Even if you are new to crypto, you certainly heard of tokens. Their concept is similar to the cryptocurrency coins, but their functions go way beyond just monetary.
In this crypto tokens guide, we will explain the difference between a token and a coin and explore the most popular types of cryptocurrency tokens.
Coin vs Token
First, let’s establish the terminology. Even though “coins”, “altcoins” and “tokens” are often used interchangeably in the crypto community there are some crucial differences.
What is a cryptocurrency coin
Cryptocurrency coin, like Bitcoin, is essentially a digital form of money that is backed up by a native blockchain The functions of a coin are strictly monetary — you can use it as a mean of payment, store of value, or as a speculative asset to trade, and essentially that’s it. The features of a coin are also similar to fiat money — it is fungible, divisible, and the supply is limited.
By definition, a cryptocurrency coin serves only as a digital form of money. The most distinctive feature of a coin is that it is native to the blockchain it’s made on and operates independently from any other platform.
Okay, then what is “altcoin”? This is essentially any cryptocurrency coin that has its own blockchain but is not Bitcoin. Some altcoins are just forks to Bitcoin, meaning that they base on Bitcoin’s open-source protocol but still have their own blockchains, like Litecoin. Others, like Monero or Ethereum, are completely independent blockchains.
What is a token
The token is a non-native blockchain asset and its value goes beyond only monetary functions. Tokens also require another platform to exist and operate.
For example, ETH is a cryptocurrency that is native to the Ethereum blockchain, which makes it a coin. However, one of the primary features of the Ethereum network is the ability to create new tokens within the network. The cryptocurrencies that are created on this network will be called tokens. For example, USDT — the most popular stablecoin pegged to the value of $USD is a token, which operates on the Ethereum blockchain.
A little tricky part to mention here is that ETH is also not purely a coin according to its functions. Yes, ETH is the native coin of Ethereum blockchain, but it is used not only as a means of payment but also to pay gas fees to fuel the smart contracts, so technically it is a token. The crypto market has its own complexities, and it’s absolutely okay if something seems a bit confusing. That’s because it is.
Fact: Around 50% of all active tokens are made on the Ethereum network using the ERC-20 token standard.
By definition, a token is not meant to serve as money. Yes, it has value and you usually can easily exchange it for cryptocurrency, but its purpose goes way beyond just monetary. A token can be just money, but can also be something bigger. It can deliver value to investors beyond speculative returns and serve a variety of functions. So let’s break down each type of token.
Fungibility
All crypto tokens break down into two broad categories — non-fungible and fungible, with the latter being the most common type. Fungibility is a feature of a token which essentially means that one token is indistinguishable from another.
In simple words, a dollar is always a dollar, and Bitcoin is always Bitcoin. You can exchange the $10 bills with your friend and each of you will still have the same value in the wallet. Fungibility means that certain Bitcoins and dollars aren’t more valuable or rarer than others. If they were, it would disrupt the entire ecosystem and make the everyday transactions a huge pain in the neck.
This feature applies not only to most types of tokens but to any fiat or crypto asset that has monetary functions to each unit of payment and distributes the value equally among them. All fiat currencies are fungible, so as all the cryptocurrencies.
Utility Tokens
Utility tokens are a popular type of fungible tokens that you can think of as the chips at the casino. In the same way that you need to buy chips to play blackjack or poker, you need utility tokens to power the operations on the protocol.
The most famous utility token example is Ether which powers all the transactions and smart contracts on the Ethereum network. As we just said before, ETH can be used as a means of payment, however, its primary purpose is to be utilized in the blockchain.
The concept of utility token came into the spotlight in relation to the 2017 ICO boom. Back then almost every project labeled their token as a utility. Why? Simply to avoid the strict regulations for investment operations.
ICO (Initial Coin Offering): A type of crowdfunding campaign in the crypto market, similar to IPO in stocks. Startups launch ICOs to raise money for the new project, app, or coin.
In many cases, there was no need for a project to create a utility token. They could have just accepted ETH or BTC as payment. It mostly served as a fundraising tool for the project and a speculatory asset for those who bought the token in the hopes that it will moon and bring huge profits.
On the other hand, when used properly, utility tokens have a clear purpose to power the operations within the network. The more there is a demand for the protocol the higher the price of the token and the project in general.
Social Tokens
Social tokens are a very interesting type of crypto utility asset that recently gained a lot of popularity among the crypto space and also presented the concept of tokenization to the broader public. In simple words, social tokens are backed by the reputation of an individual, brand, sports club, or just any community. You can think of them as “fan tokens” which you can use to buy additional content, merchandise, or just to support the community you like.
When you invest in social coins you invest in a community, with expectations that this community will grow and get more valuable over time.
Security/Equity Tokens
In contrast to collecting money with utility tokens, other ICOs decided to openly declare the fundraising campaigns and comply with the regulations. That’s how the security tokens were born. Some investors also call them equity tokens, and in some way, they are very similar to the traditional stocks. How do they differ?
When you buy regular stocks you invest in the company in expectations for its price to increase and bring profits. The important difference is that you actually buy a share in the company which you now own and can gain the dividends from it. Also, certain types of shares give you the voting power in the company and the rights to earn dividends.
Security tokens work in a similar way, but in this case tokens serve as evidence that you own a piece of the new cryptocurrency. Security token is essentially a digital stock certificate that records your ownership on the blockchain.
Even though the security tokens usually do not give any voting power to the investors, some platforms came up with the type of security token dedicated right for that.
Governance token
Governance token is the type of crypto asset that grants its holders decision-making rights over the project’s protocol, its product, and its features. Holders can influence decisions within the project such as proposing or deciding the new feature, changing the models of token distribution, and even remodel the governance system itself. The most known examples of governance tokens are Compound (COMP), Cardano (ADA), and Maker (MKR).
Does the governance token give the investors the right to receive dividends? No, but crypto space has another type of token that does.
Debt token
Debt tokens represent real estate mortgages, corporate bonds, and other common credit mechanisms. This type of token usually comes with regular dividends. However, just like the credit instruments that it’s based on, the debt token is subject to the risks of financial default.
Derivative tokens
Derivative tokens obtain the value from the underlying token, cryptocurrency, fiat money, or other assets. The most known example of a derivative token is the USDT — a stablecoin with its value strictly pegged to the US dollar. USDT is very popular among crypto traders since it eliminates the extra step of converting crypto to fiat.
Real asset-backed token
As the title suggests, real asset-backed tokens represent ownership of assets like commodities, real estate, artworks, and others. The smart contracts technology allows the transparent records of the complex algorithms and equal and fair distribution of ownership among the investors.
It is important to note that the real asset-backed tokens are fungible tokens, and they represent an equal amount of ownership per token.
Non-fungible tokens
In recent years, non-fungible tokens (NFTs) have gotten into the spotlight due to a bunch of very promising use-cases. In simple words, NFTs are tokenized scarce or unique assets.
Such tokens got popular due to the famous blockchain game Crypto Kitties. The game allows you to create and breed unique digital cats. If you want to upgrade your pet, you pay for all the bells and whistles with ETH. Every Kitty has a unique set of “cattributes”, and the Ethereum blockchain protects the pet’s digital DNI, so no one can take a kitty from its owner.
Some types of kitties are very scarce and can be viewed as an investment or a store of value. For instance, CryptoKitty #896775 (aka Dragon) was sold for as much as 600 ETH. The creation, development, and exchange of these non-fungible creatures were possible due to the ERC-721 token standard. It was the backbone of the game.
Gaming
Due to CryptoKitties, gaming is the first NFT application that comes to mind. Right now, the implementation of non-fungible tokens is primarily limited to this industry. The innovation allows players to trade various in-game assets like armors and weapons, mascots, magical artifacts, cards, etc. The good examples are the games like God’s Unchained, Decentraland, MLB Champions, My Crypto Heroes.
Some people may argue they could own and manage game assets without any blockchains, but there is an important difference to keep in mind. Without a blockchain, players never really own their in-game assets. In fact, all the in-game riches belong to the game owners, and not to the players. If the developers of Fortnite decide to shut the game down or the servers experience a significant crash, “your precious” sets, animations, and skins will be gone. But if your game assets are blockchain-based, you will keep them even if something goes wrong.
If you want to further explore the topic of blockchain in gaming, check out this article.
Collectibles
NFTs can make managing and trading your collectibles an easier task. We have already mentioned crypto-collectibles like cards or kitties, but you can also tokenize real-world items, including works of art. Their ownership rights will be verified and stored on a blockchain.
An interesting project to follow is Crypto Stamps by the Austrian Postal Service. Reportedly, they issued 150,000 copies of the blockchain-based stamps that can be used as normal ones, too.
Fractional Ownership of Assets
Tokenization makes it possible for a regular person to buy a fraction of an asset that he would not be able to afford otherwise. Under this scenario, multiple individuals could collectively own a painting, a historical building, a plot of land, securities, and collectibles. If the price of the asset grows, you can sell your share at any time. It would be much easier than selling a million-dollar painting or a mansion as a whole. Thus, non-fungible tokens will add liquidity to respective markets and allow middle-class people to make unique investments.
Digital identity
Another sector that could benefit from the NFT introduction is identity management. If you store your ID and ownership data on a blockchain, it will eliminate bureaucratic friction from many procedures. It will also help protect your information — once added to a blockchain, it will be impossible to delete or modify. Therefore, the assets become easier to transfer and manage from any place.
Additionally, you can tokenize different certificates and licenses. In this case, you won’t have to collect and move papers to prove your identity, access rights, or qualifications. Potentially, it could streamline the procedures like identity checks, voting, visa issuance, you name it.