Token is often used synonymously with “cryptocurrency” or “crypto asset.” Depending on the context, however, it can have a few more specific meanings. It can be used to describe some digital assets, which run on top of another crypto’s blockchain, like Ethereum or Binance Smart Chain. A second option is to describe all cryptocurrencies besides Bitcoin and Ethereum.
The functions of tokens are varied, from selling items in games to making decentralized exchanges possible. Like any crypto, they can be traded or held. “Token” is definitely a concept that’s making the rounds in the crypto space.
Technically, Bitcoin and Ethereum are tokens too. Since they are the biggest two cryptocurrencies by market cap, we need a word to denote other coins. Altcoin is another world with virtually the same meaning.
We just mentioned the use of the word to describe crypto assets running on top of another cryptocurrency’s blockchain. If you’re interested in DeFi, you will encounter this usage. Bitcoin may have its own dedicated blockchain, but DeFi tokens like Aave, Chainlink, and many more run on top of another one, not their own.
In terms of this second category, tokens help dApps (decentralized applications) to do all kinds of different things, from selling virtual land to automating interest rates.
The significance of tokens
It’s useful to understand some common connotations considering you’ll come across this word a lot in the process of researching cryptocurrencies. Some digital assets have the word in their name apart from the main definitions we shared. These include DeFi tokens, Non-Fungible Tokens (NFTs), governance tokens, and security tokens. Here’s a quick look at each of these.
DeFi tokens are a new space of cryptocurrency-based protocols which have the purpose to replicate the functions of the conventional finance system, such as trading, insurance, lending, and saving. While the tokens they issue can have a wide variety of functions, they can be held or traded like any other cryptocurrency. The difference from conventional finance is more transparency and objectivity. As a downside, DeFi has enabled things like flash loans, which have inflicted serious losses on entities like exchanges. For instance, you get a loan in a cryptocurrency, then manipulate the price and dump it on an exchange.
NFTs are unique digital assets with ownership rights. They make copying and sharing digital creations harder. They are used to sell unique assets, like rare items in play to earn games, and to issue a limited number of digital artworks.
Governance tokens are specialized DeFi tokens that allow holders to influence or even determine developments in a protocol or app. Being decentralized, they don’t have governing institutions like directors’ boards or another central body. For instance Compound, a savings protocol, issues its holders a token called COMP, which gives them the right to vote on upgrades to the protocol. The number of COMP tokens in someone’s possession is directly proportional to the number of votes they have.
Last but not least, these are a new class of assets aiming to act as the digital equivalent of bonds, stocks, and other traditional securities. They are mainly used to sell shares in a company or real estate. They are not unlike the shares sold on traditional markets. The difference is that there’s no middleman here. Big and small companies are increasingly looking into security tokens as a potential alternative to other fundraising methods.