Cryptocurrency is not just an investment asset class — it’s also a new technology that’s developing even as you read this article. Let us help get you up to speed with the most important crypto terminology in 2021.
While it’s perfectly possible to invest in the cryptocurrency market without knowledge of these terms, we believe astute investors should understand the technical concepts that underpin their investments.
In addition, these buzzwords are commonly found in crypto-related news and might impact both the long- and short-term value of cryptocurrency assets.
One of the most important aspects of cryptocurrency is that it can be authenticated digitally across a decentralised network.
In most cases, this is achieved with blockchain technology, a data storage system akin to a bookkeeper’s ledger. Here’s a simplified summary of how it works:
Transactions are grouped into batches and released to the blockchain network
Users on the network, also known as cryptocurrency miners, verify the transactions
Once verified, the batch of transactions forms a block
This new block is added to the chain of existing, verified blocks
Once locked into the blockchain, the data cannot be modified or erased
Blockchain lies at the heart of most cryptocurrencies. Without a robust authentication system, digital currencies would be doomed to fail — they would be too easy to counterfeit, and thus lose all value.
Like most technologies, blockchain has evolved over its decade-long history.
The first generation of blockchain technology, as envisioned by Bitcoin founder Satoshi Nakamoto, sought to make peer-to-peer money transfers possible.
A few years later in 2015, Ethereum was born, and with it came a new generation of blockchain technology. Dubbed Blockchain 2.0, this new iteration shifted its focus from money transfers to paving the way for other types of applications.
Today, the conversation revolves around the next evolution: Blockchain 3.0. With this, developers are trying to solve issues like scalability, privacy, and compatibility between platforms. The end goal is to advance blockchain technology for widespread adoption.
2. Proof of Work & Proof of Stake
Verifying the transactions in each block, also known as mining, is the most crucial step in executing blockchain technology. This verification process is the foundation of our trust in cryptocurrency.
Of course, it’s not practical for miners to witness every single transaction with their own eyes. Instead of empirical proof, programmers utilise mathematical or algorithmic proof to validate the data on each block.
The two best-known data validation methods are Proof of Work and Proof of Stake. Pioneered by Bitcoin, the Proof of Work (also known as PoW) method is as follows:
The verification process is represented as a mathematical problem and released on the blockchain network
Miners race to solve this problem; the winner is rewarded with a small amount of cryptocurrency
Each mathematical problem solved helps verify a block of transactions, which is then added to the blockchain ledger
PoW requires significant computational power, and as such, mining coins like Bitcoin consumes high levels of electricity. This can be expensive and have implications on the environment, prompting miners (at times on the back of government policy) to move operations in search of cheaper or renewable energy sources (sometimes at the behest of their government).
In response to the energy drain posed by PoW, some cryptocurrencies, like Ethereum, are shifting towards a new model known as Proof of Stake (PoS):
To verify transactions, miners need to put aside some of their own crypto as collateral
The more you’re willing to stake, the higher your chances of being chosen as the validator
The chosen miner gets to validate the transactions
Once done correctly, the validator gets rewarded with a small amount of cryptocurrency
However, if the validator gets it wrong, they will need to forfeit part of their stake. This discourages fraud.
Proof of Stake is relatively more energy- and time-efficient, which many believe makes this mining method more scalable than Proof of Work.
In spite of this, note that not all cryptocurrencies are moving to adopt PoS. Bitcoin, for example, continues to be based on Proof of Work, and there are no plans to switch to Proof of Stake.
3. Fiat Money
Cryptocurrencies are often conceived as superior alternatives to fiat money or fiat currency, designed to overcome some of their weaknesses.
Most money we use on a day-to-day basis, such as USD, SGD, or other global currencies, is fiat money. That is, any currency that’s determined and authorised by the government as the de facto means of exchange.
Fiat money has plenty of good attributes. It’s portable, easy to exchange, and widely accepted. But its main weakness is that it’s controlled by a central bank.
Just imagine what happens if the authorities decide to print more money to stimulate the economy, as the US Federal Reserve did to cope with the pandemic. With an increase in supply, the currency may depreciate in value.
Cryptocurrency, on the other hand, is set up such that no single authority can manipulate its supply. For example, Bitcoin has a fixed supply cap of 21 million coins, expected to be mined to the maximum by 2140. This guarantees the scarcity of the currency and preserves its value.
Created in 2009, Bitcoin was the very first cryptocurrency, and it dominates the crypto market as the largest cryptocurrency by market capitalization.
But there are thousands of other cryptocurrencies, which are collectively known as altcoins i.e. alternative coins. As of March 2021, altcoins represent about 40% of the total cryptocurrency market.
Altcoins can share certain characteristics with Bitcoin, and there are even some Bitcoin clones.
Some of these clones, such as Bitcoin Cash (BCH), directly address Bitcoin’s shortcomings by tweaking its original blueprint. These “new and improved” versions are sometimes known as Bitcoin forks.
However, the most successful altcoins distinguish themselves by either using another mechanism to validate transactions, or by providing new capabilities on top of peer-to-peer money transfers. These include Ethereum (ETH), Cardano (ADA), Ripple (XRP), and Polkadot (DOT).
Other altcoin sub-types include:
Utility tokens, which are specifically for use within a network (somewhat like in-game tokens)
Memecoins, cryptocurrencies created as a joke and not meant to serve any real-world purpose
Stablecoins, which are pegged to an external measure of value such as fiat currency (more below)
Major cryptocurrencies like Bitcoin and Ethereum are not pegged to any real-world asset class or commodity.
Their market value depends greatly on investors’ and users’ confidence — which can be easily swayed with any publicity around regulation, endorsement, or criticism. So, crypto prices can be extremely volatile.
Stablecoins, on the other hand, are cryptocurrencies pegged to a real-world measure of value. These can be fiat currencies (like the US dollar), commodities (gold) or even a basket of goods. As a result, their pricing is much more stable than, say, Bitcoin.
The two biggest stablecoins are Tether (USDT) and USD Coin (USDC), both of which are in the top 10 cryptocurrencies by market cap.
Despite controversies surrounding these stablecoins being fully backed by the underlying, in this case USD, their value is determined simply by the conversion rate of 1 UDST/USDC = 1 US dollar. ( In reality, Tthe coins might transact at a slight premium or discount to this par value, in line with trading supply and demand.)
Given their price stability, stablecoins can be used for transactions such as buying goods and services online, to pay crypto exchange trading fees, or in exchange for other crypto coins. Investors also buy and hold stablecoins to mitigate volatility risks — such as if their other cryptocurrencies fail or face regulatory problems.
6. Central Bank Digital Currency (CBDC)
Stablecoins like USDT and USDC have shown us that cryptocurrencies pegged to fiat currency can be useful and are in demand.
So it’s no surprise that government authorities around the world — including the Bank of England, People’s Bank of China and Monetary Authority of Singapore — are now looking into launching their own digital tokens.
But these tokens, known as central bank digital currencies or CBDCs, are different from decentralised cryptocurrencies like Bitcoin.
Just like fiat currency, CBDCs are highly centralised. They are regulated and operated by the respective authorities, backed by a country’s monetary reserves, and count as part of the total money supply (so there’s no duplication).
Nonetheless, CBDCs are an interesting new financial innovation that could provide users with some of the benefits of cryptocurrency, such as providing a reliable and secure form of digital payment.
7. Decentralised apps (dApps)
Bitcoin is one cryptocurrency that more or less fits what we think of as “currency”. But as the technology evolved over the years, we now also have cryptocurrencies that are not currency-like at all.
This evolution began in 2015, with the arrival of Ethereum. Much like how Bitcoin sought to disrupt fiat currency, Ethereum’s goal was to provide an alternative to traditional apps.
Most apps are owned and managed by a central authority — Apple, Facebook, Google and so on — and these have final say on how customer data is being used.
Ethereum’s developers didn’t like this power asymmetry, so they created a blockchain network to allow people to create decentralised apps, or dApps. Instead of being managed by a single company, dApps distribute data among the users of the blockchain.
dApps run on automated algorithms known as smart contracts, which allow the apps to theoretically function without human intermediaries.
For example, imagine buying travel insurance through a dApp. The dApp is hooked up to real-time flight data, so once it receives the update that your flight is delayed, it automatically executes your payout. Your payout is guaranteed based on programming logic.
So where does cryptocurrency come in? In the case of the Ethereum blockchain, each smart contract requires a small amount of ETH to execute (this “gas fee” compensates for computational power).
Therefore, some investors see ETH as a commodity rather than currency —, ratherjust like gas . Similar to how technologists from a century ago invested in gasoline to anticipate the advent of cars, people invest in ETH because they expect a boom in dApps.
8. Decentralised Finance (DeFi)
Decentralised finance (or DeFi) is the “open source” alternative to our current financial ecosystem. It allows us to borrow, save, invest, trade, remit and so on — but on a public blockchain network, instead of through intermediaries like agents, bankers, or brokers.
Users transact on a peer-to-peer basis, or through a software-based middleman such as the imaginary travel insurance dApp example above.
In theory, DeFi could pave the way for more efficient and cheaper transactions, without middleman fees to worry about. By relying on only software and programming logic, DeFi can also theoretically eliminate human error, fraud, or arbitrary decision-making.
DeFi is presently one of the most compelling applications of blockchain technology, showing us that blockchain can do much more than just peer-to-peer payments.
However, it is still in the early stages of development, and there are many issues that have yet to be worked out (such as how decentralised DeFi can really be). We’ll discuss the strengths and weaknesses of DeFi in a future article.
9. Initial Coin Offering (ICO)
It’s relatively easy for anyone to create their own cryptocurrency. In fact, you can even create a token that rides on an existing blockchain network, neatly avoiding the hard work of developing your own blockchain.
But if you want to launch a new crypto coin, app or service that’s of greater value, you’ll need to finance its development, which can be expensive.
One popular way to raise money is through an ICO (initial coin offering) — similar in concept to the traditional IPO (initial public offering) route that businesses take.
In an ICO, investors can buy into your offering using either fiat money or cryptocurrency. In exchange, they get a token that represents a stake in your new offering, similar to how investors get shares in an IPO.
Some notable past ICOs are: Telegram Open Network (by the founders of messaging app Telegram), Hyundai Digital Asset Company (by carmaker Hyundai), and Tezos (which has since found some success with its token XTZ).
It’s worth noting that, while IPOs are regulated by governments, ICOs are generally not. A company hoping to IPO needs to go through a rigorous process that includes underwriting, due diligence, and reporting to protect investors’ interests.
An ICO is not bound to such rigorous rules. Several big ICOs have turned out to be poor investments, ending in hacking, fraud, closures and unfulfilled promises. At other times, interest in the coin simply fizzled out, such that initial investors became unable to exit their investment.
10. Non-Fungible Token (NFT)
Non-fungible tokens (NFTs) exploded in popularity this year, generating some US$2.5 billion in sales in the first half of 2021. But what are they, and how are they related to cryptocurrency?
In the previous section on ICOs, we talked about how you can create a token on an existing blockchain network, effectively minting your very own cryptocurrency, which you dub YourCoin.
YourCoin now lives on the existing blockchain, meaning its data, information and algorithms are stored on the blockchain.
Like all currencies, YourCoin is necessarily fungible, meaning it can be swapped for another of its kind with no loss in value. (Without fungibility, it would cease to work as a medium of exchange.)
Non-fungible tokens are created in a similar way to YourFintoniaCoin, with its data and so on stored on the host blockchain. The main difference is that the NFT is programmed to be non-fungible instead.
This means every NFT is completely unique and cannot be replaced or swapped. It is a one-of-its-kind collectible; think the digital equivalent of the original Mona Lisa.
You can turn anything into an NFT, but common examples are digital art, memes, and videos. For example, digital artist Beeple sold a video for US$6.6m, while Twitter founder Jack Dorsey sold his first tweet for US$2.9 million.
Although anyone can view the video or the tweet, only one person owns it: the buyer of the NFT.
By lowering the barriers to buying and selling art, NFTs are of great interest to artists and art collectors, although it remains to be seen if NFTs are really of lasting value.
The world of crypto: it’s bigger than you think
The cryptocurrency universe is a lot bigger than it seems at first glance. With new specialisations and applications evolving as we speak, it is more of a living ecosystem than a static topic.
We hope you learnt more about some of the most interesting developments in the cryptocurrency market, and have a better grasp of crypto’s potential. The story has only just begun.