What is a token?
Key Takeaways
- The term “cryptocurrency” refers to a blockchain’s native currency, commonly named after the blockchain itself (e.g. Bitcoin, Solana, Ripple, etc);
- The term “token” refers to a broad category of digital assets which encapsulate all representations of value on a blockchain EXCEPT for a blockchain’s native currency;
- Tokens are versatile instruments that can be used to achieve a variety of outcomes, including but not limited to: protocol governance, payments, investment products, digital goods, and gaming assets.
Introduction
On any given day, there are articles and high-profile investors sharing their analysis on “cryptocurrencies” and “tokens” as they provide their perspective on blockchain technology. While the two terms are often used interchangeably, there are inherent differences between the digital assets that are classified under each term that are important for any investor to know as they evaluate opportunities in this market.
Cryptocurrencies vs. Tokens
Prior to distinguishing the differences between cryptocurrencies and tokens, it’s important to recognize the commonality that both possess. Cryptocurrencies and tokens are both blockchain-based assets that represent some form of value that can be used for a defined purpose in the future.
While cryptocurrencies and tokens represent value for future use, there are three main differences that are essential for investors and users to understand:
1. Issuance
One of the primary differences between cryptocurrencies and tokens is how they’re issued. Cryptocurrencies are native to their respective blockchains, and often adopt the namesake of the blockchain to identify themselves (i.e. Bitcoin, Solana, Polkadot). In contrast, tokens are created and issued by protocols that are built on top of an existing blockchain. For example, UNI is a token that was created on Ethereum’s blockchain by Uniswap to enable token holders to propose and vote on upgrades to the protocol.
2. Centralization vs. Decentralization
In today’s market, the blockchains with the most developers, nodes, user activity, and revenue generated are considered decentralized. The term “decentralized” refers to distribution of governance, maintenance, and security responsibilities to the individuals who compose the network, as seen with Ethereum and Bitcoin. In contrast, protocols are built by one or more individuals who are responsible for the financing, management, development, maintenance, and security, giving them a profile more akin to a corporation than a decentralized network. Given the varying levels of control required by the team, it’s common to find that the most popular tokens are “centralized,” such as FTT, OCEAN, and AXS.
3. Use Cases
While cryptocurrencies can be used for a variety of purposes, there are two main use cases that most share: store of value and medium of exchange. By offering a store of value, which can subsequently be used at a later time, cryptocurrencies are the backbone that sustains the ecosystems built upon their blockchains and aligns the incentives of market participants. In the instance of Ethereum and Bitcoin, which are the two largest cryptocurrencies by market cap, they are used as the “quote currency” used to purchase tokens on their blockchain. In contrast, tokens have a multitude of purposes that they serve for their issuing protocol and investors. Whether it’s acting a form of digital currency to undertake an action within the protocol or representation of a physical object (i.e. NFT), the use cases continue to evolve and fuel further innovation in blockchain technology.
How Are Tokens Created?
Over the last few years, there are two advancements in blockchain technology that have helped push forward innovation and public adoption: smart contracts and tokens. In particular, smart contracts provided the necessary accounting and transaction framework for ecosystems to be funded and operated through the use of tokens.
Through smart contracts, a developer or business owner can easily create their own token through a number of user-friendly sites and apps. Through these services, the token creator only needs to stipulate basic parameters: total supply, name, ticker symbol, and send/receive permissions.
Types of Tokens and Use Cases
While tokens can be utilized for a variety of purposes, there are four general categories that they can be classified:
1. Payments
While the allure of significant ETH gains can be enticing for investors, the underlying price fluctuations can be a nightmare if you’re intending to operate a business. The business owner needs to ensure that the revenue collected from customers can be exchanged for equal value when paying their suppliers. As a result, stablecoins were created as a payments solution to help minimize price volatility and enable individuals to send money around the world at a fraction of the time and cost in today’s financial system.
2. Governance
In order for a decentralized platform to operate efficiently, it requires an active community, collaboration, and prompt decision-making. Governance tokens provide a basis for individuals to collaborate, vote, and influence decision-making for that platform.
3. Utility
One of the main advantages that tokens have offered to blockchain is greater access to funding for founders looking to launch new blockchain protocols. Through the use of public listings, often referred to as IDOs or ICOs on decentralized exchanges, founders have direct access to investors who are passionate about their vision. From the investor standpoint, the utility token can offer a variety of benefits:
i) Preferential pricing for a digital asset that can be used for a specific product or service at a future date;
ii) Profit-sharing on revenues generated by the protocol;
iii) Access to use the platform or participate in a future event.
4. Security
Given the transparent and auditable nature of blockchain technology, tokens are increasingly used to represent ownership rights for digital and physical assets. Most notably, non-fungible tokens (NFTs) have created a “digital gold rush” for artwork, collectibles, music, and exclusive work from well-known content creators.
Concurrently, security tokens have enabled fractional ownership opportunities in assets that are illiquid or infrequently traded in traditional markets, such as real estate and equity in private companies. Through leading marketplaces, such as tZERO and 22x, investors can participate in “security token offerings” (or STOs) and subsequently create secondary markets to trade amongst each other.
In Summary
Cryptocurrencies and tokens are the backbone of the blockchain economy. Cryptocurrencies align the incentives of blockchain network participants allowing them to work together and achieve a common goal. Building on this foundation, tokens are essential for the development of ecosystems on top of blockchains by creating the necessary value to drive adoption across the private and public sectors. It’s important to note that we’re early in the development of the blockchain ecosystem, and it’s likely that we’ll see new classes of digital assets that provide new forms of value and utility to complement cryptocurrencies and tokens in the future.
