Cryptocurrency Token: What Is It in Simple Terms?
As you study cryptocurrencies, you may notice that there are different terms which are used when talking about cryptocurrency. Sometimes they are called tokens. Other times, they are called coins or, sometimes, altcoins.
Some of these terms may seem to be interchangeable, but in fact they all refer to different types of cryptocurrencies. In this article, we’ll explain what cryptocurrency tokens are and what makes them different.
What Cryptocurrency Tokens Are?
Cryptocurrency tokens are digital assets created on the base of the blockchain of another cryptocurrency.
A blockchain is a digital registry in which information is stored in blocks linked together. This information can consist of records of transactions or full-fledged programs running on the blockchain, which are called smart contracts. For example, when cryptocurrency transactions are validated, they are grouped into a block, and that block is then added to the blockchain.
Every cryptocurrency is built on a blockchain. If a cryptocurrency does not have its own blockchain, but instead uses the blockchain of another cryptocurrency, it is called a token.
Cryptocurrency Tokens VS Cryptocurrency Coins
A cryptocurrency can be a coin or a token, depending on whether it is a native cryptocurrency for its blockchain or not. Crypto coins have their own underlying blockchain, while crypto tokens do not.
To make it clearer, let’s take Ethereum (ETH) as an example. Ethereum is a blockchain and its native cryptocurrency is called Ether. Because Ether has its own blockchain, it is considered a cryptocurrency.
One of Ethereum’s features is that it was the first programmable blockchain. Due to this fact, developers can use it to run their own cryptocurrencies. These cryptocurrencies run on the Ethereum blockchain rather than their own, which makes them crypto-tokens (the official term for tokens created on Ethereum is ERC-20 tokens).
Early cryptocurrencies such as bitcoin (BTC) did not have this capability. Ethereum did, which helped it become the second largest cryptocurrency by market share.
Because it is much easier to create a token than a coin, there are many more frauds and low-impact projects launched using tokens. However, this does not mean that all tokens are bad investments or that all coins are good. There are many tokens with interesting usage scenarios. Of course, there are also cryptocurrencies that have no particular use case or competitive advantage.
Importance of Crypto Tokens
Tokens allow developers to create a cryptocurrency without having to build a blockchain for that cryptocurrency. This is important because it makes the process of developing cryptocurrencies much faster, easier and cheaper.
For developers who want to build their own cryptocurrency, blockchain development is a serious technical challenge. The blockchain must be able to process transactions quickly and inexpensively, and it must also be resistant to attacks so that hackers cannot steal the cryptocurrency.
Creating a blockchain is not the end of the process. The new cryptocurrency also needs validators to validate transactions. Because cryptocurrencies are decentralized, they depend on people deciding to become validators and providing processing power for the blockchain.
Bitcoin, for example, relies on bitcoin mining, but it requires people around the world to use mining devices. The developers of the new coin also need to think about how to attract enough validators to secure the blockchain and avoid fraudulent transactions.
A faster option is to issue a cryptocurrency token. Instead of creating a blockchain from scratch, developers can use an existing blockchain, such as Ethereum. Their cryptocurrency token could run on an existing Ethereum platform, which already has a robust system for confirming transactions and triggering smart contracts.
How do cryptocurrency tokens work?
Like cryptocurrencies, crypto tokens are assets with value. They can usually be transferred, exchanged, bought and sold, and are stored in blockchain wallets. A blockchain wallet is a program or hardware device that is used to store cryptocurrency.
Transactions with a cryptocurrency token are processed on the blockchain it uses. For example, if it is an ERC-20 token created on Ethereum, then all transactions with that token will be processed on the Ethereum blockchain.
In addition to the role of currency, cryptocurrency tokens can perform many other functions. Here are a few of the most common uses of cryptocurrency tokens:
- Management tokens. A management token is a cryptocurrency token that gives the owner a say in a cryptocurrency project. Token holders can make offers that help determine the future of a particular cryptocurrency and vote on them. The more tokens you hold, the more voting rights you have.
- Decentralized Finance. Decentralized finance (DeFi) refers to alternative financial systems built on blockchain technology. For example, instead of getting a loan from a lender, you can put up cryptocurrency tokens as collateral and get it from a DeFi platform. Each DeFi platform has its own token, which it uses as its official currency.
- Crypto Rewards. The previously mentioned DeFi platforms rely on investors to lend their own cryptocurrency. In return, investors receive crypto rewards as incentives. These rewards are usually paid in the form of cryptocurrency tokens.
- Non-fungible tokens. Non-fungible tokens (NFTs) are crypto-tokens that indicate ownership of a digital asset. The ownership information is stored in the cryptocurrency token. NFTs can be used to show who owns a unique digital image, GIF, or character in an online game.
Cryptocurrency, Altcoins and Crypto-Tokens
Cryptocurrency, altcoins and crypto-tokens are common terms you might come across to describe cryptocurrencies. Here’s a brief description of their definitions:
- A cryptocurrency is a decentralized digital currency. It uses cryptography to verify transactions, and transaction data is stored in a blockchain.
- An altcoin is any cryptocurrency other than bitcoin. The term comes from the fact that they are an alternative to bitcoin, the first cryptocurrency.
- A cryptocurrency token is a cryptocurrency that does not have its own blockchain. The developers create it on the blockchain of another cryptocurrency.
- These categories overlap quite a bit. Cryptocurrency includes all cryptocurrencies on the market, which means that both altcoins and cryptocurrency tokens fall into this category. And since altcoins include all cryptocurrencies outside of bitcoin, cryptocurrency tokens also fall into the altcoin category.
The Best Cryptocurrency Tokens
Now that we’ve explained what cryptocurrency tokens are, let’s take a look at a few of the most popular ones:
- Tether (USDT) and USD Coin (USDC). These are stackable tokens tied to the U.S. dollar. They are designed to keep the price at $1, and both are built on the Ethereum blockchain.
- Shiba Inu (SHIB). This is a controversial token whose price soared in 2021. This success was primarily due to its popularity, and since then the value of the token has dropped significantly. It is also built on the Ethereum blockchain.
- Chainlink (LINK). This is an oracle network that allows smart contracts on the blockchain to receive data from the real world. It is also built on the Ethereum blockchain.
- Uniswap (UNI). This is a token for a decentralized cryptocurrency exchange of the same name. Uniswap exchange offers cryptocurrency trading without a central governing body and, like the others on this list, is built on the Ethereum blockchain.
These are some of the largest cryptocurrency tokens by market value, but there are thousands more. While some have the potential to be a good cryptocurrency investment, the vast majority are not. Because it is so easy to create a cryptocurrency token, many developers are releasing useless tokens in hopes of making a quick buck.
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