Glossary For Digital Assets & Cryptocurrency
We define and explain some of the most common definitions and terms in the cryptocurrency and digital asset space in this beginner-friendly glossary.
An airdrop is when a project or token holder distributes a large number of tokens to multiple wallets, usually unsolicited and for free. Airdrops are typically done to incentivize potential new users, reward early adopters, or act as a promotional tool. Airdrops are currently classified as income on the day they are distributed.
A blockchain is a decentralized, distributed ledger that keeps track of peer-to-peer transactions without the need for a centralized entity. Blockchains are immutable, in that once recorded, transactions cannot be reversed.
Each “block” is a series of transactions submitted by individual users. Once a block of transactions is confirmed by the network, it is written to a literal chain of blocks that shows the entire history of every transaction that has ever occurred.
Cryptocurrency is any digital currency that is secured by cryptographic techniques. While digital currency refers to any kind of digital value transfer system, cryptocurrency refers to the specific subset of digital currencies that are backed by decentralized cryptography.
Decentralized Autonomous Organizations are a way of running a company or other organization using transparent, decentralized rules and an open governance process based on tokenized voting rights.
Decentralized Finance (DeFi) refers to banking, lending, and other financial apps that live on top of decentralized blockchains with smart contract capabilities.
Decentralized Exchanges (DEX) are peer-to-peer marketplaces where users can trade cryptocurrencies and other digital equities without the need for an intermediary or central order book, often making use of automated market maker liquidity pools.
Digital asset is a blanket term that refers to cryptocurrencies, coins, tokens, NFTs, and other digital stores of value secured by cryptographic techniques. This is the term preferred by most legislators and regulatory bodies as it encompasses the breadth of technology in this space and is not limited in scope to “currencies.”
A fork is when a blockchain diverges in two different paths. The forks’ shared history will be identical up to the point of forking, but each fork will produce it’s own series of new blocks and diverge from the other.
Gas refers to the computational cost of sending transactions on blockchains with smart contract capabilities. Complex smart contracts require more processing power from the network to execute. Gas is paid for by the base currency of a given blockchain, thus more computationally expensive transactions require a higher gas fee to process.
A governance token is a token that confers governance (voting) rights over its protocol. Many DAPPs issue a governance token to users, thus distributing ownership of the platform directly to those who actively use it. Given governance tokens act similarly to voting shares of stock, these tokens are more likely to eventually be classified as securities.
In cryptography, keys refer to a string of numbers and letters that can provide access to private encrypted data when processed through a cryptographic algorithm. A user’s private key unlocks access to their wallet, and anybody with the correct key can access the corresponding wallet. Centralized service providers often control the private keys to user wallets (and thus have ultimate control of the funds), hence the popular phrase “not your keys, not your crypto.”
Layer 2 is a generalized name for blockchain scaling solutions built on top of a specific underlying blockchain. Layer 2 solutions typically provide performance improvements over the base blockchain and sync up with the underlying blockchain at regular intervals. This allows for faster and cheaper user transactions that the base chain may not be capable of processing.
A core piece of decentralized exchanges and automated market makers. A liquidity pool allows users to directly deposit funds to a protocol via a smart contract, and other users can trade against the funds in that liquidity pool. Users with deposited funds are entitled to a portion of trading fees earned from the liquidity pool.
Nonfungible tokens (NFTs) are digital assets with unique characteristics that cannot be easily swapped for another similar asset. With fungible coins like Bitcoin, any single BTC can easily be swapped for any other BTC and both coins will have the same value. Nonfungible tokens allow for tokenizing data in unique ways, allowing for many novel use cases including digital art, tickets and IDs, inventory tracking, music, and more.
An oracle is a name for intermediaries that provide real-world data to blockchains and decentralized applications. Blockchains are inherently limited to data contained within their own decentralized ledger; they have no way of “knowing” anything that goes on externally. Oracles expand blockchain use cases by bringing novel off-chain data from the real world. Examples include asset prices, event outcomes, weather data, inventory tracking, and random number generation.
Proof of Stake
Proof of Stake is a process where network users must “stake” some of their currency in order to become a validator and secure the network. Bad actors are punished by having their stake slashed, so users are financially incentivized into doing what is best for the network.
This process does not require much energy usage, typically less than 0.1% of the energy required by a proof of work consensus mechanism. This process is typically referred to as “staking.” Blockchains like Ethereum, Cardano, Polygon, and many more use some type of staking mechanism for their consensus mechanism.
Proof of Work
Proof of Work is a process where network validators must expend considerable energy solving mathematical puzzles in order to produce the next block for the entire blockchain. The node that solves the puzzle first gets to record the next block and is rewarded in cryptocurrency for doing so. All other nodes on the network can then validate that this work is correct. This process is typically referred to as “mining.”
Proof of work requires a large amount of energy, but this also makes the network extremely resilient to attack (an attacker would need to expend more energy to attack the network). Cryptocurrencies like Bitcoin, Litecoin, and Monero use proof of work.
Smart contracts are blocks of code that are published to the blockchain that users of that blockchain can interact with. Almost any code or app that can be programmed can be written as a smart contract and deployed on the blockchain.
Use cases of smart contracts include:
Blockchains with smart contract capabilities also have the power to issue independent tokens on that blockchain. One such type of token is stablecoins – digital currencies that are pegged to the price of a real-world currency or asset. Since many cryptocurrencies have highly volatile prices, stablecoins offer a predictable way to transact on these networks.
Types of stablecoins include:
- Backed by USD and hard assets (centralized)
- Backed by other digital assets (decentralized)
- Algorithmic & free-floating (decentralized)
Tokens are digital assets issued on top of another blockchain. Tokens are not used to govern or pay fees on the underlying blockchain, but are used by DAPPs built on that blockchain. Types of tokens include:
- Utility tokens – tokens that perform a specific utility within a decentralized app
- Governance tokens – tokens that grant voting shares and/or profit sharing rights
- Payment tokens – tokens meant to facilitate payments and transfer of value (ie stablecoins)
Validator refers to the physical machines that secure and maintain a decentralized blockchain. For proof of work blockchains like BTC, a validator is an individual miner that runs the software and validates new blocks. For proof of stake blockchains, a validator is an individual staker that is running the software and validating new blocks. The more unique validators a chain has, the more decentralized it is. Hardware requirements to run a validator vary based on the blockchain, and are usually one of the main factors in how decentralized a blockchain is.
Virtual currencies are a type of digital currency, typically controlled by its creators and used and accepted among the members of a specific virtual community. One example would be the in-game currency you buy in Fortnite to purchase different “skins” you use while playing.
A wallet is a device that stores the private and public cryptographic keys for a user on a given blockchain. Wallets make it easier for users to send and receive funds, interact with smart contracts, and cryptographically sign information. Wallets can be software (run on a phone, computer, or browser), or hardware (physical devices connected through USB).