Investing in cryptocurrencies has increased dramatically over the past decade as investors seek better and more rapid returns. If this is your first foray into the world of crypto, however, you may find some of the terminology confusing. To help demystify at least some of these terms, we’ve created this handy glossary. While not comprehensive, this should provide you with a basic understanding of some of the most common cryptocurrency terms for the field of investment.
Common Cryptocurrency Terms
Each cryptocurrency transaction is identified by a specific address. Without this address, a transaction cannot be logged or recorded. If a coin can’t be verified, it can’t be owned.
Bitcoin first appeared in 2011, and since then, many other forms of cryptocurrency have been created. The term ‘altcoins’ refers to any form of cryptocurrency other than Bitcoin. Currently Ethereum is the largest and most popular form of altcoin, but others (like Chainlink and Aave) are emerging.
A block chain is a ledger of all transactions made using a particular cryptocurrency. Transactions are grouped in blocks, with new blocks opened as old ones fill up. Each block is linked to another by a cryptographic signature. In some cases, as with Bitcoin, this ledger is accessible by the public, allowing you to trace any Bitcoin transaction. Other cryptocurrencies, like Monero, have block chains that are not viewable by the public, allowing transaction histories to remain private.
Cold Wallet, Cold Storage
The world of cryptocurrency is more fluid than many other marketplaces, and the opportunities for corruption and abuse of the system exist. For this reason, many choose to store their cryptocurrencies in a digital wallet that is not connected to the Internet. This ‘cold wallet’ lets you store your crypto securely, so that only you can access your transaction information.
Cryptocurrencies are only one form of digital currencies. Some digital currencies are tied to flat (paper) currencies, while others exist only in the digital sphere. These forms of digital currency rely upon trust among the parties using them, while crypto transactions (such as those using Bitcoin) can be tracked and verified in real time.
Each crypto transaction is attached to a fee. So each time you ask a miner to receive cryptocurrency for you, this fee must be paid. In the world of cryptocurrencies, this fee is called a “gas price”—these can add up quickly and account for a major expense for crypto investors.
An intentional misspelling of the word “hold,” HODL refers to the act of retaining cryptocurrency assets for long periods, even during a volatile market cycle. It was created to discourage impulse selling and rein-in volatility. Some also refer to the term as an acronym for “hold on for dear life.”
Initial Coin Offering
Similar to an initial public offering (IPO) of stocks or securities, an initial coin offering (or ICO) refers to the launch of a new form of cryptocurrency. Investors who buy into the offering receive a new crypto token issued by that company.
Mining is the process used to verify new transactions on a blockchain. When someone donates computer power to a miner to complete an encryption challenge, that donor is then rewarded in cryptocurrency.
A computer connected to the blockchain network is referred to as a node. A full node can download all pieces of a specific blockchain’s data and fully validate transactions.
Non-fungible Tokens (NFTs)
A non-fungible token is a unique and non-interchangeable unit of data stored on a digital ledger. NFTs can be used to represent easily-reproducible media like photos, videos, and audio. NFTs also use blockchain technology to establish a verified and public proof of ownership in crypto transactions.
A private key is a security measure to protect the currency in your wallet. An alphanumeric data string, the private key lets only the holder access critical and personal account data. Caution: To avoid data compromise, don’t share your private key with anyone.
Proof of: Authority, Stake, Work
The world of crypto transactions is maintained by a system of verification, allowing each transaction to be logged, recorded, and stored. Proof of authority, proof of stake, and proof of work are each consensus mechanisms aimed at validating some action or transaction within the system.
Proof of Authority
Gives a single private key the authority to validate a transaction or to generate all the blocks in a chain.
Proof of Stake
Allows an individual validator to affirm transactions or blocks.
Proof of Work
Allows a miner who solves for a group of variables (“hashing a block”) to verify their work and to be rewarded in crypto.
Crypto transactions require a key pair: the public and private key. You can derive a public key from a private key, but not vice versa. The public key is obtained and used by anyone to encrypt messages before they are sent to a known recipient with a matching private key for decryption. By pairing a public key with a private key, transactions do not depend on trusting either involved parties or intermediaries.
In crypto, as with any currency, it’s essential to keep a ledger of all transactions. A public ledger maintains participants’ identities anonymously, their respective cryptocurrency balances, and a record of all verified transactions executed between network participants.
A crucial part of blockchain security, the seed phrase is a set of ordered words corresponding to a set of determined values. Your control over your account is tied to this secret recovery phrase. Do not share this info with anyone. This seed will allow you to restore/recover your account in the event of a breach or network failure.
Imagine a contract that could execute its own actions to keep you current and compliant. A smart contract is a computer program or a transaction protocol designed to automatically execute, control, or document legally relevant events and actions according to the terms of a contract or an agreement.
An asset built upon a blockchain is referred to as a token.
Your ‘wallet’ is a secure location where your crypto assets are stored. Each wallet is linked to an address for sending and receiving funds.
A high-value crypto address is referred to as a ‘whale.’ Whale accounts are most often held by top-level crypto investors with high-value portfolios.
To learn more about the tax implications of cryptocurrency mining, check out our recent blog post
We hope this glossary has helped you better understand the world of cryptocurrencies. Want to learn more about investing in crypto? Contact the professionals at Moskowitz LLP. We help taxpayers and investors get the most for their money.