Introduction
Can you remember a time when crypto started making sense to you? Well, for most crypto enthusiasts, it was when they realized that there was so much more to cryptocurrencies than just Bitcoin.
Today, most of the services available in the traditional financial systems are also available in the crypto ecosystem. You can take out loans, earn interest on your cryptocurrency or even take out insurance for your assets. For all this to be possible, the blockchain community had to develop an asset class that was secure and had value. Here is where cryptocurrency tokens came in.
Crypto tokens revolutionized the crypto space by introducing an asset class that people had only imagined. Although it started with Bitcoin, the blockchain space has grown to host thousands of crypto tokens, each with its unique application.
What are crypto tokens?
The term crypto token describes crypto assets that run on top of another cryptocurrency’s blockchain. If you’ve been in the crypto game for a while, I’m sure you have heard of the two largest cryptocurrencies by market cap — bitcoin and Ethereum. Each of these crypto coins has its blockchain network, and they act as the native currencies to their respective networks.
While Bitcoin mainly focuses on peer-to-peer transactions, Ethereum allows developers to create personalized projects using smart contracts. Simply put, a smart contract is a program on a blockchain that holds the terms of the agreement and executes when participants meet certain conditions.
Crypto tokens can represent fungible assets, tradable assets, and utilities on a smart contract. You can think of them as the currency or assets on a smart contract.
How are tokens different from cryptocurrency coins?
Most people often use the words coins and tokens interchangeably. However, the two are distinct types of assets.
As we mentioned above, the most distinct feature is the difference in where they operate. Coins are units native to the blockchain network they are built on. On the other hand, tokens are not native to the underlying blockchain network. They operate within the smart contact they are built on. Examples include Tether, MakerDAO, and Aave protocols on the Ethereum blockchain.
When a user sends a token, it’s transferred from one digital asset to another. Non-fungible tokens (NFTs) are the best examples of this. NFTs represent the ownership of a particular asset, so when you send your NFT asset to another person, it’s manually transferred from your digital wallet to the receiver’s wallet.
On the other hand, Cryptocurrency coins are just updates to your wallet balance. For instance, when you send 5 BTC to another person, 5 BTC is deducted from your account balance, and 5 BTC is added to the receiver’s balance. It’s very similar to how bank transfers work where the physical notes or coins are not transferred. Only the balances are updated.
Another key difference is what they represent. Cryptocurrency coins represent a digital version of underlying value, which in some cases might be debatable. For instance, while most of bitcoin’s intrinsic value is derived from its scarcity, the value primarily depends on what people think its worth.
Unlike crypto coins, tokens represent digital or real-world assets and what the beholder owns. You can use crypto coins to buy tokens, but the number of coins you pay will depend on the value of the underlying assets. Moreover, some tokens like NFTs do not share crypto coins’ liquidity.
What are tokens used for in the crypto ecosystem?
Tokens are classified in various ways depending on how they are used. The primary classification divides them into two categories according to their functionality: utility tokens and security tokens. The other classification distinguishes tokens based on their features: fungible and non-fungible.
Let’s have a look at how tokens are used.
Decentralized finance (DeFi) tokens
Blockchain has evolved from just offering peer-to-peer transactions to cryptocurrency-based protocols that aim to reproduce the services provided by traditional financial institutions. In the DeFi space, tokens are used to facilitate lending, crypto saving, insurance, trading, and also as a way to earn passive income. Additionally, investors can hold tokens as a store of value like any other cryptocurrency.
Governance tokens
Cryptocurrency projects can be viewed as decentralized autonomous organizations (DAOs). This means that they do not have any central governance. The decision-making process is delegated to the nodes in the network. As a result, the blockchain introduced a consensus mechanism that enables the nodes to take votes on the state of transactions in a blockchain or any protocol changes. To take part in the decision-making process, participants have to hold a project’s crypto tokens.
The popular Ethereum saving protocol MakerDAO issues users with MKR tokens, allowing holders to vote on any upgrades to the MakerDAO smart contract. It’s also crucial to note that the more tokens you hold, the more votes you get.
Dive deeper into the MakerDAO protocol here [Link to MakerDAO spotlight article]
Fungible and Non-fungible tokens (NFTs)
Although tokens run on smart contracts, users can also use them as a medium of exchange. For instance, you can take one DAI token on the MakerDAO protocol and swap it for another DAI token. It does not matter which unit you hold since they serve the same purpose. Due to this nature, they are considered fungible tokens — interchangeable.
NFTs, on the other hand, represent ownership rights to unique digital or real-world assets. Since they are unique and one of a kind, they cannot be swapped, making them non-fungible. For example, although there are 10,000 CryptoPunks avatars, you cannot swap one for another. The tokens used to represent a single avatar have different features from other CryptoPunk avatars.
Security tokens
Security tokens are among the most revolutionary asset classes in the crypto space. They aim to be the crypto equivalent of traditional securities like stocks and shares.
Security tokens became quite popular in 2017 when crypto companies used them to raise funds through Initial coin offerings (ICO). In simple terms, an ICO is a type of startup funding, but instead of using fiat currencies, investors use cryptocurrencies. Taking part in an ICO gives you ownership rights to a portion of the crypto project, like shares or fractional shares in traditional markets.
Where can you get tokens?
The most common way to get crypto tokens is through cryptocurrency exchanges. A good example is the CEX.IO exchange. It will allow you to trade between different crypto tokens, crypto coins and regular currencies, manage your wallet balances, check the value of other tokens and facilitate the process of sending and receiving tokens.
Closing thoughts
“Looking from an investment point of view, tokens are better than coins as they have a specific purpose and will never go out of demand so easily unless the application in the real world becomes extinct,” Patel of Mudrex said.
As a crypto investor, this makes a lot of sense. Would you rather trade the USD/EUR forex pair or buy Tesla tokens? Buy Tesla shares, of course, right?
Well, investing in tokens is just the same thing. While most native cryptocurrencies are used to run blockchains and offer P2P transactions, the value in crypto projects lies with tokens. This is because tokens represent ownership in a crypto project directly tied to the project’s utility.
Crypto tokens are challenging traditional financial services. You can now own a portion of a startup, acquire a loan or earn passive income on your tokens without the need of any central authority.
Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.
