Blockchain and digital asset terminology
INSIGHT ARTICLE |
Address: Cryptocurrency addresses are used to receive and send transactions on the network. An address is a string of alphanumeric characters, but can also be represented as a QR code.
Airdrop: The act of distributing digital assets to a set number of addresses without any consideration from those addresses. Companies looking to distribute their digital assets to the whole ecosystem and generate interest by receiving parties usually conduct airdrops. Airdrops may create additional tax events.
ASIC: Application-specific integrated circuit are a class of computing chips and equipment that are specifically designed and optimized for mining cryptocurrency on different blockchains. The most common types of ASICs are used in mining bitcoin and are significantly more efficient than graphics processing unit (GPU) computing chips.
Atomic swap: A technology that uses smart contracts to exchange cryptocurrencies deployed on different blockchains without the use of centralized exchanges or trusted third parties.
Bitcoin: An encrypted digital currency operating through blockchain technology independent of a central bank.
Bitcoin Improvement Proposal (BIP): Developers send BIPs to their community as a proposed code update to the bitcoin protocol. These proposals can be in various stages, including proposed, in discussion, accepted and implemented.
Block: A file where transactions and/or other data are permanently recorded. It is the digital equivalent of a page in a ledger or record book. This block is mathematically (cryptography) tied to the prior block in the chain, thus creating tamper resistance. A transaction block refers to a collection of transactions on the bitcoin network, gathered into a block that can then be hashed and added to the blockchain.
Blockchain: A distributed ledger technology in which records are kept in blocks that are linked via cryptography, allowing for immutability and preventing duplication of digital data or value.
Block reward: The reward given to a miner that has successfully hashed a transaction block. Block rewards can be a mixture of coins and transaction fees, depending on the policy used by the cryptocurrency in question, and whether all the coins have already been successfully mined. The current block reward for the bitcoin network is 25 bitcoins for each block.
Byzantine fault tolerance: A consensus algorithm that is generally designed to be used between trusted parties in a permissioned, consortium blockchain model. This algorithm comes in a variety of different forms, but all are based on providing transaction finality without cryptocurrency rewards while still maintaining the ability to defend against both accidental and intentional failures.
Centralized exchange: An online digital asset marketplace in which a company or other intermediary facilitates the trading. Because a centralized party has control of all wallets on the exchange, personal assets stored there are at risk in the event of financial mismanagement or unauthorized access.
Cold/hot storage: The level of security associated with wallets that provide access to digital assets within a wallet address. Hot storage refers to the higher risk level of security, which is exposed to various types of malware and social engineering attacks (but offers greater ease of use and efficiencies). Cold storage refers to the lowest risk level of security (which is completely offline and therefore, not at risk of malware and social engineering attacks as long as they are never connected to the internet). Cold storage is also more time-consuming and can make management of digital assets more difficult. Significant operational security management and processes may need to be established for both hot and cold storage methods.
Confirmation: A confirmation means that the blockchain transaction has been verified by the network. This happens through a process known as mining, in a proof-of-work system (e.g., bitcoin). Once a transaction is confirmed, it cannot be reversed or double spent. The more confirmations a transaction has, the harder it becomes to perform a double-spend attack.
Consensus: When all network participants agree that transactions are valid, either guaranteeing that the majority of nodes has an identical copy of the ledger or some other means of governance when using various consensus models, has dictated that the transaction is valid.
Consensus algorithm: A computer process, specification or set of rules used to achieve agreement on a data value among distributed systems.
Consortium blockchain: A partially private blockchain in which a few selected nodes are predetermined.
Cryptocurrency: A digital currency utilizing cryptography to create units of currency and verify funds transferred independent of a central bank.
Cryptography: The act of encryption, decryption and signing, which converts ordinary information into unintelligible text and back again or establishes legitimacy of a message or transaction. This is generally through the use of public/private key pairs.
Decentralized application (Dapp): An open-source application that stores its data on a blockchain, operates autonomously using smart contracts and utilizes tokens to incentivize use.
Decentralized exchange (DEX): A digital asset marketplace in which a protocol facilitates peer-to-peer trades that are settled on the blockchain. Users can trade directly from wallets that they control, which provides an added level of security.
Digital signature: Generated by public key encryption, a digital signature is a code attached to an electronically transmitted document to verify its contents. This technology is leveraged in a wide variety of securing transmissions, conversations and content.
Distributed ledger: A ledger that is shared and updated in real time between many parties that may be dispersed geographically, across industries or in a controlled, segregated way internally. It may or may not be permissioned and can vary in use of consensus algorithms.
Double-spend: Refers to the most significant problem that cryptocurrency and blockchain helped solve, the “double-spend problem,” i.e., the ability to spend the same digital coins twice from one wallet address.
ERC20: A specific token standard for the creation of new digital assets based on top of the Ethereum blockchain. The vast majority of tokens that are not protocol-based are ERC20 tokens. ERC stands for Ethereum Request for Commit, which is similar to a bitcoin BIP.
Ethereum blockchain: A distributed public blockchain that differs in capabilities from bitcoin. While Ethereum can operate as a peer-to-peer electronic cash system, unlike bitcoin, it carries extensions that allow Turing complete programmatic “smart contracts” to be codified and operate within the blockchain.
Ethereum Virtual Machine (EVM): EVM is Turing complete and allows anyone in any location to execute arbitrary EVM byte code. All Ethereum nodes run on the EVM. The project is designed to prevent denial-of-service attacks. It is home to smart contracts based on the Ethereum blockchain.
Fiat: Government-issued currency.
Fork: A split in the storage and future computations of an existing blockchain. It may be contentious, in that it creates a new blockchain while the original continues to operate (bitcoin versus bitcoin cash). A soft fork is one implemented without affecting the existing protocol level code. A rule change that creates blocks recognized as valid by the old software but not the new that can result in a potential divide in the blockchain as the old software generates blocks seen as invalid according to the new rules. A hard fork is when participants must upgrade their nodes to continue to participate. This may create additional tax events if holding a forked asset. If you participate in running a node that requires a hard fork, you may have infrastructure-related impact.
Gas: The transaction fee, paid in ether, required to send a transaction or execute a smart contract on the Ethereum blockchain.
Genesis block: The first block in the creation of a blockchain, where generally all available cryptocurrencies and/or data are held within a singular wallet that is disbursed to a variety of others.
Hardware wallet: A type of wallet that is an offline, cold storage solution. It may provide ease of use through compact, offline USB keys that sign transactions. Debatably, it is the easiest and safest solution for parties looking to self-custody digital assets.
Hashing: A hash function is a tool in cryptography that turns any information or value input into a hash output of a fixed length to enable security during transmission. A hash function is deterministic so any small change to the input will have a drastic change to the output. It is also pseudorandom, meaning that the output hash does not tell you anything about the input that produced it.
Hashrate: The number of hashes that can be performed by a bitcoin miner in a given period of time (usually a second).
Hyperledger: A specific permissioned blockchain infrastructure design. It is partially customizable in terms of the consensus algorithm used, but generally uses different forms of Byzantine fault tolerance models. It is currently one of the most popular infrastructures designed for permissioned consortium blockchains and comes in various types.
Initial Coin Offering (ICO): A method of fundraising where investors purchase newly minted tokens, which will eventually be used in the proposed blockchain, Dapp or service. Investors purchase these tokens with the hope that they will increase in value or utility once they begin trading on exchanges. U.S. investors should understand the legal implications (and international residents) of participation in an ICO.
Immutability: The inability to alter or manipulate previously accepted data within its block.
Internet of things (IoT): A network of connected hardware devices that can transmit information such as identity or location, or readings such as speed, temperature or weight. IoT can be used to take a snapshot of the current state of an item and then record that information to the blockchain, allowing for real-time traceability. Items can be tracked all the way along the supply chain by using radio-frequency identification chips to uniquely identify them.
Interoperability: The ability to easily share information or transact across completely different blockchain networks.
Keys (public/private): Blockchains are built using public-key cryptography, a system that employs the use of keys, or pieces of computer code to sign, encrypt and decrypt information sent via the internet. On a blockchain, the key pairs are used to generate blockchain wallets. The public key is a publicly known address used for identity verification and encryption purposes to send information or funds. Private keys should be known only by the owner and used so only the private key holder can decrypt the information with the corresponding public key in the pair.
Know your customer (KYC)/Anti-money laundering (AML): Know your customer regulations require financial institutions to perform due diligence on its customers. This involves collecting official identity information from customers to assist companies in better identifying and preventing suspicious financial activity. Anti-money laundering regulations are meant to prevent the generation of income by illegal means. Similar to KYC, companies must also perform due diligence activities on its customers to identify individuals with money laundering risk. Many companies in the blockchain space, most commonly exchanges and ICOs, require that their customers go through KYC/AML approval.
Miner: An incentivized participant in a blockchain network who contributes computational power and acts as validator on a Proof of Work blockchain.
Multisignature (multisig): Refers to a wallet established to require X of Y signatures (keys) in order to authorize a transaction or message broadcasted to the other nodes on a blockchain network. Security implications exist for the management of these wallets.
Nodes: A computer that is connected to the network that receives a copy of the blockchain ledger, updates approved changes to the ledger and can submit changes to the ledger. A node can also be a “full node,” which additionally runs a program to fully validate transactions and blocks (changes) on the ledger.
Oracle: A data feed that links the blockchain to the real world, providing external and executable information. This data feeds are typically leveraged for smart contracts, e.g., a physical package was delivered to an address.
P2P: The decentralized interactions that happen between at least two parties in a highly interconnected network. P2P participants deal directly with each other through a single mediation point.
Permissions: Limitations placed on one allowed to be a validator (i.e., a miner) based on predefined criteria set by an entity, or group of entities, controlling a private blockchain.
Private blockchain: A blockchain in which limitations are placed on both participants and validators (i.e., miners) in a private blockchain.
Proof of Authority: A consensus algorithm that rewards validators based on putting their identity at stake. The right to be the validator of a block is earned. Validators are inversely incentivized to uphold the transaction process integrity and thereby avoid the penalty of a negative reputation.
Proof of Stake: A consensus algorithm that rewards validators based on the number of coins that they hold, or their ‘stake’ of all coins that exist on the network. The more coins held, the more coins may be earned.
Proof of Work: A consensus algorithm that rewards validators (also called miners in context of Proof of Work) based on the amount of computational power, or “work,” that they provide to the network. The more computational power provided, the more coins may be earned.
Provenance: Refers to the ability to prove ownership and authenticity of an item throughout its life cycle.
Pseudo-anonymous identity: Identities, or wallet addresses, that are disguised through cryptographic encryption, typically in the form of a string of numbers and characters.
Public blockchain: There are no limitations placed on who can participate and who is allowed to be a validator (i.e., a miner) in a public blockchain.
Security token: A token whose value is derived from a tradeable, real-world asset, such as equity in a company or a commodity. Since security tokens are designed to be an investment, they must comply with securities laws.
Sign: The act of authorizing a transaction or message on a ledger or blockchain using public and private keys.
Solidity: The most commonly used coding language on the Ethereum-based blockchain. Solidity is a contract-focused programming language that is designed to create smart contracts.
Smart contract: An agreement written into code on the blockchain that automatically executes only when predetermined conditions are met.
Sovereign identity: A form of identity where the actual owner of the identity maintains control and administration. The identity must be transportable and flexible in its control where it cannot be specifically located at one site or storage location.
Testnet: Blockchain networks used as a means to test new upgrades and implementations for the primary blockchain networks. Testnets do not include “real” cryptocurrencies that are tradeable on secondary exchanges for fiat currency.
Three-way match: A concept that the current “two-way match” in accounting will evolve to where a third match is a check by a blockchain system that both parties’ entries for a transaction agree with the underlying transactional and informational support.
Token: Digital assets that represent a particular fungible and tradeable asset or a utility.
Traceability: The ability to trace a product or component in real time at every step along the supply chain.
Transaction fee: A small fee imposed on some transactions sent across the bitcoin network. The transaction fee is awarded to the miner who successfully hashes the block containing the relevant transaction.
Trustless: No need to trust a central entity to act as a facilitator or middleman.
Turing complete: The ability for a blockchain to validate and execute any type of algorithm or situation through programmatic coding that can typically solve any reasonable computational problem. This is an important feature related to smart contracts.
Utility token: A token that is used to pay for products or services within a decentralized application and is not designed as an investment. However, the value of a utility token may increase if demand for the product or service increases.
Wallet: Software or hardware that stores an address and private key, and interacts with blockchain.
Blockchain is changing how companies operate. RSM breaks down the complexities of this disruptive technology.