Jul 26, 2022
Participation in the blockchain ecosystem has grown significantly over the past year, with 47% of family offices and 43% of financial advisors currently invested in digital assets. Even traditional financial players are joining in, with JPMorgan, BNP Paribas, and Bank of New York Mellon announcing tokenization plans. As so many new people become aware of, open to, and interested in digital assets, the universe of new terms to know can be daunting. Here are the top 15 terms that new entrants to the digital assets ecosystem need to know (sorted alphabetically).
1) What Is Blockchain? A system in which a record of transactions are maintained across computers that are linked in a peer-to-peer network using cryptography (which is described further in the "What Is a Hash?" section below).
2) What Is Cryptocurrency? Digital currencies that do not rely on centralized authorities like banks or financial institutions to operate. Cryptocurrencies differ from Digital Asset Securities (DAS), which are regulated financial instruments like equity and debt that record ownership rights on the blockchain.
3) What Is DeFi? Decentralized finance (DeFi) resembles traditional finance but without intermediaries. DeFi removes many of the intermediaries that traditional financial transactions rely upon by using blockchain technology to settle trades. With fewer middlemen, DeFi enables peer-to-peer (P2P) borrowing and lending operations, trading, and even P2P insurance. DeFi is often referred to in relation to traditional finance (TradFi).
4) What Are Digital Assets? Digitally native financial assets that operate on the blockchain. Examples of digital assets include, but are not limited to, bitcoin and ether.
5) What Are Digital Asset Securities? Digital-first securities like equity and debt that operate natively on the blockchain. While investors may hear different words describing this technology (e.g. security tokens), the Securities and Exchange Commission refers to these financial instruments as "Digital Asset Securities."
6) What Is a Digital Wallet? A mobile and/or desktop application which can store, transact, sign, and/or verify digital asset and digital asset security transactions. Digital wallets that are connected to the internet are called "hot wallets," whereas the term "cold wallet" refers to a type of digital wallet that is not connected to the internet. Cold wallets may include "hardware wallets," which do not have an internet connection, but can connect to other devices to effectively store, execute, sign, and/or verify transactions offline.
7) What Is a Distributed Ledger? A distributed ledger is a database that is synchronized and accessible across different sites and geographies by multiple participants. While all blockchains use distributed ledger technology, not all distributed ledgers use blockchain. For example, Hyperledger uses distributed ledger technologies but is not a blockchain.
8) What Is a Hash? Simply, it serves as a stamp of authenticity. A cryptographic hash is a one-way cryptographic function that is practically impossible to reverse. A hash is the result of cryptography. Cryptography is the science of making and breaking codes that enables blockchain technology to operate without intermediaries. Cryptography is at the core of blockchain technology and what enables digital assets to operate.
9) What Is a Private Key? A private key is similar to a master password and used to protect digital asset transactions. Because digital assets are self-custodied, controlling access to your private key is critical. Never lose or misplace your private key.
10) What Is a Smart Contract? A smart-contract is a programmed contract that can not be modified and that self-executes when pre-established conditions are met. For example, if an employee receives shares with a vesting period of 1 year, the employee won't be able to move the token until the first year has passed. Once the first year is over, the employees are free to trade the shares.
11) What Are Stablecoins? Stablecoins are digital assets that use outside capital to stabilize unit price. Each stablecoin's unit price is designed to be stable and not affected by the volatility of the broader digital asset market. For instance, USD Coin (USDC) stabilizes its unit price (with each unit equal to $1) by collateralizing USDC with U.S. Dollars (USD) and short-term government obligations denominated in USD.
12) What Is The Howey Test? The Howey Test determines whether or not a transaction qualifies as a security or investment contract. Under The Howey Test, there are four criteria which would determine that something is a security under U.S. law. If any three of the four criteria are met, the item is classified as a security.
13) What Is a Token? Tokens represent individual units of cryptocurrency, digital assets, and/or digital asset securities beside bitcoin and ether (although they are technically tokens as well). Tokens operate on different blockchains, including but not limited to, Avalanche, Ethereum, and Polygon, and transact value as a utility or asset. While tokens can be self-custodied using digital wallets, like other digital assets, managing tokens on your own requires properly managing the private keys protecting them.
14) What Is Tokenization? The tokenization of assets is the process of digitizing traditional financial products and registering ownership cryptographically on the blockchain. Tokenization uses the blockchain to make investing more direct, so that ownership is immutable, investments can be easily broken down into smaller pieces through "fractionalization," and settled instantly without counterparty risk. The ability to fractionalize large assets into small pieces makes them more easily accessed by individual investors, contributing to the democratization of finance.
15) What is Web3 for Financial Assets? Web3, or the "decentralized web," replatforms centralized web experiences so that they operate without needing intermediaries to function. Web3 is an evolution of Web 2.0 that defines new standards for decentralized interactions, including digital identity, gaming, and data monetization, which facilitate more direct and decentralized experiences. From a financial perspective, Web3 can also give cryptocurrency, digital asset, and digital asset security holders new ways to manage their alternative assets.
Digital assets hold the potential to democratize the capital markets. But the new technologies and language to understand can be daunting, particularly since many of the key terms to know are inter-connected or derivative of each other. Hopefully the definitions and explanations above help give you context in better understanding this fast-growing world.
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