contracts — meaning you don’t need to trust the other person because the smart contract acts as the trusted third party instead of a bank, for example.

Stablecoin: A type of cryptocurrency pegged one-to-one to a specific fiat currency. The main and safest way to do this is for the issuer to create a reserve of that fiat currency or highly liquid investments (like short-term U.S. treasuries) that back the stablecoin, giving users confidence that they can always redeem one stablecoin for a dollar (or euro, or ounce of gold, whatever). Other, less safe methods exist, including algorithmic stablecoins that use a smart-contract controlled arbitrage mechanism with a second coin to maintain the peg.

Staking: Putting up a stake of tokens as a bond for good behavior when validating a proof-of-stake blockchain.

Validator: The person who takes the miner’s role in a proof-of-stake blockchain. The validator gathers and organizes transactions, determines that they are valid, and then writes them onto a blockchain for a reward of new tokens and transaction fees.

Tomorrow, we’ll look at some regulatory and legal terms used in the blockchain industry.

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