If you are like millions of Australians that are curious about cryptocurrency and are thinking about investing in digital currency it is important to know the basics and understand the meanings of these key definitions and key terms related to cryptocurrency.

Cryptocurrency

Cryptocurrency is the term used for a currency that is both digital and decentralized. Cryptocurrency can be used to both buy or sell goods or services, it can also be used as a long-term store of value. If you are planning on investing you should understand the key terms related to cryptocurrency.

Decentralization

Decentralization is the principle of distributing power away from a central point. Blockchains are traditionally decentralized because they require majority approval from all users to operate and make changes, rather than a central authority as in the case of a banking system of a country. 

Blockchain

Blockchain can be best described as a system of recording information in a way that aims to make it difficult or almost impossible to change or hack.

A blockchain is a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Every block in the chain contains several transactions, and every time a new transaction occurs on the blockchain, a record of that transaction is added to every participant’s ledger.

The decentralised database managed by multiple participants is known as Distributed Ledger Technology (DLT).

Blockchain is a type of DLT in which transactions are recorded with an immutable cryptographic signature called a hash.

On cryptocurrency blockchains, blocks are made up of transaction records as users buy or sell coins. Each block can hold only a certain amount of information. Once it reaches that limit, a new block is formed to continue the chain.

Hash

Whenever a transaction of cryptocurrency has been verified and needs to be added to a block in a chain, it will be put through a hash algorithm to convert it into a set of unique numbers and letters, similar to what would be created by a random password generator.

As a result of this, two transaction hashes will be combined, and put through the hash algorithm to create another unique hash. This process of combining multiple transactions into new hashes continues until finally there remains just one hash which is the ‘root’ hash of several transactions.

The thing that makes hashes unique, and a major security feature for blockchains, is that they only work one way. While the same data will always produce the same hash of numbers and letters, it is impossible to ‘un-hash’, or reverse the process, using the numbers and letters to decipher the original data.

This means that while you can carry out a crypto transaction to transfer a certain amount from A to B, you are unable to reverse the transaction from B to A in the case of an incorrect transaction; as would be possible in the case of a bank transaction.

Bitcoin

Launched in 2009, bitcoin is the first ever and the most popular form of cryptocurrency. Bitcoin was created as a reward for a process which is commonly referred to as mining.

Bitcoin can be exchanged for other currencies, services or products. However, the real-world value of bitcoin is extremely volatile and unpredictable. Although its value has climbed steadily since 2009, it has witnessed fierce fluctuations over time.

Wallet

Your wallet is the place where an individual keeps their cryptocurrency holdings digitally. Cryptocurrency wallets keep your private keys, the passwords that give you access to your cryptocurrencies making them safe and accessible, enabling you to send and receive cryptocurrencies like Bitcoin and Ethereum.

Cryptocurrency wallets come in many forms, from hardware wallets like Ledger that looks like a USB stick, to mobile apps which makes using cryptocurrency as easy as shopping with a credit card online.

Mining

Crypto mining is when a person gains cryptocurrency by solving cryptographic equations through the use of computers.

The process of crypto mining involves validating data blocks and adding transaction records to a public record (ledger) known as a blockchain.

Altcoin

The word altcoin is used to define any type of coin that isn’t a bitcoin. Altcoin can be best described as alternative currencies that were established after the success of Bitcoin. Altcoins usually try to brand themselves as better replacements for Bitcoin. Bitcoin’s emergence as the first peer-to-peer digital currency was paving the way for many to follow.

The majority of altcoins are trying to target any perceived drawbacks that Bitcoin has and come up with competitive advantages in newer versions. 

The term ‘altcoin’ is a combination of the two words: ‘alt’ and ‘coin’ meaning that alt means ‘alternative’ and coin means ‘cryptocurrency’. This combination of words implies a category of cryptocurrency, that is an alternative to the Bitcoin cryptocurrency. 

Cryptocurrency Exchanges

A cryptocurrency exchange is an online platform where users can exchange one kind of digital currency for another. The most popular crypto exchanges are currently Binance and GDAX.

It is important to avoid confusing cryptocurrency exchanges with cryptocurrency wallets or wallet brokerages. Cryptocurrency wallets and wallet brokerages usually enable you to buy and sell a small range of popular digital assets (Bitcoin and Ethereum), which you can then send to a different exchange to trade for other digital assets like altcoins.

In most cases, the majority of cryptocurrency exchanges will usually limit their users to only trade digital assets for digital assets, but a few allow trades of fiat currencies such as AU dollars for cryptocurrencies.

Fork

The term Fork is the word used whenever a blockchain’s users make changes to its rules. These changes to the protocol of a blockchain may result in two new paths, one that follows the old rules, and a new blockchain that splits off from the previous one. An example of fork would be when Bitcoin resulted in Bitcoin Cash.

In simple terms a Blockchain fork is a split in the blockchain network. The network is an open source software, and the code is freely available.

This means that anyone can recommend improvements and change the code. The option to experiment on open source software is a fundamental part of cryptocurrencies, and also facilitates software updates to the blockchain.

Forks occur when the software of different miners become misaligned. It’s up to miners to decide which blockchain to continue using. If there isn’t a unanimous decision, then this can result in the creation of two versions of the blockchain. There can be periods of increased price volatility around such events. When investing to any coins or cryptocurrency it is important to know and understand the key terms related to cryptocurrency.

Need Help?

The Team at Vault understands the complexity around the reporting for cryptocurrency and will assist you in properly reporting this through your tax return. With qualified tax agents specializing in digital currency, we are here to help.

R