If you are new to the world of cryptocurrency, you have likely encountered fascinating articles and videos that capture your attention, but leave you more confused than when you started reading or watching.
Take heart. You are not alone.
The sheer amount of terms involved in understanding even the basics of cryptocurrency can be mind-boggling.
Part of the confusion stems from the fact that cryptocurrency is a phenomenon that combines many fields of study. Thus, the world of crypto is full of jargon.
There is computer science jargon. There is legal jargon. There is cybersecurity jargon. There is financial jargon.
Some of the cryptocurrency literature is so dense and filled with technical jargon it takes hours to read and comprehend. There is a lot of terminology.
My goal is to translate some of the jargon into simple terms we mere mortals can understand.
I’ll dissever the obfuscating lexicon for your erudition.
Translation: I’ll explain the terms and make them easy for you to understand.
Further translation: These definitions are in plain English.
Here goes... Let’s add some cryptocurrency words to your vocabulary.
Definitions in Plain English
Cryptocurrency is an amalgamation of cryptography and currency (i.e., cryptography + currency = cryptocurrency). Cryptography is a method of using codes to keep information hidden or secret. In the most basic terms, currency is money.
If you have heard of encryptions, secret messages, or algorithms, you already know about cryptography. Cryptography uses rules and instructions to solve a problem.
Cryptography is all about secret messages and decoder rings (or at least it used to be). The intent of cryptography is that the secret message can only be read by the intended recipient. Here is an example of cryptography.
Secret Message: Uijt jt b tfdsfu nfttbhf.
Can you crack the code?
What if you have the key?
Key: Write down the alphabets from A to Z. For each letter in the secret message, use the alphabet that comes before it (e.g., U becomes T; A becomes Z; T becomes S).
A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
Can you crack the code now?
Secret Message: Uijt jt b tfdsfu nfttbhf.
Answer: This is a secret message.
Cryptography is a complicated puzzle that keeps something secure. Of course, the cryptography used for cryptocurrencies is way more complicated than the simple code above. Cryptocurrency codes consist of long strings of randomly generated numbers and letters. You would need to do more than shift the alphabet to crack those codes.
Currency is used as a method of payment to get something you want. Currencies are generally approved by a government and accepted as a way to purchase goods and services (i.e., you use currency to buy and sale stuff).
Although the word currency is usually associated with money, there is debate about whether cryptocurrencies are currencies or assets.
Is a cryptocurrency money? Is it an asset? Is it both? The answer depends on three things: 1) the purpose of the cryptocurrency, 2) the actual use of the cryptocurrency, and 3) whom you ask.
If you live in the United States, the Internal Revenue Service (IRS) categorizes cryptocurrencies as assets. For tax purposes, cryptocurrencies are considered property and they are taxed like stocks.
Even if you use them as a method of payment? Yes. Even if the word currency is in the name? Yes. Even if you think it’s money? Yes.
As of the writing of this article, the government of the United States of America does not classify cryptocurrencies as money. That stance may change in the future, but, for now, we must play by the rules (rules that are constantly evolving as cryptocurrencies gain traction).
If, on the other hand, you live in El Salvador or the Central African Republic, at least one cryptocurrency is considered legal tender – bitcoin. Legal tender means it is money. The government has approved the currency and it is an accepted form of payment.
In sum, a cryptocurrency is a digital asset (and in some places a legal currency) that uses cryptographic methods to improve security. Increased security makes it more difficult to tamper with and helps verify transactions and the transfer of assets.
DECENTRALIZED | DECENTRALIZATION
Decentralization is the process by which power and authority are spread across multiple entities. There is not one central authority.
In contrast, a centralized process is concentrated in one area. Authority is held by one entity (e.g., one computer, one server, one company, one parent).
A decentralized process takes place in many areas or locations. Work, responsibility, and authority are spread across multiple sources (e.g., multiple computers, multiple servers, multiple companies, every family member).
Benefits of decentralization include a decreased likelihood of an entire system, function, or website outage; improved data sharing, data tracking, and data reconciliation; and reduced censorship because information is decentralized.
In a decentralized network, a collection of individual entities interact with each other. These entities are interconnected, and they work together to solve a problem, make a decision, or complete a process.
For example, in a family, one person making all of the decisions is a centralized process. However, if multiple family members interact, share information, and make the decision together, the process is decentralized.
Processes occur without the need for a centralized power.
In a decentralized cryptocurrency network, processes occur without the need for a central server, central bank, or central government. Instead, work, workload, and authority are spread across multiple entities (e.g., computers, individuals, users of a network).
All of the entities share control.
Note: It is possible to have a decentralized network embedded within a centralized network. For example, a bank (centralized) may run its processes on multiple, interconnected computers that work together to solve a problem (decentralized). As companies and individuals harness the benefits of decentralized networks, we will likely see an increase in decentralized networks contained within centralized entities.
DISTRIBUTED | DISTRIBUTED LEDGER
Distributed means something is spread across multiple areas or entities. Although you may see the words distributed and decentralized used interchangeably, the terms do not mean the same things.
Distribution is about spread. Decentralization is about power.
For example, work can be spread across many entities (i.e., distributed). However, if only one entity determines the final decision, the process is not decentralized; one entity holds all the power and authority.
A ledger is a recordkeeping method. Examples of ledgers include spreadsheets, databases, and inventory logs. Ledgers can be physical (e.g., a piece of paper or book) or digital (e.g., on a computer or server).
A distributed ledger is a recordkeeping method in which transactions are duplicated across entities. If the entities are computers, the same record, or file, is on each computer. Entities work together to achieve a common goal.
Pop quiz. 100 entities share a distributed ledger. A new entry is made into the ledger. 78 of the entities raise a red flag, indicating the new entry is fraudulent and should be rejected.
However, only entity 001 can make a determination about which entries are fraudulent and which entries are not. Entity 001 determines that the new entry is legitimate, accepts the entry in the ledger, and distributes the updated ledger to the other 99 entities.
Is this distributed ledger decentralized?
If you answered no, you are correct. Although the ledger is distributed, entity 001 holds all the decision-making power. Therefore, this is a centralized distributed ledger.
In contrast, if all entities have equal power and the decision-making process is decentralized, the 78 entities would reject the new entry. Therefore, the entry would not be entered into the ledger. In this example of a decentralized distributed ledger, majority rules. There is consensus (i.e., agreement) regarding what to do with the new entry.
Group consensus could mean all entities agree or the majority of entities agree; or there could be specific rules about what constitutes consensus. The key takeaway is that there is a process by which each entity can verify and approve an entry to the ledger.
If there is not consensus, the entry is not recorded.
Because consensus is needed to modify the ledger, distributed ledgers in decentralized networks are difficult to hack or modify.
As more entities join the distributed, decentralized network, processes may slow down because it takes longer to verify legitimate entries (i.e., it takes longer to reach consensus). Yet the decrease in speed is accompanied by greater data security.
To enter a fraudulent entry into the record, a nefarious entity would have to overwhelm, out vote, and out maneuver the majority. That is difficult to do when all entities share the same ledger and each entity has an equal vote regarding what information is rejected or entered into the ledger.
That ends your vocabulary lesson for the day. You are now wiser and more savvy about the mysteries of cryptocurrency.
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