Find out what crypto tokens are and the difference between them and coins. Discover their applications, types and how they work within blockchain networks.
As you learn more about cryptocurrencies, you will notice that various terms such as cryptos, tokens, coins and more often come up. Most of the time you will see people use the terms token and coin loosely and interchangeably. However, the terms have completely different concepts and meanings.
Coins are the main medium of exchange for blockchain networks. Crypto tokens, on the other hand, are additional assets built on existing blockchain networks and are not essential to the functioning of the networks. Although each blockchain has only one main cryptocurrency, it can have many different crypto tokens.
When people talk about “crypto,” they usually mean both assets together. In this guide, we will talk about crypto tokens and how to use the term correctly. Let’s dive in.
Table of contents
What are crypto tokens?
Crypto tokens explained are programmable digital assets built on top of an existing blockchain using smart contracts.
These tokens typically serve a variety of purposes, including granting holders access to certain services and features within a blockchain ecosystem or as digital representations of physical objects.
They can also give their holders voting rights in crypto projects, with those who own more tokens having more say in how things work on a blockchain platform.
Holders of crypto tokens can also use them for investments in decentralized finance (defi) protocols, as a store of value, or to make purchases within decentralized applications (dapps). They are often created, distributed, sold, and circulated through crowdfunding rounds, such as Initial Coin Offerings (ICOs).
The difference between a coin and a token
Now that we have understood what crypto tokens are, we will now distinguish them from coins, a term that people often use interchangeably with tokens.
Coins are digital assets that operate on their own independent blockchain. They are native to their blockchains and are primarily used as a medium of exchange on the blockchain, just as we use fiat money in traditional transactions. They can also act as a store of value or have chain-specific use cases.
On the other hand, tokens are digital assets built and operated on an existing blockchain network. They do not have their own blockchain, but require another platform to function.
Tokens are priced differently and serve a different purpose than the native cryptocurrency of the blockchain they are built on. Moreover, although you can use tokens as a means of payment, their primary purpose is often to provide access to the functionalities of a decentralized application.
Simply put, the main difference between a cryptocurrency and a token is how and why they are created. Coins operate on their own blockchain and mainly function as a medium of exchange. However, tokens are built on top of existing blockchain networks and offer a wider range of functionalities.
In terms of creation, tokens are easier to create than coins. Creating a coin requires building a new blockchain, which requires time and expertise. However, tokens can be created on an existing blockchain using smart contracts, making the process easier and more accessible.
How do crypto tokens work?
While cryptocurrency is generated and distributed through the consensus mechanism of a blockchain network, crypto tokens come to life through smart contracts that are automatically executed on blockchains such as Ethereum (ETH).
These smart contracts contain the rules and behavior of the crypto tokens, such as how many will exist, how they will be created, and what they can do.
Developers can create custom tokens by writing smart contract code that adheres to a specific token standard, such as ERC-20, ERC-721, or ERC-1155 for Ethereum-based tokens.
These token standards play a crucial role. They establish regulations that dictate the essential data a token must possess, its functionalities, and the actions allowed for token holders or communities. They also provide instructions for generating, distributing, staking, transferring, deleting, and various other aspects of tokens within the underlying blockchain.
ERC-20 tokens are the most common type of token on Ethereum and are used for fungible or interchangeable assets.
The ERC-721 standard is primarily used for unique, non-fungible assets such as collectibles, gaming items, or digital art. Each ERC-721 token has a different value and cannot be directly exchanged for another.
For their part, ERC-1155 tokens combine features of both the ERC-20 and ERC-721 standards. They can support both fungible and non-fungible tokens within one contract.
When you hold tokens, your address is linked to a balance of those tokens on the blockchain, and you can transfer those tokens to other addresses by calling the appropriate smart contract function.
Investors can use crypto tokens for various purposes. They can keep them to show their stake in the blockchain project or for economic purposes – to trade or buy goods and services.
As assets with value, crypto tokens can usually be moved, traded, bought and sold, and are held in digital wallets, which are software programs or physical devices used to store cryptocurrency.
Transactions involving a crypto token take place on the blockchain to which it is linked. For example, if it is an ERC-20 token built on Ethereum, Ethereum will handle all transactions for that token.
Various use cases exist for crypto tokens, including utility, security, governance, and non-fungible tokens (NFTs). We’ll take a closer look at each of these features later in this article.
You can trade most tokens on cryptocurrency exchanges, and their transactions are validated by network nodes to ensure security and consensus.
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Types of crypto tokens
As mentioned earlier, there are different types of tokens in the blockchain: transactional tokens, governance tokens, utility tokens, security tokens, and non-fungible tokens.
However, a single crypto token can fall into multiple categories depending on its characteristics and use cases. These are the main types:
Transactional tokens
As the name suggests, these tokens are used for transactions within the ecosystem of a particular project. They often function like traditional currencies, but sometimes offer additional benefits, such as increased liquidity and investment options.
An example of a transactional token is Bitcoin (BTC), which was originally created as a way to transfer money cheaply and efficiently.
Governance Tokens
These types of tokens allow holders to vote on the decisions of a blockchain project. They are a type of cryptocurrency used to vote on proposals, make decisions and influence the future of a project. Each governance token a person holds usually corresponds to one vote on a proposal.
Utility Tokens
These tokens are issued by blockchain projects to cultivate their ecosystems. They are designed to give users access to a product or service, usually available on a dapp. Utility tokens are unique to their ecosystem and allow users to perform specific actions on the network.
Additionally, utility tokens are usually pre-mined, created all at once, and distributed in a manner chosen by the project team.
In most cases, project creators distribute these tokens to raise capital for further development. The holders can then use these tokens to pay for fees and services related to the project.
Security tokens
These tokens are digital representations of ownership rights or asset value transferred to a blockchain token. They are created using a process called ‘tokenization’.
As an investment asset, a security token transfers the value of a real-world asset or bundle of assets to whoever owns the token.
With tokenization, a project inputs what the token represents and then generates the token. The project would then offer this token on an exchange or other suitable investment platform for investors.
Ownership of that token is then recorded on the blockchain and tagged with the owner’s blockchain address.
Security tokens can represent ownership of a fraction of any valuable asset, such as a car, real estate, or company stock.
Non-fungible tokens
NFTs are unique tokens encoded on a blockchain, making them impossible to replicate or replace. People can use them to certify the ownership and authenticity of any physical item or digital file, including music, artwork, or a video recording.
The tokens are created through a process called minting, where the information about the asset is encoded and recorded on a blockchain.
We mainly use this type of crypto token to create digital art, which is bought and sold through online marketplaces such as OpenSea and Rarible, depending on the value that the market and its owners have placed on it.
However, these tokens do not necessarily confer legal rights over the item they are associated with, as their ownership has no inherent legal significance in most jurisdictions.
While some NFTs give their holders intellectual property rights, they usually represent proof of ownership of an item. As such, they cannot restrict anyone from sharing or copying the associated digital file, nor can they prevent others from creating new NFTs based on the same files.
Conclusion
Understanding the dynamics of crypto tokens is essential to effectively navigate the world of cryptocurrencies. From utility tokens that facilitate access to services to security tokens that represent ownership rights, each type serves a different purpose in the blockchain ecosystem.
Crypto tokens can serve as digital expressions of ownership of an asset or can enable transactions within a blockchain. However, their similarity to cryptocurrencies often leads to confusion, given their tradable and interchangeable nature.
Whether you are an investor, developer or enthusiast, understanding the nuances of tokens opens up a world of possibilities in decentralized finance and digital ownership.
These tokens often serve as a means to raise money for projects through initial ICOs. However, for those considering tokens as an investment, thorough research into the issuing team or company is essential to make informed decisions.
Read more: How to Create an Ethereum Wallet: Securely Manage Your ETH and ERC-20 Tokens