The technical and traditional definition of a "token" in blockchain and cryptocurrency has been as another word for "cryptocurrency" or "cryptoasset." But as the blockchain ecosystem and use cases have increased, the word token has taken on more meanings and could be better considered as an umbrella term to describe digital assets that run on its own blockchain and digital assets that run on top of another cryptocurrency's blockchain. This gives tokens a more extensive range of potential functions, such as governance, video game items, and identification vehicles. But all tokens can be traded or held.
Cryptocurrency tokens can be differentiated from digital assets, although some definitions include tokens and digital assets as a single definition. Even in these definitions, tokens are typically seen as a subcategory of a digital asset because a digital asset can be broadly understood as a non-tangible asset created, traded, and stored in digital format, which includes, in a blockchain context, cryptocurrency coins and tokens. In that way, a token is a more specific unit of value developed on top of blockchain networks and often shares compatibility with the cryptocurrency coins of the network. Put simply, all cryptocurrency coins and tokens are digital assets, but not all digital assets are cryptocurrency coins or tokens.
Tokens are typically described in terms of their standards, with widely used token standards—including the ERC-20 token standard, which allows the creation of tokens on Ethereum's ecosystem of decentralized apps. And ERC-721, which was designed to create non-fungible tokens that are individually unique and cannot be interchanged with similar tokens.
Tokens are programmable, permissionless, trustless, and transparent. This means tokens are meant to run on software protocols, composed of smart contracts, which outline the features and functions of the token as well as the network's rules of engagement. Permissionless describes the ability for anyone to participate in the system, and trustless describes the lack of one central authority offering control over a system. Instead, the token and the blockchain run on rules predefined in the network protocol. And transparency implies that the rules of the token are viewable, verifiable, and followed.
The differentiation between a cryptocurrency token and a cryptocurrency coin is perhaps simpler. Although cryptocurrency coins have historically been understood to be cryptocurrency tokens, they have been differentiated with the expansion of the roles of cryptocurrency tokens and the more limited role cryptocurrency coins continue to inhabit.
In this expanded context, cryptocurrency coins are considered a native asset of a blockchain network that can be traded, used as a medium of exchange, and used as a store of value. A coin is issued by the blockchain protocol on which it runs, and this is why it is referred to as that network's native currency. In this way, coins can be used to pay transaction fees and to incentivize users to keep a network secure.
Coins are also used to exchange value, allowing a coin holder to exchange the coin for goods or services, hold it for increased value (if the coin's native network increases in value), or exchange it for a fiat currency. Typically, a coin is decentralized and relies on code (smart contracts) to manage issuance and transactions; it is built on a blockchain and is used to enforce the rules of the system in an automated and trustless fashion; and it is secured using cryptography to further secure the underlying network.
Tokens can be used in various ways, unlike coins, which have a fixed use case. Tokens can be held for value, traded, staked to earn interest, and used with decentralized applications (dApps). Often, even though a token may be built on top of a blockchain, like Ethereum, the token will only be capable of being used on dApps or DeFi projects built on the same blockchain, with limited interoperability between blockchains.
For example, an ERC-20 token will be used mostly with other DeFi projects and dApps built on the Ethereum blockchain but cannot be used in place of the Ether coin, which is the native cryptocurrency coin of the Ethereum blockchain used for staking and governance.
Tokens are often thought of as being easier to develop than coins, and their use cases have grown in part due to this and due to their use in DeFi organizations; for example, they have seen increasing application as non-fungible tokens (NFTs) used in open markets or in video games, and they have been used for security or identity tokens, issued to verify users. From this has grown a large group of other types of tokens:
Types of cryptocurrency tokens
DeFi tokens are used in various applications involving finance, such as trading, lending, borrowing, derivatives, synthetics, insurance, and more as new DeFi projects are built. These platforms tend to steer away from traditional cryptocurrency platofrms and work to enable users to often work in peer-to-peer networks, in which the native DeFi token is important, as it can be used for borrowing, loaning, or farming tokens. They tend to be related to exchange tokens.
These are often used to help an exchange differentiate itself from competitors, and can be used to pay fees, buy and sell cryptocurrency coins, and power community operations. Often also called native exchange tokens, they can be used for various other schemes in a token exchange, depending on how the exchange decides to use the token. And, in some cases, when traded against other cryptocurrency coins, they can begin to take on characteristics of coins. But, as most, if not all, exchanges are built on a blockchain that is not their native blockchain, these exchange tokens will remain tokens.
Governance tokens are often issued by DeFi or dApp projects and are used for the purpose of decision making in regards to the protocol's future. These tokens offer holders voting power and a say in the direction of a protocol, and could be likened to exchange listed securities or shares of a company. These tokens are essential to create decentralized organizations or applications, as without the voting power offered by governance tokens a centralized leadership group of a given project will continue to steer the project's course. The governance token also increases the transparency in the direction of a project, often including discussion and debate with the project developers for a future direction.
An ICO (Initial Coin Offering) token is often thought of more as a token developed by a cryptocurrency project, rather than a cryptocurrency coin offering for a blockchain, that is used to raise money, and could be thought of as a fundraising token as much as ICO token. This token is often used as a source of capital for new startup companies, and as more DeFi projects have found other sources of funding, and in response to larger market changes, these tokens have been used less.
Non-fungible tokens (NFTs)
Perhaps the most popular type of token, NFTs are digital certificates of ownership to a unique asset on the blockchain. It can be used to represent a variety of assets, such as photos, videos, audio, collectibles, real estate, virtual worlds, memes, GIFs, digital content, or any file of value on a blockchain. NFTs can be owned by a single person at a time, and when they are traded they often include payments back to the originating creator or artist (they are often associated with art). This can helps artists, creators, and collectors oto sell items, and they are widely traded on NFT marketplaces.
As more enterprises wade into the world of cryptocurrency and blockchain, and as the possibilities of blockchain technology, DeFi, and dApps continue to grow, the potential use cases for tokens continue to be discovered or developed. Some use cases include:
Use cases for cryptocurrency tokens
DeFi platforms often rely on investors who lend their cryptocurrency funds or stake their tokens into a liquidity pool, and often they will receive rewards to incentivize their taking part in a project. Often these rewards are usually paid out as cryptocurrency tokens.
Cryptocurrency tokens are integral to dApps, such as games or social media platforms, as they are often required to login or participate on a given dApps. The specific use case will depend on the specific application.
Decentralized finance (DeFi)
DeFi refers to alternative financial systems built on blockchain technology, and often these projects have tokens specific to their use cases and ecosystem used as their official currency. These could be used to get a loan for a lender, or to put up as collateral for one of those loans.
Digital user identities
Digital user ideas can be tokenized, and this can even be used to move the digital technology towards more government and regulatory use cases, as a decentralized digital identity held on a token can be used to verify access to digital services and software.
For governance, tokens can be used to give a token holder voting rights in a cryptocurrency project, allowing them to make and vote on proposals to determine the specific cryptocurrency, and often the more governance tokens held the more voting power the token holder has.
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