A token is a broad notion used beyond cryptocurrencies and has different meanings in many contexts. In general terms, it’s a symbol or conventional sign. In numerous scientific disciplines, such as philosophy, logic, and semiotics, it represents a type of object. In the context of board games, a token replaces a certain game element. In a casino — a coin for slot machines. In the context of finance — a substitute for money.
In information security, a token refers to a USB-type device with confidential data about the owner, a kind of digital key to access a bank account. Such tokens store cryptographic keys (digital signature) or biometric data (fingerprint pattern).
What Is a Token in Crypto?
A token in the context of cryptocurrencies is a record in a register. The record describes the essence of the property that is “represented” in the token. Typically, a token is a specific amount of a particular cryptocurrency but in some systems, tokens can contain rights to securities, art, and other assets. So, you could characterize a token as a “digital asset.”
Each particular token is stored in a decentralized blockchain network. Tokens are accessed via special apps and crypto e-wallets. Tokens in different blockchain networks have various technical standards and aren’t fungible.
Tokens and Cryptocurrencies: What Is the Difference?
Cryptocurrencies and tokens are different concepts. The main difference is that cryptocurrencies can’t be centrally issued and managed, while tokens can.
Since any token is a record in a ledger, the following statement is true: any cryptocurrency is a token, but not every token is a cryptocurrency. The difference between the two concepts can be described as follows:
- cryptocurrency always has a unique blockchain, tokens can be issued based on another blockchain;
- the price of cryptocurrencies depends only on supply and demand, the price of tokens depends on a variety of factors (a peg to specific assets, additional token issuance, and others);
- crypto transactions can only be issued and validated in a decentralized way, while tokens can be issued in both decentralized and centralized ways.
Moreover, unlike cryptocurrencies, the token algorithm isn’t prescribed in a blockchain code and is implemented through smart contracts. The most obvious example is the Ethereum network, where ETH is a cryptocurrency. SHIB of the Shiba Inu project are ERC-20 standard tokens issued in the Ethereum network.
Tokens and Coins: What Is the Difference?
Technically, cryptocurrency coins are tokens, which people can only use as a means of payment. They are fungible within the same blockchain network and retain their value by changing ownership.
At the same time, “identical” coins can differ in token technological standard, blockchain network ownership, price formation algorithm, etc. For example, USDT stablecoins are issued on Ethereum, Tron, and even Bitcoin blockchain networks via the Omni Layer protocol. They all have the same value but different token standards and therefore aren’t fungible.
The concept of a token is broader than that of a cryptocurrency coin. Tokens can represent not only units of value, but also other assets in digital form.
How Asset Tokenization Happens
Tokenization is the process of transferring the management and accounting of real assets into a digital environment. Each token is a digital certificate confirming that the user owns the specific property described in the smart contract.
Using smart contracts automates asset management and accounting processes, speeds up and simplifies the handling of assets, increases data security, and eliminates the necessity for most intermediaries.
A token can include any commodity or service. For example, a business owner values an hour of work for their team at $100. They tokenize the services, issuing 1,000 tokens for an hour of work worth $100,000 to the market. They are bought up by consumers of the service or by investors. The first can use the service directly to the extent that they paid for the tokens; the latter can make money on tokens if the demand for the service of the company in question grows and, consequently, their market value increases.
In the same way, ownership of shares, securities, ordinary money, and other movable and immovable property can be issued in the form of tokens. The company issuing the tokens is called the issuer.
Different Types of Tokens
Tokens are divided into two main types:
1. Utility tokens. They involve the possibility of being exchanged for units of goods or services. Such tokens are used by various projects to secure their funding. Essentially, it’s synonymous with the cryptocurrency of a particular project, regardless of whether these tokens are issued on their own blockchain or deployed on others.
2. Security tokens. This is the analog of securities, stocks, and other investments that imply profit.
The U.S. Securities and Exchange Commission (SEC) defines the difference between utility and security tokens. The U.S. has a “Howey test” to determine whether financial transactions have the characteristics of investment activity. Security tokens have such features. Their issuers are required to register to issue virtual shares and are subject to relevant laws. On the other hand, utility tokens don’t involve these measures and aren’t recognized as securities.
The category of security tokens includes:
1. Asset-backed tokens. Digital certificates that verify the ownership of real commodities or services, e.g., 1 kilo of platinum, 1 ton of coal, 1 barrel of oil, 100 kilowatts of electricity, etc. Initially, the physical asset is transferred to the issuing platform, after which an asset-backed token is created.
2. Non-fungible tokens. Digital ownership, which records the fact of ownership of digital objects, movable, and immovable property in the blockchain. Tokens of this type lack fungibility, which is why they are called “unique.”
3. Leveraged tokens. A kind of analog of exchange-traded futures, a trading instrument with fixed leverage.
There are also the following types of tokens that are exclusively relevant to blockchain projects:
- Government tokens (GT tokens). They’re created to allow holders to manage a project and shape its future development. Most often, these tokens are used in decentralized autonomous organizations.
- Wrapped tokens. They’re analogous to one cryptocurrency but on a different blockchain. Wrapped tokens are required to use native tokens outside the native network. Tickers of such tokens have an extra letter in the name and allow for cross-chain activity. For instance, to use BTC on Ethereum, it can be “wrapped” into a WBTC token. In this case, the value of wrapped Bitcoin will remain equal to the value of the original one, however, this asset can be used in DeFi projects based on Ethereum, for example.
- Liquidity tokens. These are used in DeFi platforms, where there’s such a concept as “providing liquidity in a pool.” To keep it very simple and omit a lot of details, it’s similar to investing money at a certain interest rate. In exchange for the investment, the platform generates liquidity pool tokens, which are digital certificates confirming the investment and the platform’s commitment. They’re also called LP tokens, where LP stands for Liquidity Provider. However, “deposit interest” is accrued in reward tokens, which are also referred to as RT tokens.
Other types of tokens also exist. For instance, reward tokens are used as an analog of a loyalty program or a reward for targeted activity: contests, promotions, referral programs, etc. Donation tokens are similar to crypto donations. Moreover, there are app tokens, platform tokens, reputation tokens, and many other strictly “specialized” types of tokens. If there’s a need, a technical possibility, or at least some kind of inspiration, you can create your own type of tokens, nobody can prevent you from doing that.
By the way, NFTs are also tokens that are forming a separate segment of the cryptocurrency market. Stablecoins are sometimes singled out as a separate type of token, too. So, a token is a very broad concept. Types of tokens have no strictly fixed scientific classification or system, only a generally accepted one. At the same time, “token” is one of the key concepts in everything that concerns the cryptocurrency market, each project on which has its own tokenomics.
