What are Crypto Tokens and how do they work?

Team Cypherock
Team Cypherock
7 min read
 What are Crypto Tokens and how do they work?

Crypto tokens are known to offer many benefits, including increased speed, reduced costs, and increased security and transparency in transactions. However, they also come with risks, including the possibility of fraud, hacking, and volatility in value. But what exactly are they and how do they differ from other crypto terminology such as cryptocurrency and altcoins? It’s important to thoroughly research and understand the risks before investing in crypto tokens.

Key Takeaways

  • Crypto tokens are digital assets built over existing secure blockchain platforms via smart contracts, responsible for a particular purpose or use within a particular blockchain ecosystem.
  • Crypto tokens can either be utility tokens, which are used to access products or services on a blockchain platform, or security tokens which represent ownership of a physical or digital asset.

  • Tokens have subtle differences from cryptocurrencies and altcoins.

What are crypto tokens?

Crypto tokens are a type of digital asset built on top of an existing blockchain platform to offer diverse functionality such as the representation of assets, security or other platform-specific features. Crypto tokens are created using smart contracts, which are self-executing contracts with the terms of the agreement between parties being directly written into lines of code. The code and the agreements contained therein are stored and replicated on the blockchain network. Its diverse functionality only goes on to show the flexibility and the variety of use cases blockchain can offer.

Although there are numerous types of tokens, the majority of tokens will fall under two categories: Utility and Security tokens.

Utility Tokens

Utility tokens serve a specific purpose in its respective ecosystem. In short, they are used to access a product or service on a particular blockchain ecosystem. For example, a user might purchase a utility token to access a new online game or to pay for goods and services within a virtual marketplace. Similarly, a type of utility token is the governance token, which gives voting rights to investors in proposing changes to their respective ecosystem. Utility tokens are usually pre-mined and distributed to the community depending on the roadmap the team sets for token allocation. Examples of utility tokens include: Chainlink (LINK), Basic Attention Token (BAT), Zilliqa.

Security Tokens

Security tokens are financial instruments designed to represent an ownership stake in an underlying asset, such as a company, real estate or even art. They can be traded on a secondary market, similar to traditional securities like stocks and bonds, but without a broker. Security tokens are subject to federal securities laws, which means that they must be registered with regulatory agencies and may be subject to additional reporting requirements. Examples of security tokens include: Siafunds, INX, BCAP.

So, utility tokens can only be used to serve a particular purpose within a particular blockchain ecosystem, but security tokens are used to represent ownership in a third-party enterprise. Both types of crypto tokens can be bought and sold on cryptocurrency exchanges, which are online platforms that allow users to trade cryptocurrencies and other digital assets. To buy or sell crypto tokens, you will need to set up a digital wallet and link it to a bank account or credit card. You can then use the wallet to send and receive tokens, as well as track your transactions and balances. A digital wallet is a software program that stores private and public keys and interacts with various blockchain to enable users to send and receive digital currencies and monitor their balance.

What are some applications of tokens?

  • Cryptocurrencies: Cryptocurrencies, such as Bitcoin and Ethereum, are digital assets that are used as a medium of exchange and store of value. They are decentralized and use blockchain technology to verify transactions.
  • DeFi Tokens: DeFi aims to reproduce financial system operations across blockchains, and tend to offer their native tokens with their own set of utility.

  • Non-fungible tokens (NFTs): Non-fungible tokens (NFTs) are unique digital assets that cannot be exchanged for other tokens or assets on a one-to-one basis. They are often used to represent ownership of unique digital items, such as artwork or collectibles.

  • Stablecoins: Stablecoins are cryptocurrency tokens that are pegged to a specific asset, such as the US dollar, in order to maintain a stable value. They are often used as a way to mitigate the volatility of other cryptocurrencies.
  • Governance tokens: Governance tokens are used to facilitate decision-making processes within decentralized autonomous organizations (DAOs). Holders of these tokens can vote on proposals and make other decisions within the DAO.

Crypto Tokens vs Cryptocurrencies vs Altcoins

In addition to crypto tokens already discussed above, there can often be other confusing terminology used when dealing in the crypto space. Such terms have subtle differences that confuses first timers.

Digital assets involving blockchain can generally be termed as cryptocurrencies even if they aren’t necessarily used for making payments. Altcoins are categorized under cryptocurrencies as they tend to be derived from a particular cryptocurrency, with their own set of features. In this sense, cryptocurrency can be used as a broader term for other variations, all which can be summarized as:

  • Cryptocurrency: Native currency or asset of a unique blockchain used as incentive and means of payment on the network. For example, BTC or ETH.
  • Altcoins: Short for “alternative coins”, are usually referred to as cryptocurrencies aside from Bitcoin and Ethereum, as most altcoins emerged as forked versions of these two blockchains.They are meant to improve upon existing features or provide solutions to problems other cryptocurrencies may not address. For example, Peercoin, Litecoin, XRP.

  • Tokens: Represent assets or utility built over an existing blockchain. They are created using a process called tokenization and this creation is simplified using smart contracts. Ethereum for example has various token standards that help the creation of different types of tokens, namely the ERC-20 token standard and ERC 721 token standard help the creation of various cryptocurrencies and NFTs based on the Ethereum blockchain.

Frequently Asked Questions (FAQs):

  1. What is a crypto token?
  2. Cryptocurrency tokens are digital assets that represent a specific purpose or use within a particular blockchain ecosystem. Tokens are often built on top of existing blockchain platforms, such as Ethereum, and can be created through a process called an initial coin offering (ICO). Unlike cryptocurrency coins, which are used as a medium of exchange and store of value in their own right, cryptocurrency tokens are often tied to a specific use case or application. Cryptocurrency tokens can be traded on cryptocurrency exchanges, just like coins, and their value can fluctuate significantly and they are highly speculative investments.

  3. What is the purpose of a crypto token?
  4. Cryptocurrency tokens serve a variety of purposes which enable the holder to participate in and contribute to the operation of a particular blockchain ecosystem. These include representing a share in a company (security tokens), serving as a means of exchange, enabling access to a product or service and facilitating governance.

  5. Is Bitcoin a token or a coin?
  6. Bitcoin is a cryptocurrency coin, not a token. A cryptocurrency coin is a digital asset that is used as a medium of exchange and store of value. Bitcoin is the first and most well-known cryptocurrency coin. A cryptocurrency token, on the other hand, represents a specific purpose or use within a particular blockchain ecosystem and can be used for a variety of tasks as mentioned above.

  7. What Are Some of the Different Types of Tokens That Reside on Blockchains?

  8. There are several different types of tokens that can reside on blockchains such as:

    • Cryptocurrency coins
    • Utility tokens
    • Security tokens
    • Non-fungible tokens (NFTs)
    • Stablecoins
    • Governance tokens
    • DeFi Tokens
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