Understanding what are crypto tokens: differences, uses, and types

Learn what crypto tokens are and the difference between them and coins. Explore their uses, types, and how they operate within blockchain networks.

As you learn about cryptocurrencies, you’ll notice that various terms such as cryptos, tokens, coins, and more often arise. Usually, you’ll see that people use the terms token and coin loosely and interchangeably. However, the terms have entirely 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 existing blockchain networks and are not vital for the networks to run. While each blockchain only has one main cryptocurrency, it can have many different crypto tokens.

When folks talk about “crypto,” they usually mean both assets together. In this guide, we’ll speak of crypto tokens and how to use the term correctly. Let’s dive in.

What are crypto tokens?

Crypto tokens explained, are programmable digital assets built on top of an existing blockchain using smart contracts.

These tokens usually serve various purposes, including giving holders access to certain services and features within a blockchain ecosystem or as digital representations of physical objects. 

They can also give their holders voting rights in crypto projects, with those owning more tokens having a greater say in deciding how things work on a blockchain platform.

Crypto token holders can also use them for investment on decentralized finance (defi) protocols, as stores of value, or to make purchases within decentralized applications (dapps). They are often created, distributed, sold, and circulated through crowdfunding rounds such as initial coin offerings (ICOs).

Difference between a coin and a token

Having understood what are crypto tokens, we will now differentiate them from coins, a term people often use interchangeably with tokens.

Coins are digital assets that operate on their own independent blockchain. They are native to their blockchains and are primarily used as a medium of exchange on the blockchain, much like we use fiat currency in traditional transactions. They may also act as a store of value or have chain-specific use cases.

On the other hand, tokens are digital assets built and operated on an existing blockchain network. They do not have a native blockchain of their own but require another platform to operate.

Tokens are priced differently and have different utility from the native cryptocurrency of the blockchain they are built on. Furthermore, while you can use tokens as a means of payment, their primary purpose is often to provide access to the functionalities of a decentralized application.

Simply put, the main difference between a crypto coin and a token is how and why they are made. Coins operate on their own blockchain and primarily function as a medium of exchange. Tokens, however, are built on top of existing blockchain networks and provide a broader range of functionalities.

In terms of creation, tokens are easier to create than coins. Creating a coin requires building a new blockchain, which requires time and expertise. Tokens, however, 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 a blockchain network’s consensus mechanism, crypto tokens come to life through smart contracts running automatically on blockchains such as Ethereum (ETH). 

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

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

These token standards play a crucial role. They establish regulations dictating the essential data a token should possess, its functionalities, and the actions permitted for token holders or communities. They also provide instructions for generating, distributing, deploying, transferring, removing, and various other aspects of tokens within the underlying blockchain.

ERC-20 tokens are the most common type of token on Ethereum, and they are used for fungible or interchangeable assets.

The ERC-721 standard is mainly used for unique, non-fungible assets like collectibles, game items, or digital art. Each ERC-721 token has a distinct value and cannot be exchanged directly for another.

On their part, ERC-1155 tokens combine features of both the ERC-20 and ERC-721 standards. They can support both fungible and non-fungible tokens within a single contract.

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

Investors can use crypto tokens for different purposes. They can keep them to show a share in the blockchain project or for economic purposes—to trade or buy goods and services.

As assets with worth, crypto tokens can usually be moved, traded, bought, and sold, and they’re held in digital wallets, which are software programs or physical devices used to store cryptocurrency.

Transactions with a crypto token occur on the blockchain it’s tied to. For instance, if it’s an ERC-20 token built on Ethereum, then Ethereum handles all transactions for that token.

Several use cases exist for crypto tokens, including utility, security, governance, and non-fungible tokens (NFTs). We shall look at each of these functions more closely later in the article.

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

Types of crypto tokens

As hinted at earlier, there are several types of tokens in the blockchain: transactional tokens, governance tokens, utility tokens, security tokens, and non-fungible tokens. 

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

Transactional tokens

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

An example of a transactional token is Bitcoin (BTC), which was initially created as a way of cheap and efficient money transfer.

Governance tokens

These types of tokens allow holders to vote on the decisions of a blockchain project. They are a type of cryptocurrency used to vote on proposals, make decisions, and influence the future of a project. Each governance token a person holds usually equates to one vote on a proposal.

Utility tokens

These tokens are issued by blockchain projects to cultivate their ecosystems. They are designed to grant users access to a product or service, usually available on a dapp. Utility tokens are unique to their ecosystem and allow users to perform specific actions on the network.

Furthermore, utility tokens are usually 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. The holders can then use these tokens to pay for fees and services related to the project.

Security tokens

These tokens are digital representations of ownership rights or asset value that have been 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 bundle of assets to whoever holds the token.

In tokenization, a project inputs what the token represents and then generates the token. The project would then offer this token on an exchange or other appropriate investment platform for investors. 

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

Security tokens can represent ownership of a fraction of any valuable asset, like a car, real estate, or corporate stock.

Non-fungible tokens

NFTs are unique tokens coded on a blockchain to make them impossible to replicate or substitute. People can use them to certify the ownership and authenticity of a physical item or digital file, including music, artwork, or a video recording.

The tokens are created through a process called minting, in which the asset’s information is encrypted and recorded on a blockchain.

We mainly use this type of crypto token to create digital art, which is bought and sold through online marketplaces such as OpenSea and Rarible, depending on the value the market and owners have placed on them.

However, these tokens do not necessarily convey legal rights over the item they are associated with since their ownership has no inherent legal meaning in most jurisdictions.

While some NFTs give their holders intellectual property rights, most usually represent proof of ownership of an item. As such, they may not restrict anyone from sharing or copying their associated digital file, nor can they prevent others from creating new NFTs based on the same files.

Conclusion

Understanding the dynamics of crypto tokens is essential to navigating the world of cryptocurrencies effectively. From utility tokens facilitating access to services to security tokens representing ownership rights, each type serves a distinct purpose in the blockchain ecosystem.

Crypto tokens can serve as digital expressions of ownership in an asset or enable transactions within a blockchain. However, their similarity to cryptocurrencies often leads to confusion, given their tradable and exchangeable nature.

Whether you’re an investor, developer, or enthusiast, grasping the nuances of tokens opens up a world of possibilities in decentralized finance and digital ownership. 

These tokens frequently serve as a means to gather funds for projects through initial ICOs. However, for those contemplating tokens as an investment, thorough research into the issuing team or company is essential to making informed decisions.