Entering the world of cryptocurrency involves learning a new language. With terms like blockchain, proof-of-stake, and decentralized networks, the jargon can be overwhelming – especially at first. 

To help you navigate the digital assets discourse, this glossary includes basic crypto terms as well as more advanced concepts. By familiarizing yourself with these definitions, you'll gain a better understanding of key elements that make up crypto and its increasing impact on global finance.

Essential crypto terms and definitions

Blockchain

A blockchain is a decentralized digital ledger that records all transactions across a network of computers. Each transaction is securely stored in a block that is linked to the previous one, forming a chain. This structure uses cryptographic techniques to ensure data integrity and transparency, making it nearly impossible to alter a transaction without altering all subsequent blocks in the chain.

Centralized exchange (CEX)

A CEX is an intermediary that enables its users to buy, sell, and trade cryptocurrencies. CEXs are run by a private organization that provide services like order matching, custody of funds, customer support, and more, offering clients a user-friendly experience. Popular examples of CEXs include Coinbase, Binance, and Kraken.

Cryptocurrency

Cryptocurrency is a type of digital asset that exists exclusively online – examples include Bitcoin (BTC) and Ethereum (ETH). Unlike fiat currencies such as the U.S. dollar or euro, cryptocurrencies operate on decentralized blockchain networks that are not controlled by any government or central bank. However, while there are differences, traders still owe taxes on certain cryptocurrency transactions.

Cryptocurrency wallet

Crypto wallets store, send, and receive cryptocurrencies. These wallets securely hold the user’s private keys and various public addresses to prove ownership and authorize blockchain transactions. These wallets are vital for traders to access their digital funds, manage their assets, and interact with various blockchain applications.

Each crypto wallet offers different levels of security and convenience:

• Hardware (cold) wallets: Physical devices that store private keys offline, offering higher security against online threats.
• Software (hot) wallets: Applications or programs that can be installed on a computer or mobile device, providing a balance of convenience and security.
• Paper wallets: Physical printouts of private and public keys, providing a secure way to store cryptocurrencies offline but requiring careful handling to avoid loss or damage.

Popular examples of crypto wallets include Ledger (a hardware wallet), MetaMask (a software wallet), and Trezor (another hardware wallet).

dApp (decentralized application)

dApps (decentralized applications) run on blockchain networks instead of centralized servers, providing enhanced security and transparency. These decentralized applications use smart contracts to automate processes, reducing the need for intermediaries like banks or brokers. This automation ensures that transactions are secure, transparent, and tamper-proof, as all data and actions are recorded on a public ledger.

Decentralized autonomous organization (DAO)

DAOs are groups of individuals or stakeholders governed by rules encoded as smart contracts on a blockchain. They operate without centralized control, allowing for decentralized decision-making and transparency. Members of a DAO typically vote on proposals and rules, ensuring that all decisions are made collectively and reflect the interests of the entire community. This structure allows DAOs to manage resources, make strategic decisions, and coordinate actions in a decentralized and democratic manner.

Decentralized exchange (DEX)

DEX platforms allow users to trade cryptocurrencies directly with one another without needing a central authority. These exchanges run on blockchain networks and use smart contracts to handle transactions automatically. Unlike centralized exchanges (CEXs), which hold user funds in platform-controlled wallets, DEXs let traders keep complete control of their assets. Once a trade is complete, the platform doesn’t retain custody of funds, cutting out counterparty risk.

Another advantage DEXs offer is additional privacy. Most DEXs require little to no personal information, while CEXs typically enforce know-your-customer (KYC) requirements. With more security, control, and anonymity, DEXs continue to grow in popularity among crypto traders. Well-known examples include Uniswap, SushiSwap, and PancakeSwap.

Decentralized finance (DeFi)

DeFi is a financial ecosystem built on blockchain technology that aims to provide an open and accessible alternative to traditional financial services. DeFi leverages smart contracts and decentralized applications (dApps) to enable peer-to-peer lending, borrowing, trading, and other financial activities without centralized intermediaries like banks. This decentralized approach enhances transparency, security, and user control over financial assets.

EVM (Ethereum virtual machine)

The Ethereum Virtual Machine (EVM) is the runtime environment that executes smart contracts on the Ethereum blockchain. As a Turing-complete system, it can perform any computation given enough resources, which allows developers to create complex decentralized applications (dApps) and protocols. This flexibility makes the EVM a crucial component of Ethereum, supporting the network's ability to run a wide range of applications and smart contracts securely.

Financial crimes enforcement

Financial crimes enforcement involves regulations and measures designed to prevent illegal activities, such as money laundering, within the crypto sector. It requires monitoring and reporting of cryptocurrency transactions to detect and deter criminal activity, helping maintain the integrity and security of the financial system. Organizations like the Financial Crimes Enforcement Network (FinCEN) and other regulatory bodies enforce these rules to ensure compliance and protect against financial crimes.

Hard fork

A hard fork is a significant change to a blockchain's protocol that creates two distinct versions of the blockchain. This split usually occurs when there is a disagreement within the community, such as differing opinions on software upgrades or changes to the rules governing the blockchain. A hard fork results in two separate blockchains, each with its own version of transaction histories and rules.

Initial coin offering (ICO)

An ICO is a fundraising method in which new cryptocurrencies are sold to investors, similar to an initial public offering (IPO) in the stock market. During an ICO, investors purchase tokens that can be traded or used within the project's ecosystem, but these tokens usually do not represent equity in the project. This process allows startups to raise capital while providing investors early access to potentially valuable digital assets. However, ICOs can also carry significant risks, as the project's success is often uncertain.

Liquidity pool

Liquidity pools are smart contracts that hold funds to facilitate trading on DEXs, providing the necessary liquidity for users to trade without intermediaries. Users can deposit their assets into a shared pool, which the platform uses to execute trades, ensuring enough liquidity for efficient transactions. In return for providing liquidity, users (often called liquidity providers) can earn rewards, such as a share of the transaction fees or yield farming opportunities. This system is fundamental to DeFi activities, including token swaps and yield earning.

Non-fungible token (NFT)

NFTs are unique digital assets stored on the blockchain that represent ownership or proof of authenticity of a specific item or piece of content, such as art, music, videos, or virtual real estate. Unlike cryptocurrencies like Bitcoin or Ethereum, NFTs are indivisible and unique, meaning no two are identical. This uniqueness and scarcity make them ideal for certifying ownership of digital and physical items in a secure and transparent way.

Proof-of-stake (PoS)

PoS is an energy-efficient consensus mechanism where validators verify transactions based on the amount of cryptocurrency they hold and "stake" as collateral. Unlike proof-of-work (PoW), which relies on computational power, PoS reduces energy consumption and increases transaction speed, making it a more environmentally friendly option. This mechanism is becoming increasingly popular, as demonstrated by the transition to Ethereum 2.0, which uses PoS to achieve faster and more sustainable transactions.

Proof-of-work (PoW)

PoW is a consensus mechanism used in blockchain networks where miners compete to solve complex mathematical problems to validate transactions and add new blocks to the blockchain. While PoW is energy-intensive due to the computational power required, it provides robust security by making it difficult for malicious actors to alter the blockchain. This mechanism is widely used in networks like Bitcoin, where security and decentralization are prioritized.

Satoshi Nakamoto

Satoshi Nakamoto is the pseudonymous creator of Bitcoin, whose true identity remains unknown. Nakamoto introduced Bitcoin in 2008 by publishing the Bitcoin whitepaper, which outlined the concept of a decentralized digital currency. In 2009, Nakamoto mined the first Bitcoin block, known as the Genesis Block, marking the launch of the Bitcoin network. Despite numerous speculations and investigations, Nakamoto's identity – whether an individual or a group – has never been revealed, adding to the intrigue and mystery surrounding Bitcoin's origins.

Segwit (Segregated Witness)

Segwit, short for Segregated Witness, is an upgrade to the Bitcoin protocol that improves transaction efficiency by separating transaction signatures (witness data) from the transaction data. This separation effectively increases the block size limit, allowing more transactions to be included in each block and improving the network's scalability. Segwit also reduces the risk of transaction malleability – a vulnerability that could allow changes to a transaction's ID without altering its content – thereby making the Bitcoin network more secure and efficient.

Sharding

Sharding is a scalability solution that divides a blockchain network into smaller, more manageable pieces called shards. Each shard processes its transactions independently, allowing for parallel processing and significantly boosting the network’s efficiency and transaction throughput. This approach helps alleviate congestion and improves the overall performance of the blockchain, making it more scalable and capable of handling a larger number of transactions simultaneously. Sharding is especially useful for blockchain networks that experience high transaction volumes, such as Ethereum.

Smart contract

Smart contracts are self-executing agreements with the terms directly written into code, ensuring transparency and making them tamper-proof. These contracts automatically execute and enforce the agreed-upon terms when predetermined conditions are met, eliminating the need for intermediaries like lawyers or banks and reducing the risk of fraud or manipulation. Smart contracts are widely used on blockchain networks to facilitate various dApps and transactions.

Stablecoin

Stablecoins are cryptocurrencies designed to minimize price volatility by pegging their value to an external reference, typically a fiat currency like the U.S. dollar. This pegging makes them more stable than other cryptocurrencies, which can experience significant price fluctuations. Stablecoins are widely used for trading and lending and as a store of value within the crypto ecosystem. However, exchanging other cryptocurrencies for stablecoins may incur tax obligations, as many regulatory authorities consider these transactions taxable events. Popular examples of stablecoins include Tether (USDT), USD Coin (USDC), and Dai (DAI).

Staking

Staking is the process of validating transactions on a blockchain network by holding and "staking" cryptocurrency as collateral. It is primarily used in PoS systems, where stakers are selected to validate transactions and create new blocks based on the amount of cryptocurrency they hold. This process contributes to the network's security and efficiency; in return, stakers often earn rewards. Unlike PoW, which relies on computational power, staking provides a more energy-efficient way to maintain blockchain consensus.

Turing complete

A system is Turing complete if it can perform any computation given enough time and resources. This means that with the right algorithm and sufficient resources, it can solve any problem that a computer can. The EVM is an example of a Turing complete system, which allows it to execute complex smart contracts and dApps on the Ethereum blockchain. This capability is crucial for enabling a wide range of functionalities and innovations in the blockchain ecosystem.

web3

web3 is the next evolution of the internet, focused on decentralization and user empowerment through blockchain technology. Unlike traditional web (web2) experiences, dominated by centralized platforms, web3 aims to create a more open, secure, and user-controlled online ecosystem. It enables dApps, smart contracts, and digital ownership, giving users greater privacy, control over their data, and the ability to participate directly in the governance and operation of online services.

Wrapping

Wrapping is the process of converting one cryptocurrency into a token that can be used on a different blockchain network, enabling interoperability between various blockchains. Wrapped tokens represent the value of the original asset, allowing users to use their assets on multiple platforms without losing value. For example, Wrapped Bitcoin (WBTC) is a tokenized version of BTC that operates on the Ethereum blockchain, enabling Bitcoin holders to participate in Ethereum's DeFi ecosystem.

Zero-knowledge

Zero-knowledge proofs are cryptographic techniques that allow one party to prove to another that they know a specific value without disclosing the actual value itself. This method enhances privacy and security in blockchain transactions by ensuring sensitive information remains confidential while still allowing the transaction's validity to be verified. Zero-knowledge proofs are widely used in privacy-focused cryptocurrencies, such as Zcash (ZEC), to enable secure transactions without exposing transaction details.

Popular cryptocurrencies to know

Bitcoin (BTC)

Bitcoin (BTC), often referred to as “digital gold,” was created by the pseudonymous Satoshi Nakamoto and is the first and most widely recognized cryptocurrency. It operates on a proof-of-work (PoW) consensus mechanism, utilizing the SHA-256 hashing algorithm to secure the network through complex mathematical puzzles. Unlike many other cryptocurrencies, Bitcoin did not have an initial coin offering (ICO), making its distribution unique and decentralized from the start.

Ethereum (ETH)

Ethereum (ETH) is a cryptocurrency and blockchain platform known for its smart contracts and decentralized applications (dApps), which use Ethereum's blockchain to create decentralized alternatives to traditional apps.

In 2022, Ethereum transitioned from its original PoW system to a PoS mechanism, improving energy efficiency and transaction speed. The platform also supports the largest ecosystem for non-fungible tokens (NFTs), with smart contracts managing unique digital assets like visual art. With its extensive use cases and ongoing development, Ethereum's potential in the future web3 landscape remains highly promising. Notably, Ethereum's ICO in 2014 was one of the most successful early token sales.

Tether (USDT)

Tether (USDT) is a stablecoin pegged to the U.S. dollar, designed to provide stability amid the crypto market's volatility. It serves as a reliable store of value for investors who want to avoid the risks associated with price fluctuations. Unlike tokens launched through initial coin offerings (ICOs), Tether is backed by reserves, such as cash, cash equivalents, and other assets, to ensure its value remains stable. However, there have been ongoing debates and scrutiny regarding the transparency and adequacy of these reserves.

Binance Coin (BNB)

Binance Coin (BNB) is the native cryptocurrency of the Binance exchange. Initially created to reduce transaction fees on Binance, BNB's utility has expanded to include trading, payment processing, travel bookings, and participation in Binance's Launchpad for new token sales. Since its inception, Binance Coin has gained substantial value and widespread use, offering holders additional benefits such as discounts on fees and access to exclusive services within the Binance ecosystem.

Solana (SOL)

Solana (SOL) is the native cryptocurrency of the Solana blockchain, designed to support DeFi applications, dApps, and smart contracts. SOL tokens are used to pay for transaction fees on the network and can also be staked to participate in the network’s PoS mechanism, earning rewards for helping secure the blockchain. Solana’s unique combination of PoS and proof-of-history (PoH) ensures fast transaction processing and low fees, making SOL an attractive option for developers and users alike. Due to its scalability and efficiency, SOL has gained significant traction in the market, with some speculation that it could challenge other major cryptocurrencies in the DeFi space.

XRP (XRP)

XRP is the native cryptocurrency of the Ripple network, designed to facilitate fast and cost-effective cross-border payments. Unlike many other cryptocurrencies that rely on PoW or PoS mechanisms, XRP uses a unique consensus protocol that leverages a network of trusted validators to confirm transactions quickly and securely. This makes XRP particularly suited for transferring value across different currencies, offering a scalable solution for global payments.

Building your crypto vocabulary

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.