What are crypto tokens? | Difference between a coin and a token

Learn what crypto tokens are and the difference between them and cryptocurrencies. Explore their uses, types, and how they work in blockchain networks.

As you learn about cryptocurrencies, you will notice that various terms such as cryptocurrency, token, coin, etc. appear frequently. You will often find that people use the terms coin and coin loosely and interchangeably. But the terms have completely different concepts and meanings.

Coins are the primary medium of exchange for blockchain networks. Crypto tokens, on the other hand, are extra assets built on top of existing blockchain networks and are not vital to the operation of the networks. While each blockchain has only one main cryptocurrency, it can have many different crypto tokens.

When people talk about “crypto” they usually mean a combination of both assets. In this guide, we will talk about crypto tokens and how to use the term correctly. Let’s dive.

What are crypto tokens?

The crypto tokens described are programmable digital assets built on an existing blockchain using smart contracts.

These tokens often serve a variety of purposes, including providing holders with access to certain services and features within a blockchain ecosystem or as digital representations of physical objects.

They can also give holders voting rights on crypto projects; Those who hold more tokens have more say in deciding how things will run on the blockchain platform.

Crypto token holders can also use them to invest in decentralized finance (defi) protocols, as a store of value, or to make purchases within decentralized applications (dapps). These are typically created, distributed, sold and distributed through crowdfunding rounds such as initial coin offerings (ICOs).

Difference between a coin and token

Having 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 run on their own independent blockchain. They are native to their respective blockchains and are primarily used as a medium of exchange on the blockchain, just as we use fiat currency in traditional transactions. They can also act as a store of value or have chain-specific use cases.

Tokens, on the other hand, are digital assets created and operated on an existing blockchain network. They don’t have a native blockchain of their own but need another platform to run.

Tokens are priced differently and have different benefits than the native cryptocurrency of the blockchain they are built on. Additionally, although you can use tokens as a means of payment, their main purpose is usually to provide access to the functionality of a decentralized application.

Simply put, the main difference between a cryptocurrency and a token is how and why they are made. Coins operate on their own blockchains and function primarily as a medium of exchange. However, tokens are built on top of existing blockchain networks and offer a wider range of functionality.

From a creation standpoint, tokens are easier to create than coins. Creating a coin requires creating a new blockchain, which takes time and expertise. However, tokens can be created on an existing blockchain using smart contracts, making the process simpler 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 run automatically on blockchains such as Ethereum (ETH).

These smart contracts contain the rules and behavior of crypto tokens, such as how many there will be, how they will be created, and what they can do.

Developers can create custom tokens by writing smart contract code that conforms to a specific token standard, such as ERC-20, ERC-721, or ERC-1155 for Ethereum-based tokens.

These token standards play a very important role. They establish regulations that dictate the underlying data a token must have, its functions, and the actions allowed for token holders or communities. They also provide instructions regarding the generation, distribution, distribution, transfer, removal and various other aspects of tokens on the underlying blockchain.

ERC-20 tokens are the most common token type on Ethereum and are used for assets that can be exchanged or exchanged.

The ERC-721 standard is primarily used for unique, immutable assets such as collectibles, game items, or digital artworks. Each ERC-721 token has a separate value and cannot be directly exchanged for another.

ERC-1155 tokens combine the features of both ERC-20 and ERC-721 standards. They can support both fungible and non-fungible tokens under a single contract.

Once you own tokens, your address is associated with the balance of those tokens on the blockchain and you can transfer these tokens to other addresses by calling the appropriate smart contract function.

Investors can use crypto tokens for different purposes. They can hold them to show a stake in the blockchain project or for economic purposes (to trade or buy goods and services).

As valuable assets, crypto tokens are often portable, traded, bought and sold, and held in digital wallets, which are software programs or physical devices used to store cryptocurrency.

Transactions with a crypto token occur on the blockchain to which it is connected. For example, if it is an ERC-20 token built on Ethereum, Ethereum handles all transactions for that token.

There are a variety of use cases for crypto tokens, including utility, security, governance, and non-fungible tokens (NFTs). We’ll take a closer look at each of these functions later in the article.

You can buy and sell most tokens on cryptocurrency exchanges, and their transactions are verified by network nodes to ensure security and consensus.

Types of crypto tokens

As mentioned earlier, there are various types of tokens on the blockchain: transaction tokens, governance tokens, utility tokens, security tokens, and non-fungible tokens.

However, a single crypto token can fall into multiple categories depending on its features and use cases. Here are the main types:

Transaction tokens

As the name suggests, these tokens are used for transactions within the ecosystem of a particular project. They generally function like traditional currencies but sometimes provide additional benefits such as increased liquidity and investment opportunities.

One example of a transactional token is Bitcoin (BTC), which was originally created as a way to transfer money cheaply and efficiently.

Governance tokens

Such tokens allow their holders to vote on the decisions of a blockchain project. It is a type of cryptocurrency used to vote on proposals, make decisions, and influence the future of a project. Each governance token a person holds generally equals one vote on a proposal.

Utility tokens

These tokens are issued by blockchain projects to develop their ecosystems. It is designed to give users access to a product or service, usually available on a dapp. Utility tokens are specific to their ecosystem and allow users to perform certain actions on the network.

Additionally, utility tokens are often 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. Holders can then use these tokens to pay 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 value from a real-world asset or suite of assets to the person who holds the token.

In tokenization, a project enters what the token represents and then generates the token. The project will then offer this token to investors on an exchange or other suitable investment platform.

Ownership of this token will then be recorded on the blockchain and tagged with the owner’s blockchain address.

Security tokens can represent ownership of a portion of any valuable asset, such as a car, real estate, or company shares.

Non-fungible tokens

NFTs are unique tokens that are encoded on a blockchain to make them impossible to copy or replace. People can use them to confirm ownership and authenticity of a physical item or digital file, including music, artwork, or video recording.

Tokens are created through a process called minting, where the asset’s information is encrypted and recorded on a blockchain.

We mostly use these types of crypto tokens to create digital art, which are traded through online marketplaces like OpenSea and Rarible depending on the value the market and their owners place on them.

However, these tokens may not provide legal rights over the item to which they are associated, as their ownership has no inherent legal meaning in most jurisdictions.

While some NFTs grant intellectual property rights to their owners, most generally represent proof of ownership of an item. Therefore, they cannot restrict anyone from sharing or copying their relevant digital file or prevent others from creating new NFTs based on the same files.

Solution

Understanding the dynamics of crypto tokens is crucial to effectively navigate the world of cryptocurrencies. From utility tokens that facilitate access to services to security tokens that represent property rights, each type serves a different purpose in the blockchain ecosystem.

Crypto tokens can serve as expressions of digital ownership in an asset or enable transactions within a blockchain. However, their similarities to cryptocurrencies often lead to confusion, given their tradable and fungible 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 of raising funds for projects through initial ICOs. However, it is crucial for those considering tokens as an investment to do thorough research on the issuing team or company to make informed decisions.