The ever-evolving world of blockchain and decentralized finance needs a medium to facilitate payments, exchanges, and trades in the ecosystem. Tokens and cryptocurrencies are the current mechanisms utilized by decentralized platforms to execute transaction payments, rewards, and asset ownership.
However, the similarities between the functions of a cryptocurrency and a token have made it difficult for many traders, investors, and crypto enthusiasts to recognize the differences that exist between a token and a cryptocurrency.
In this article, we will explore what a crypto token is and how it differs from a cryptocurrency.
A cryptocurrency is also referred to as a coin in the digital world. It is a digital currency secured with complex cryptography that runs on its native blockchain. A cryptocurrency is a currency just like fiat currencies. It has value and can be used for trade and exchange.
Cryptocurrencies are unique because they are often native coins on a particular blockchain. A blockchain is a digital and decentralized ledger system that stores transactions.
A blockchain is a decentralized digital ledger system that stores transactions and programs into immutable blocks linked to a previous chain of blocks.
A blockchain ensures the security and immutability of transactions validated and added into a block because no central authority solely confirms transactions. The most popular blockchains today include Bitcoin, Ethereum, and Cardano. Bitcoin's blockchain has BTC as its native cryptocurrency. Ether (ETH) is the native cryptocurrency of the Ethereum blockchain, while ADA is the native coin of the Cardano blockchain.
One distinct feature that crypto coins have is that they are usually native coins to a particular blockchain.
Although used interchangeably with cryptocurrencies, a token serves an entirely different purpose. Crypto tokens are digital assets representing anything of value, including physical assets, governance rights, exclusive blockchain services, and gaming features. In most cases, crypto tokens are not native to a blockchain. Instead, tokens are built on another blockchain and leverage that platform.
A developer can create a crypto token on a blockchain such as Ethereum and run the token successfully. Ethereum is one of the most popular blockchain networks today because its programmable structure supports the development of smart contracts, tokens, and decentralized applications (dApps). It means a token does not need its blockchain to exist. Tokens usually go live on an alternative blockchain.
Tokens are mostly created to facilitate operations on decentralized projects. They are not currencies like crypto coins, but they have several functions and use cases which include serving as a means of payment, security, utility, and governance. Examples of crypto tokens are Uniswap, Cronos, Filecoin, and Arweave.
While both tokens and coins are distributed on the blockchain, they do have some differences we should be aware of.
Tokens are often not native to a blockchain. They usually run on top of another blockchain. This feature makes tokens easier to build because they don't require developers to create an entirely new blockchain, thus saving costs, time, and computing power. Tokens are a way for developers to create cryptocurrencies and run them on secure networks like Ethereum at a cheaper rate.
Cryptocurrencies are often native coins to a blockchain and serve to store value and facilitate exchanges. Tokens can also serve these purposes and more. Tokens are digital assets that can effectively store value, facilitate payments and exchanges, give governance rights, and many more.
Think of crypto coins as digital currencies similar to fiat currencies in function, and think of tokens as digital assets that can carry out various payment functions and more.
Coins must be mined or earned through a Proof of Work (PoW) or a Proof of Stake mechanism (PoS). Bitcoin uses a Proof of Work system that requires miners to solve complex equations before validating a block of transactions and adding it to the blockchain.
On the other hand, Proof of Stake requires validators to stake a reasonable share of coins before they can validate transactions.
The Proof of Work mechanism requires a lot of computing power only some have access to, while the Proof of Stake requires the ownership and staking of a good amount of cryptocurrencies or tokens before becoming a block validator. Tokens make it easier for developers to build crypto tokens and run them securely using another blockchain.
This means that tokens leverage another blockchain's established security and validation system without having to create theirs. It makes developing tokens and coins easier, faster, and cheaper.
Developers can run their crypto tokens on blockchain giants like Ethereum, which has an established blockchain system that supports the development of tokens, dApps, and smart contracts, thus making their tokens viable on the blockchain. Tokens on the Ethereum blockchain are called ERC-20 tokens because they follow a set of standards to run on the Ethereum network.
Crypto tokens have a variety of use cases in the blockchain space. They are mostly used within blockchain projects and decentralized platforms. The first cryptocurrency, Bitcoin, was created as a digital replacement for traditional currencies. That is the main function of cryptocurrencies.
They serve as digital currencies that facilitate exchanges. Crypto tokens function similarly to crypto coins in facilitating exchanges, payments, and revenue generation. Some of the use cases of crypto tokens include:
Exchange of value: Tokens represent tradable assets which could be a company's stock, coins, voting rights, game points, and so on. While tokens are not a medium of exchange like cryptocurrencies, they are tradable and can store value.
Facilitate rewards: Tokens also serve as rewards for developers and validators for all their efforts in the blockchain. In a Proof of Stake system, the validators are rewarded with coins or tokens for successfully authenticating a block of transactions. Blockchain games also feature tokens as the reward mechanism for gamers.
Governance rights: Tokens are very useful in conferring governance rights to users in the blockchain ecosystem. This feature is very common in decentralized autonomous organizations (DAOs). DAOs function as a decentralized community where members can vote and decide on proposals, changes, and upgrades by owning a share of tokens. This means that possessing tokens can give users exclusive voting and governance rights.
Securing value: Tokens store value because they are digital assets. They can be bought, sold, and traded on the blockchain network. Tokens can even represent physical artworks or digital possessions, like in the case of NFTs, offering the token-holder ownership of a unique asset.
There are different types of crypto tokens, each with specific use cases. This section explores the different types of crypto tokens and their unique applications.
Decentralized finance (DeFi) tokens: Decentralized finance refers to an alternative financial system different from the traditional financial structure and based on blockchain technology. DeFi encompasses a variety of financial processes, including saving, lending, trading, and insurance.
DeFi tokens are extremely useful in lending cases as they can serve as collateral when a user takes a loan from the DeFi platform. These tokens can also be traded just like any cryptocurrency.
Utility tokens: Utility tokens are financial instruments, services, or products that offer certain benefits to users within the blockchain ecosystem it was created. Utility tokens can facilitate operations on a blockchain, unlock access to restricted upgrades, and also serve to reward users on the platform.
Non-fungible tokens (NFTs): NFTs are crypto tokens representing a user's ownership rights over digital or real-world assets. NFTs are, in simple terms, tokens that prove the ownership of unique assets. They store the ownership information of an asset and make it easier for duplicates to be created. NFTs are also useful in selling real-world artworks or unique digital assets like the features in an online game.
Security tokens function similarly to traditional securities such as stocks and bonds. They can represent the shares of a company and facilitate the buying and selling of these shares without the need for a broker.
Governance tokens: Governance tokens are unique tokens that grant holders the right to vote over proposals and changes in a blockchain project. The number of tokens a user possesses determines the number of votes the user will have. Governance tokens give users the right to participate in the decision-making process of a cryptocurrency project, thus giving them a say in the proposals and decisions that shape the project's future.
Tokens, stablecoins, and altcoins are cryptocurrency terms whose meanings overlap in the blockchain ecosystem, making it hard to identify what differentiates them.
Altcoins refer to every other cryptocurrency created after Bitcoin, the first-ever cryptocurrency to exist. Altcoin was coined from "alternative coins," referring to crypto coins other than Bitcoin. Altcoins include Litecoin, Dogecoin, Cardano, and many others.
Stablecoins are cryptocurrencies or tokens whose value is linked to fiat currencies like the U.S. dollar or high-value exchange instruments like gold. Stablecoins serve as a way to control the volatility of cryptocurrencies by pegging them to stable currencies and exchange commodities. Examples of stablecoins include Tether, USD Coin, Dai, Binance USD, and many more.
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