It would be difficult not to have noticed just how much the world of crypto has exploded over the last few years, note here that I am using the word crypto and not specifically cryptocurrency.
Crypto is nowadays no longer just about coins, but about tokens too. In this article we are going to get into crypto coins vs tokens and what this actually means.
Back in the day, a digital currency was the primary use case when the Bitcoin token arrived on the scene. Since then the crypto world has changed a lot!
Where cryptocurrency was the main attraction, it’s now perhaps more of a supporting act without which the crypto scene wouldn’t be able to function.
What are crypto coins?
Way back in 2009 when Bitcoin first arrived on the scene, we were looking at a revolutionary new form of digital currency built on an innovative technology called blockchain.
The sole purpose of a cryptocurrency was to provide a decentralised means of digital value storage and transfer which was fit for the needs of the internet age, not controlled by any government or private organisation and not geographically limited. A digital currency for the entire world!
The basics of how blockchain technology works
A blockchain is a decentralised ledger running across a peer-to-peer network of computers. No single computer, organisation or person controls it.
When done well, it’s near impossible to hack or manipulate and, if public, is totally transparent.
A blockchain operates as a digital ledger validating and recording each transaction across the network according to strict protocols.
Each blockchain has its own currency which effectively rewards the participant computers that make up the blockchain with coins such as Bitcoins or Ether in the case of Ethereum.
Another key aspect of a blockchain is that the coins cannot be duplicated.
All of these factors provided by blockchain technology have created a suitable environment in which digital crypto coins can be created and used as secure means of payment.
What are blockchain tokens?
Now that we have some understanding of what blockchain technology is, we can see that this non-centralised, robust, secure network of computers and strict protocols could be used to do a whole host of other things beyond simply being a currency and payment system.
Well, some people realised this and the token was born!
What is a token?
Tokens often get mistaken for digital coins but are in fact created on existing blockchains and are not a blockchain’s currency in their own right.
The most popular blockchain platform for token developers is Ethereum due mainly to being a well-established blockchain and having a well-established cryptocurrency called Ether, which is the second most popular crypto coin after Bitcoin.
Tokens built on Ethereum follow several standards, but the most widely known and used is “ERC-20”. Those are “fungible” tokens.
When built using the ERC-20 standard, tokens are known as ERC20-tokens. One such example is Uniswap’s UNI.
There are other blockchains that allow for the creation of tokens, such as Binance Smart Chain, Stratis, Waves, Lisk and NEO.
NEO for example uses tokens known as NEP-5 tokens, Binance’s are BEP-20.
There are also “non-fungible tokens” (NFT) created atop blockchains. Those on Ethereum, for example, are known as ERC721.
In summary: a coin is a unit of value of and native to a blockchain network, and a token is a unit of value for something built atop a blockchain network.
Coins, tokens and blockchain simplified
A simplistic way to imagine how crypto coins, tokens and blockchains work together could be as follows: Imagine that blockchain is like the operating system running on your Android or iOS smartphone, something very powerful yet quite useless without any applications. An app like a video game – a piece of software running on the operating system – could be powered by a token.
To play the game, you would pay for the use of your phone’s operating system with the OS’s native currency – the coin – and for in-game items using the game’s native currency, the token.
The game can’t run on anything else than your phone, and the game’s currency can’t be used outside of the game, but any game can run on your phone and any game can create its own currency.
That’s how you have many decentralised exchanges on Ethereum (Uniswap, dY/dX, SushiSwap, …) each with their own tokens, but all requiring that you pay transaction fees in ETH for the privilege of using the underlying blockchain.
What are Stablecoins?
Stablecoins are called “coins” but are, in fact, an interesting application of the “token” use case.
Stablecoins are literally designed to be “stable” “coins”, and the name came in opposition to most crypto coins and tokens which experience very high volatility.
Stablecoins try to “peg” their price to that of something more stable and predictable. It can be a fiat currency like the US Dollar or EURO or a commodity such as gold or silver where the price does not fluctuate as wildly as is generally the case with crypto coins.
Stablecoins on Ethereum usually follow the ERC-20 standard.
Examples include USDC, Tether, Dai. But they are not all created equal, so let’s take a look at the types of stablecoins you can find.
A few types of stablecoins
Fiat-backed stablecoins (USDC)
One of the ways stablecoins can manage price fluctuations is by tying the stablecoin to a fiat currency such as the US Dollar or the EURO. A currency like the US Dollar or EURO is way more stable when compared directly to crypto.
Usually, the entity behind the stablecoin will have a reserve in place where it will secure or guarantee the value of each stablecoin on a par basis to a fiat currency.
That way, if we take the example of the dollar, 1 coin can always be redeemed for 1 US Dollar.
Just as in the old days of the gold standard, each coin is backed by real money sitting in a real bank somewhere.
The price of the coin fluctuates as much as the currency does, in this case exactly as the US dollar fluctuates.
In this way, a digital stablecoin and a real-world asset such as the US dollar are neatly tied together.
Crypto-backed stablecoins (DAI)
DAI is a crypto-backed stablecoin on the Ethereum blockchain using the MakerDAO protocol.
What sets DAI apart is that MakerDAO wants the DAI to be decentralised, i.e. there is no central authority that has control of the system.
Instead, smart contracts running on Ethereum aim to maintain the “peg”.
This effectively means that DAI does not hold collateral in a bank on a 1:1 basis like the fiat-backed stablecoin but rather holds decentralised Ethereum reserves in a smart contract that are not controlled by any single entity.
Naturally Ethereum reserves can of course be converted to fiat money at any point thus still giving the stablecoin real value in the non-digital world.
Since Ethereum’s price can go up or down, DAI is “over-collateralized”; meaning that there the reserve of ETH is worth more, in dollar terms, than the value, in dollar terms, of all DAI in circulation.
That way, if the price goes down, DAI can still be redeemed for 1 USD’s worth of ETH.
Algorithmic stablecoins (TERRA, CELO)
The algorithmic stablecoin takes a completely different approach and isn’t backed by “external” collateral waiting on the sidelines ready to step in if things go south. It uses its own native coins to make its tokens stable.
Terra has a USD stablecoin (UST, and it actually has a lot of other stablecoins pegged to other stuff too) which is collateralized by LUNA, the native token of the Terra blockchain.
The Terra protocol acts as a market maker for the stablecoin. If the stablecoin system runs out of assets, it restocks by inflating the native LUNA supply and it goes on the market to buy and sell the stablecoin to maintain the peg.
Some, like Terra and Celo, have done fairly well so far.
Others, like FEI, haven’t fared too well. It’s admittedly harder to create that kind of market than to just hold the real asset which you will exchange on request against the “tokenized” proof.
Conclusion
In the ever-exciting and constantly changing world of crypto nothing ever stays still.
What started out back in 2009 as a new and somewhat crazy idea of creating a digital currency that nobody owns or controls has morphed into something truly massive and continues to grow at an unprecedented rate.
Crypto no longer just refers to a digital currency but to a plethora of digital assets in the form of coins and tokens.
This constant innovation keeps the engine running and presents plenty of opportunities for investors.
The blockchain technology that enables both coins and tokens really is something of an outstanding innovation to be marvelled at.
From where we stand now, we are certainly nowhere near the end of the road but rather still very much at the beginning and opportunities abound.
It will be exciting to see just where we go from here in the exciting and ever-changing world of crypto coins and tokens!