What is a token? Understanding crypto tokens: Types and functionality

In an ever-advancing world, crypto tokens have become a focal point. Whether you are an investor, a technophile, or just interested in the world of finance, it is necessary to know what a crypto token is. In this article, you will learn everything you need to know about digital tokens, the different types of tokens, their uses, and how they can revolutionize other industries.

Crypto tokens are a special class of digital assets that facilitate value transfer. To appreciate their full scope, one must know their types and uses.

Crypto tokens can be divided into five categories: utility, security, mirrored assets, non-fungible tokens (NFTs), and ‘meme coins.’ Each has a specific function in the blockchain environment and provides certain benefits to participants and investors.

What is a crypto token?

At the most superficial level, a crypto token is a digital asset built within a blockchain environment. Tokens differ from cryptocurrencies like Bitcoin or Ethereum because cryptocurrencies have their own blockchain, while tokens, in most cases, run on existing blockchain platforms. For instance, many crypto token projects run on Ethereum. Below is a description of each token type:

– Utility tokens provide access to particular goods and services in a blockchain environment. For example, Basic Attention Token (BAT) is an ethereum crypto token distributed to users based on their time and attention using the Brave browser.

– Security tokens are digital assets backed by physical assets, such as commodities such as gold and luxury assets such as Rolex watches.

– Mirrored assets are synthetic tradable versions of assets, such as stocks that use blockchain oracles to track and mirror the price of their core assets.

– NFTs are a mechanism for making artwork and unique, non-fungible digital objects, that is, neither replaceable nor interchangeable. Some of the most famous – and valuable – NFTs are the crypto punks, with an average worth of around $70,000 at the time of writing.

– Meme coins, the most famous of which is the Ethereum-based Dogecoin, are tokens created as jokes that are deemed to have value only because of their popularity and speculative trading.

Related: Fiat currency vs cryptocurrency: understanding the future of money and Web 2.5

History of Crypto Tokens

The history of crypto tokens dates back to 2012 when J.R. Willet introduced the first recognized Initial Coin Offering (ICO) and token, Mastercoin, on the Bitcoin Forum. Mastercoin pioneered its approach, using layers to enhance a cryptocurrency’s functionality. The project linked the value of Mastercoin to Bitcoin and outlined a plan to use the funds raised to pay developers for creating new coins from Mastercoins.

From 2012 to 2016, the creation of crypto tokens and ICOs steadily increased. However, it was in 2017 that token offerings truly skyrocketed. Investors became increasingly aware of the potential value increases promised by these tokens. This period saw a surge in the creation of tokens by developers, businesses, and, unfortunately, scammers, all looking to capitalize on the fundraising boom. Regulatory agencies began issuing warnings to investors about the risks associated with ICOs.

The ICO bubble burst in 2018, leading to the emergence of Initial Exchange Offerings (IEOs). In an IEO, exchanges facilitate token offerings, claiming to have vetted the projects to reduce investor risks. Despite these claims, regulatory agencies continued to issue alerts about the dangers of participating in IEOs. Today, crypto tokens are still being created and used to raise funds for various projects through ICOs, albeit with more caution and regulatory scrutiny.

Related: Understanding on-ramp vs off-ramp: the key to cryptocurrency accessibility

What are utility tokens, and what do they do?

Utility tokens are intended to grant users the right to products or services in the blockchain environment. Crypto tokens work by facilitating secure online transactions and interacting with smart contracts. They are commonly used as the platform’s internal currency, enabling users to pay for services, unlock certain features, or engage in network governance.

An excellent example of this is the ENJ token on the Ethereum blockchain. ENJ was created to allow different game environments to create in-game items with fungible value. Game developers lock Enjin in a smart contract when issuing these items, which gives the underlying item its value. Users acquiring these items can then interact with them based on their original minting cost, whether using them in the game, trading them for another item, or selling them.

Another popular utility token is Chainlink (LINK), which fuels an Ethereum-based Oracle network. In essence, Oracles are tools that provide information external to the blockchain to execute smart contracts. For instance, in the earlier example of mirrored assets, an oracle would provide pricing information about the asset or stock being mirrored by the smart contract.

What are security tokens, and how are they used?

Security tokens represent ownership in physical or financial assets and are treated as securities. These tokens link classical financial instruments and the blockchain environment to provide new means of expressing and exchanging ownership.

Traditionally, securities ownership existed as paper contracts for private ownership or as tradable assets on stock exchanges. The emergence of blockchain and security tokens has changed this environment and opened up new asset management and trading opportunities. However, it is not without its own issues.

Take, for example, the initial coin offering (ICO) boom of 2017. An ICO is a mechanism for startups to fundraise by offering access to security tokens. Naturally, many of these projects ran against the law as they were later deemed as unregistered securities offerings. The most famous example is Ripple (XRP). Although Ripple did not have an ICO, it has been caught up in ongoing lawsuits with the Securities and Exchange Commission (SEC) over illegally raising funds by selling unregulated securities (XRP). While the SEC has since dropped the majority of its charges, a court has found Ripple liable for a $125 million fine to the SEC. It is unclear whether Ripple Labs will appeal. In short, many tokens might be considered de facto securities by bodies such as the SEC, so it is always important for companies launching tokens to look at the law and seek guidance where possible.

What is a Non-Fungible Token (NFT)?

Most cryptocurrencies and tokens on a particular blockchain can be traded for one another. NFTs, however, are tradable only on a one-to-one basis. Every NFT has its properties that differentiate it from other NFTs. This enables NFTs to bear the tokenization of specific details or tangible properties such as art, collectibles, real estate, and even ideas.

The most common propositions of NFTs include:

– Digital art and collectibles: artists can make and sell digital art pieces that are one-of-a-kind, with the ownership and origin of the artwork being easily traced on the blockchain

– Royalties: Smart contracts can guarantee that the creators get a share of the revenue from all secondary sales of their NFTs.

– Gaming assets: in-game assets can be turned into NFTs so owners can truly own them and trade them on the blockchain

– Fractional ownership: NFTs allow for the creation of fractional ownership of physical items, from luxury goods to real estate

What are Governance Tokens?

Governance tokens are a unique type of crypto token that grants holders voting power within a decentralized organization or project. These tokens enable community members to participate in decision-making processes, such as proposing and voting on changes to the project’s protocol or governance structure. Governance tokens are commonly used in decentralized autonomous organizations (DAOs) and decentralized finance (DeFi) projects.

Governance tokens can be used to:

– Propose and vote on changes to the project’s protocol or governance structure.

– Elect representatives to make decisions on behalf of the community.

– Participate in decision-making processes related to the project’s development and growth.

– Influence the direction of the project and its future development.

An example of governance tokens in action is the MakerDAO project, where MKR token holders can vote on key decisions affecting the protocol. Governance tokens play a crucial role in decentralized governance, allowing for community involvement and ensuring that the project evolves in a way that aligns with the interests of its stakeholders.

How do blockchain tokens work?

Blockchain tokens work on the basis of distributed ledger technology and are secured and managed on the blockchain networks. To understand how crypto tokens work, it is essential to know that they use encryption techniques to protect them and facilitate secure online transactions. Here’s a breakdown of how they function:

– Creation: tokens are created through a process known as ‘minting’. This is the process of executing a smart contract that outlines the token standard, the total supply of tokens, and the functionality of tokens.

– Distribution: After the creation of tokens, these tokens can be dispersed through different means such as ICOs, airdrops, or as a reward for contributing to the network.

– Storage: tokens are kept in cryptocurrency wallets. These may be software wallets (on computers or mobile devices) or hardware wallets (physical devices specifically designed for crypto storage).

– Transactions: In order to send tokens, a user has to make a transaction from his or her wallet. This transaction is then sent to the network to be verified by other nodes in the network.

– Validation: the transaction is approved by the network nodes which are computers that have the blockchain software installed. They verify that the sender has enough balance and that the transaction is valid according to the network’s guidelines.

– Consensus: Once validated, the transaction is included in a block. The network agrees on the validity of this block through a consensus mechanism, the two most common being Proof of Work or Proof of Stake. Once consensus has been achieved, the block is added to the blockchain. The transaction has been completed and cannot be reversed.

– Smart contract interaction: most tokens, especially those on Ethereum, can engage with smart contracts. This makes it possible for functions such as trading, lending, or voting to be done automatically.

What role do smart contracts play in token ecosystems?

Smart contracts are digital contracts that are self-executing with the terms of the contract coded into the contract. They play a crucial role in token ecosystems by enabling and automating various functionalities:

– Token issuance: smart contracts can help in the creation and distribution of tokens in a self-automating and transparent manner

– Yield and royalties: In DeFI applications, smart contracts govern the process of yield distribution. For NFTs, they can also split the royalties to the creators when there is a secondary sale.

– Ownership transfer: smart contracts enable the safe and effective transfer of tokens with the ownership of tokens without the need for a third-party

– Governance: in many token ecosystems, the use of smart contracts provides for decentralized governance, whereby token holders can cast their votes on proposals and alterations to the protocol.

Most token projects in the market utilize smart contracts in one way or another. For instance, Uniswap leverages smart contracts to enable peer-to-peer token exchange, while Aave leverages the same to enable lending and borrowing of cryptocurrencies.

How do you identify and avoid crypto token scams?

To protect yourself from token scams

1. Research thoroughly: investigate the team, whitepaper, and community
2. Be wary of unrealistic promises: If it sounds too good to be true, it probably is
3. Check for transparency: legitimate projects are typically open about their operations
4. Use reputable exchanges: stick to well-known, regulated platforms
5. Practice sensible portfolio allocation: never invest more than you can afford to lose
6. Be cautious of social media hyper: many scams spread through aggressive marketing.

Crypto Tokens as Digital Assets

Crypto tokens are digital assets that represent ownership or value on a blockchain. They serve various purposes, such as representing a cryptocurrency, a security, or a commodity. Crypto tokens can be created using different consensus algorithms, including proof-of-work and proof-of-stake.

Crypto tokens can be classified into several types, including:

– Utility tokens: These tokens grant access to a particular service or product within a blockchain environment. For example, the Basic Attention Token (BAT) is used to reward users for their attention within the Brave browser ecosystem.

– Security tokens: These tokens represent ownership in a company or asset and are subject to securities regulations. They provide a way to tokenize traditional financial instruments, such as stocks or bonds.

– Governance tokens: These tokens represent voting power in a decentralized organization or project, allowing holders to participate in decision-making processes. Examples include MKR tokens in the MakerDAO project.

– Non-fungible tokens (NFTs): These tokens represent unique assets, such as digital art or collectibles. Each NFT has distinct properties that differentiate it from other tokens, making it ideal for representing ownership of unique items.

Crypto tokens can be traded on various exchanges and platforms, with their value fluctuating based on market demand and supply. They offer a versatile way to represent ownership or value on a blockchain, making them a popular choice for a wide range of use cases.

In summary, crypto tokens are digital assets that represent ownership or value on a blockchain. They can be used for various purposes, such as representing a cryptocurrency, security, or commodity, and can be classified into different types, including utility tokens, security tokens, governance tokens, and non-fungible tokens.

The future of cryptocurrency tokens

The token ecosystem continues to evolve, with the potential to impact various industries:

– Traditional finance: tokenization of traditional assets, allowing even for ownership of small parts in the case of fractional shares, as well as constant trading around the clock.

– Supply chain: Better tracking and productivity are achieved through the use of tokens in the supply chain.

– Real estate: property rights tokenization, which may contribute to the enhancement of the real estate markets’ efficiency

– Identity management: the use of token systems in decentralized identity solutions

– Governance: token-based voting systems for increasing the transparency in the management of corporations or political organization

What is the potential for digital tokens in future transactions?

Digital tokens have the potential to revolutionize transactions:

– Micropayments: providing a cheap and efficient way of conducting transactions for small amounts of money

– Tokenized assets: real-world assets that are tokenized and can be traded on the blockchain with ease

– Decentralized finance (DeFI) is the expansion of peer-to-peer lending, decentralized exchanges, and other financial services.

With the advancement of technology and the development of legal frameworks, it is possible to predict that digital tokens will be more and more used in everyday life and become a part of the new economic system of the digital world.

Therefore, it is safe to say that the world of crypto tokens is vast and ever-changing. From the utility tokens that enable decentralized applications to the NFTs that are changing the way we own digital assets, tokens are the new kings of blockchain. 

Looking ahead, tokens will continue to significantly impact the development of our digital and financial systems. Nevertheless, it is essential to be cautious and do your homework when entering the space and be aware of the trends and changes in regulation.

FAQ

What is the difference between a token and a digital coin?

Coins are digital assets with their blockchain. They are mainly used as a means of payment and fees for facilitating transactions, similar to fiat money, but in the context of the crypto ecosystem. On the other hand, Tokens are digital assets that exist on existing blockchains and are used for specific functions in certain projects or ecosystems. They can have a variety of uses beyond just being a means of exchange. Coins like Bitcoin and Ethereum are the building blocks of blockchain networks. Still, tokens – such as Enjin on the ethereum blockchain –  are the keys to creating a wide range of applications and use cases in the cryptocurrency space, thus expanding the ecosystem’s possibilities.

Is a digital token an NFT?

Not all digital tokens are NFTs, but all NFTs are a type of digital token. While digital tokens can be either fungible (interchangeable) or non-fungible (unique), NFTs specifically refer to non-fungible tokens that represent ownership of unique digital or physical assets on a blockchain.

What is the difference between a digital asset and a digital token?

A digital asset is an even more general term that refers to any content or value that is stored in a digital medium, which can be in the form of cryptocurrencies, tokens, files, and even digital copies of physical products. Digital tokens, on the other hand, are a specific type of digital asset built on existing blockchains and represent specific utility, ownership, or value within a particular ecosystem or project and can have various characteristics such as voting rights, staking, or non-interchangeability.