What is the Difference Between Coins and Tokens?
What is the Difference Between Coins and Tokens?
In cryptocurrency parlance, the words “coin” and “token” are often used interchangeably. For example: Ether is a coin on Ethereum. Bitcoin is also considered a coin, as is Ripple’s XRP. But, TRON is defined as a token on Ethereum’s platform. Despite the complicated jargon, coins and tokens are actually distinct “currencies” with separate purposes.
The native currency of a blockchain is referred to as a coin. It functions in a manner similar to regular physical currency. That is, it can be used to purchase or sell assets and is used to exchange economic value. Tokens, on the other hand, are built on top of an existing blockchain. They may or may not be an active currency on a platform. They are essentially representations and can be used for a wide variety of tasks. They can even represent equity in a startup, or physical assets, such as real estate.
Examples of tokens include prediction platform Augur’s REP token and Cardano’s ADA token. Both are built on top of Ethereum’s blockchain and are used for transactions within their respective blockchains. Tokens that represent ownership of real estate and those that fractionalize physical assets, such as paintings, have also been offered to investors. These are known as security tokens, as they stand in for traditional securities.
Utility vs. Security Tokens
There are two different types of tokens from a regulatory standpoint. As its name implies, the utility token is used to conduct transactions inside the given blockchain. For example, it can be used to purchase certain services within a blockchain platform or to accomplish tasks. Investors in the utility token may or may not profit from an increase in its price. On the other hand, security tokens have been designed expressly for investors interested in profiting from the token ecosystem. They are representations of an external asset, whose value may increase in the future. The regulatory status of tokens has been the subject of much confusion and uncertainty and has recently caused a decline in funding for the ICO markets.
While Bitcoin is the original cryptocurrency, Ethereum has emerged as the most popular platform for tokens. This is mainly due to the presence of smart contracts on the Ethereum network, which make it easier to develop and distribute tokens, on its platform. In technical terms, tokens are simply entries in a smart contract database denoting balance and ownership. They also display transfers to and from a total balance. There were more than 16,166 smart contract tokens on the Ethereum blockchain, per etherscan.io, as of this writing. The EOS blockchain is currently positioning itself as an alternative to Ethereum for smart contracts, yet it remains to be seen whether it will emerge as a successful token development platform.
The characteristics and functionality of a token are determined by its format. The format of a token determines its behavior and the information that passes onto — or is collected from — an Ethereum address within a smart contract. There are currently two popular token formats on Ethereum’s blockchain — ERC-20 and ERC-721.
ERC20 is the most commonly used Ethereum token format. It is fairly simple in its structure. Using addresses on Ethereum’s blockchain, developers can transfer, receive and check balances for tokens. But it is not possible to drill further down. The tokens used in ERC20 are fungible, meaning that it is assumed that they are equal in value to each other.
The ERC721 token format is used for non-fungible token standards. In addition to providing balances, ERC721 defines other parameters. These include ownership information, contract duration and unique information about an asset. While ERC20 is typically used for assets resembling money in their utility, ERC721 is used for assets that are unique in their characteristics. For example, Cryptokitties, the decentralized gaming application on Ethereum’s blockchain, uses ERC721. This token format is also used by companies extending the usage of Ethereum to other industries that have unique requirements, such as the power industry.
Tokens based on ERC721 are, for example, being used by WePower, an Australian startup developing solutions for the energy industry. Its token, $WPR, is an electronic version of the typical power purchase agreement (PPA) to be used for trading between independent renewable energy producers. The price of power is dependent on several external factors, including time-of-use and amount of energy produced or type of renewable energy used.
Coins vs. Tokens and Trading
The status of a cryptoasset does not make much of a difference to its trading. Both coins and tokens are listed on cryptocurrency exchanges. But a token’s health is dependent on its underlying blockchain. This means that its speed and security may be a function of the same metrics on its base platform. Governance protocols and key decisions made at the underlying platform will have a domino effect on token structures as well as development. As an example, release of the ERC 721 standard on Ethereum’s blockchain led to the development of Cryptokitties. Coins can be used to purchase tokens but the reverse transaction – converting tokens to coins – is not possible. However, coins and tokens can be exchanged with each other.
Bitcoin: The First Cryptocurrency
Bitcoin was the first coin. It has its own native blockchain. The concept of Bitcoin was first released to the world in 2008, when anonymous scientist(s) Satoshi Nakamoto released a white paper outlining a “peer-to-peer version of electronic cash” that allowed online payments to be sent directly from one party to another without the use of an intermediary. He proposed the setting up of a distributed timestamp server for consensus for a given transaction. Currently, financial intermediaries, such as banks, are responsible for this task. The idea behind proposing such a system was to make Bitcoin trustless, meaning no trust was needed when conducting transactions.
But, Nakamoto’s idea has not fully succeeded, so far. Adoption of Bitcoin for daily transactions remains negligible since it was first introduced to the world more than ten years ago. This is mainly on account of its technical complexity and problems with processing transactions on its blockchain. The cryptocurrency has, instead, pivoted to becoming a store of value and its market capitalization has skyrocketed. Leading institutional investors, like Goldman Sachs and Fidelity, are developing infrastructure and reportedly developing products for it.
There are two key points of difference between Bitcoin and physical coins. The first one relates to the transparency in transactions on its blockchain — the distributed system proposed in Nakamoto’s paper. This means that all transactions occurring in its network are published on its blockchain. Using Bitcoin addresses, it is possible to figure out the nature and amount of transactions taking place within the Bitcoin economy. This is in contrast to the regular economy, where it is difficult to figure out the distribution and velocity of coins in an economy. That said, Bitcoin addresses are not giveaways to the actual identity of an organization or individual.
The second difference between Bitcoin and physical coins lies in their provenance and mining methods. Bitcoin is a digital asset, meaning that it originated in and utilizes tools, such as algorithms, which are native to the digital world. It is mined using a proof-of-work algorithm that involves solving cryptographic puzzles with varying levels of difficulty. Among other things, the supply and distribution of coins depends on the difficulty level for the puzzles. That said, anyone with the required computing resources can mine Bitcoin by downloading a software client. Physical coins, on the other hand, are made from metals extracted from earth and are minted and distributed by centralized authorities, such as governments and federal agencies.
Ethereum: Cryptocurrency’s Next Generation
In its most basic form, money is a medium for exchange of value between entities. Bitcoin digitized and decentralized the production and distribution of money. Ethereum takes the concept further through the use of smart contracts to facilitate this value exchange. As defined in Ethereum’s white paper, smart contracts are defined as cryptographic “boxes” that contain value and only unlock it when certain conditions are met. An example of a smart contract is a real estate transaction in which the doors to an apartment’s smart lock are opened immediately after the landlord receives rent payment.
The white paper further states that three types of applications are possible on Ethereum. The first one is contracts and products related to the financial services industry. Financial derivatives and hedging contracts, in which a trade occurs only after certain conditions are met, are examples of this type of smart contract. The second application possible on Ethereum’s blockchain are semi-financial applications, such as real estate transactions. Finally, smart contracts also have non-financial transactions, such as online voting and decentralized governances. Whilst they may not involve monetary exchange, these transactions involve execution of certain actions under certain conditions.
Ethereum’s future vision is still some time away. This is because the cryptocurrency’s blockchain is still in a nascent stage and faces several problems. For one, the blockchain’s core development team is still working on scaling solutions to dramatically increase the number of transactions that can take place on its blockchain. Security may also turn out to be another problem — Ethereum Classic, the original Ethereum blockchain, was recently compromised due to a type of hack that allowed a single entity to control more than 50% of the chain.