Despite their similarities, there are fundamental differences between cryptocurrencies and tokens.
In Brief — Tokens and cryptocurrencies are two of the most common digital assets based on blockchain technology. By far, the biggest difference between the two is that cryptocurrencies have their blockchains, while crypto tokens are built upon existing blockchains.
What Is a Digital Asset?
It’s imperative that you understand the difference between digital assets, cryptocurrencies, and tokens if you’re new to blockchain and cryptocurrency. Even though there are many similarities between these terms, they are also different in many important ways. To put it simply, a digital asset is non-tangible and can be created, traded, and stored in a digital format. Among the digital assets associated with blockchains are cryptocurrency and crypto tokens.
Cryptocurrency and tokens are special cases of digital assets that use cryptography, an advanced encryption technology that eliminates the possibility of counterfeiting and double-spending.
A key factor to distinguish between these two types of digital assets is that cryptocurrencies are the native assets of a blockchain, such as BTC or ETH, whereas tokens are part of a platform built on a blockchain, such as the many ERC-20 tokens that make up the Ethereum ecosystem.
How Does Cryptocurrency Work?
It can be used as a currency, a medium of exchange, or a store of value. The cryptocurrency is an inherent asset of a blockchain network. As cryptocurrencies are issued by the blockchain protocol on which they operate, they are often referred to as a blockchain’s native currency. Cryptocurrencies are often used not only to pay transaction fees on the network but also to encourage users to keep the network of the cryptocurrency as secure as possible.
Cryptocurrencies are typically used as a medium of exchange or as a store of value. They are used as a means of exchanging one asset for another. An asset that may be held or exchanged for a fiat currency at a later date without incurring significant losses in terms of purchasing power is referred to as a store of value.
Cryptocurrencies typically exhibit the following characteristics:
1. Decentralized, or at least not dependent on a central issuing authority. To manage issuance and transactions, cryptocurrencies rely on code.
2. Built using a blockchain or other Distributed Ledger Technology (DLT), which enables participants to enforce the rules of the system in an automated, trustless manner.
3. The cryptocurrency’s underlying structure and network system are protected with cryptography.
How Do Tokens Work?
Tokens — also known as Crypto Tokens — are units of value that blockchain-based organizations or projects develop based on existing blockchain networks. Despite having deep compatibility with the cryptocurrencies of that network, they represent a distinctly different class of digital assets.
In contrast, cryptocurrency is the native asset of a specific blockchain protocol, while tokens are created by platforms that are built on top of that blockchain. Ether (ETH) is the native token on the Ethereum blockchain. Although ether is the native cryptocurrency of the Ethereum blockchain, there is a large variety of other tokens that use it as well. Ethereum-based crypto tokens include DAI, LINK, COMP, and CryptoKitties, among others. In addition to participating in Defi mechanisms, these tokens can be used to access platform-specific services and even play games on the platforms for which they are built.
Several widely used token standards have been developed for creating crypto tokens, the majority of which are built on top of Ethereum. ERC-20, which allows tokens to operate within Ethereum’s ecosystem of decentralized apps, and ERC-721 are the two most commonly used token standards. The latter allows the creation of non-fungible tokens that are individually unique and cannot be interchanged with other similar tokens. As of 2020, there are hundreds of different ERC-20 tokens in circulation and thousands of ERC-721 tokens. The number of different tokens will presumably continue to grow at a remarkable rate as new tokens are developed to address blockchain’s expanding uses cases.
As a rule, crypto tokens are programmable, permissionless, trustless, and transparent. Those tokens that are programmable run on software protocols that are comprised of smart contracts that specify the features and functions of the token and the rules of engagement for the network. The permissionless nature of the system indicates that anyone can access it without requiring any special credentials. Trustless means that no central authority controls the system; rather, it operates under the rules predefined by the network protocol. Finally, transparency implies that all participants can see and verify the rules of the protocol and its transactions.
The crypto-token, like cryptocurrency, has value and can be exchanged, but it can also be designed to represent physical assets or more traditional digital assets, or a particular utility or service. It is possible to create crypto tokens that represent tangible assets, such as real estate or art, as well as intangible assets, such as processing power or data storage space. Furthermore, tokens are also used as governance mechanisms for voting on specific parameters, such as protocol upgrades and other decisions that determine how various blockchain projects will proceed. Tokenization is the process of creating crypto tokens to serve these various functions.
As the blockchain industry continues to mature, the number of unique digital assets will only continue to grow following the multifaceted needs of all ecosystem participants ranging from enterprise partners to individual users. Given that creating new assets within the digital world is less restrictive than in the physical realm, these digital assets are widely expected to improve the way countless industries operate, interact, and generate value, thereby enabling a vast array of new social and economic possibilities.