Useful Crypto Terminology Explained

What is Blockchain?

Blockchain is a term coined by Satoshi Nakamoto, the creator of Bitcoin, and is the key innovation behind all digital assets. It is a revolutionary technology which promises to transform in a fundamental level the underlying infrastructure of many industries. Companies whose business model relies on solving complex logistical problems are at the most risk of being displaced by this technology. For instance, the role of banking as a money transmission system can now be easily replaced by a single blockchain-based protocol (e.g. Bitcoin).

At heart, blockchain is simply a database which is:

1. Decentralized — The latest copy of the database is shared across all participating computers (i.e. the network) in a continuous fashion.

2. Secure — The method and economic incentives by which entries in the database are recorded is such that it is extremely difficult to hack and guaranteed to be unique.

3. Immutable — The entries once recorded are almost impossible to change.

It is how this database is applied (i.e. use case) which makes all the difference. In Bitcoin’s case the entries to this database are the numbers which compose a ledger. This is because the use case of Bitcoin is a currency, thus having an open and sharable ledger which tracks transactions and holdings functions works well in this case. On the other hand, since Ethereum’s use case is to create a “decentralized world computer,” the entries to this database is code rather than numbers.

What Does Decentralized Mean?

The mantra behind blockchain technology is “decentralize,” but what does this really mean? and why is it important? To help answer these questions, it’s important to understand the context.

Picture taken from Vitalik Buterin’s medium post: “The Meaning of Decentralization”

Before cloud computing centralization (A) was a natural state of providing services via the internet. This was because servers needed to be set in place in order for the company to function. This made the system highly vulnerable and prone to downtime, since shutting down the server implied critical failure of being able to produce the promised services. Cloud computing solved many problems by decentralizing (B) the service provision across multiple servers. Blockchain scales the idea of decentralization by distributing © a shared database across all members of the network. This further reduces critical chokepoints in the network and effectively reduces downtime to zero. The reason why this is important is:

1. It enables direct communication across computers without an intermediary.

2. If a server is turned off, it does not corrupt the contents of the database, since all the other computers share the same database.

These two properties reduce the complexity of logistical problems by orders of magnitude. Take for instance the case of sending money from US to Indonesia. For the transaction to occur, it takes a large number of banks (among them the respective Central Banks) to coordinate the logistics. This is why transaction times tend to take weeks to happen. Sending money is a complex logistical problem. If we were to do the same transaction using blockchain technology, all you need is your wallet address, making intermediaries obsolete. The reason why this is possible, is precisely because there is a shared database (ledger in this case) and can easily be checked if the transaction occurred without the need of a third-party verification. Because blockchain technology strips away the need of a third party and thereby reduce the logistical complexity from “n” parties to “two”, it is particularly suitable at solving complex logistical problems.

Whas is a Wallet?

A wallet is a piece of software which tracks ownership of a digital asset. Wallets are always coin-specific and generally do not have cross-compatibility (e.g. use a Bitcoin wallet to store Ethereum). The most important components of this piece of software are the public and private key. Public keys allows the network to “see” ownership of each wallet. The private key is what allows transactions to occur. In fact, the private key is what is used to “sign” a transaction, thereby proving ownership. This key is of extreme importance since it allows the withdrawal of money from the wallet.

Security is the biggest challenge when investing in digital assets. Hacking risk is an everyday reality and extreme care must be taken to secure assets, especially when dealing with large sums. This problem is the primary reason why custodianship of this asset class remains an unsolved issue. Broadly speaking there are two ways of storing digital assets: hot wallets, and cold storage.

How do you Secure Crypto?

A hot wallet refers to a kind of wallet which is online and connected in some way to the Internet. Because it is connected to the internet, it is more vulnerable to theft (e.g., hack). The reason is during a hack attack, if the thief gets access to your wallet they have uncovered the private key. With this key, they are able to empty the wallet in minutes. When using crypto exchanges, your wallet is most likely connected to the internet, and thus vulnerable to hack. That is not to say crypto exchange are unsafe, but rather that’s where money is most at risk. As a side note, the crypto exchange industry has improved their security standards such as adding multi-factor authentication as well as reducing the amount of coins stored online (e.g. 20% hot wallet and 80% cold storage) as well as other security procedures to reducing the risk of a successful hack.

Unlike a hot wallet, cold storage is a wallet which is offline and not connected to any kind of network. This means that during a hack attack, it is close to impossible for the transgressor to uncover the private keys. This is often a necessary security precaution, especially when dealing with large amounts of digital assets. There are different degrees of cold storage. They range from storing the wallet in a simple USB drive to encrypting the computer where the wallet is found, and storing it in a vault where access is restricted to selected individuals.

A metaphor we like at DigiCor is imagine you’re in a bank like Wells Fargo. The hot wallet is like the tellers, and cold storage is the vault behind the giant round steel door. If a thief attempts to steal from the bank, the most vulnerable points of theft are the tellers. The vault on the other hand is substantially more difficult to access. That is not to say the bank is unsafe, but rather there are points that are more vulnerable to theft than others.

Originally published at blog.digicor.io on March 16, 2018.