Coin and Token Types
Blockchain 101 - Part 3
Coins are native cryptocurrencies that operate on their own dedicated blockchains, functioning independently from other cryptocurrencies, blockchains, or platforms. Examples of coins include ETH (Ethereum), BTC (Bitcoin), and BNB (Binance Smart Chain).
Coins primarily function as a medium of exchange and store of value. They are designed to be used as digital currencies for transactions and may have broader acceptance as a form of payment.
Native coins can be likened to fuel for cars. Similar to how cars require fuel to operate, native coins are essential for the functioning of their respective blockchain networks. Native coins are used to pay for transaction fees, facilitate transactions, and incentivize network participants. Just as fuel powers a car’s engine, native coins power the operations and activities within a blockchain ecosystem.
Tokens encompass a broader category that includes various digital assets within specific platforms. Tokens are typically built and operate on existing blockchain platforms like Ethereum or Binance Smart Chain, utilizing their infrastructure, protocols, and standards.
Although the terms “token” and “coin” are frequently used interchangeably within the cryptocurrency realm, they possess separate definitions that can vary depending on the context.
Remember, to engage in transactions involving tokens issued on a particular blockchain, it is necessary to possess the native cryptocurrency (coin) of that blockchain. This requirement arises because transaction fees, which are incurred when conducting transactions, must be paid using the native coin of the blockchain.
Tokens often adhere to specific token standards defined by the blockchain platform they are built on, providing guidelines for their functionality and interoperability.Popular token standards or protocols on the Ethereum blockchain are for example ERC-20 (most widely adopted token standard for fungible tokens), ERC-721 (token standard for NFTs), ERC-1155 (hybrid token standard for fungible and non-fungible tokens within the same smart contract).
Tokens can serve various functions, with security and utility tokens being the most common types.
Tokens are primarily classified based on their functionality. The two primary categories are utility tokens and security tokens.
Tokens can also be classified based on their features as either fungible or non-fungible. Fungible tokens, similar to dollar bills, can be exchanged with other tokens of the same value without any distinction. Each unit holds the same purpose. On the other hand, non-fungible tokens, like unique pieces of art, have distinct properties, and each unit must be treated separately.
The primary purpose of utility tokens is to enable users to access and utilize specific features, products, or services offered by a blockchain-based platform or application. Utility tokens are created on a blockchain and are specific to the platform they are used on.
Utility tokens frequently function as a medium of exchange or transaction within the platform, enabling users to make payments for goods, services, or access privileges. They encompass a range of functionalities, including but not limited to:
- payment for services or transactions within the platform’s ecosystem,
- access to restricted areas, premium content, or exclusive features within a platform,
- interact with decentralized applications (dApps) or access specific functionalities like voting, staking, or participating in governance mechanisms,
- loyalty rewards, incentivizing users to engage with a platform by offering benefits, discounts, or bonuses, etc.
It is worth highlighting that although utility tokens are primarily designed for functional purposes, their value can still be subject to changes based on the dynamics of supply and demand. However, it is important to note that utility tokens are generally not promoted or sold as investment opportunities since they do not represent ownership or provide profit-sharing rights in the same manner as security tokens.
A security token is a digital form of traditional securities, including equities, debt, or a hybrid of both. Examples of traditional securities include stocks, bonds, ETFs, options, and futures. These securities can be tokenized to become security tokens, allowing them to be traded digitally.
Security tokens are financial assets that mirror the characteristics of traditional securities. For instance, during an Initial Coin Offering (ICO), a company could issue tokenized shares that provide ownership rights and dividends to the holders. Legally, these tokenized shares are equivalent to traditionally-distributed shares.
Individuals who own security tokens can benefit from the token’s performance and may also receive dividends in the form of additional tokens. They may also enjoy other advantages, such as voting power. In this way, security token holders can enjoy similar benefits to those provided by stocks and other securities.
It’s important to note that the regulatory treatment of security tokens may vary in different jurisdictions.
Stablecoins are cryptocurrencies designed to retain a consistent value over time, typically linked to prominent fiat currencies such as the U.S. dollar, a collection of fiat currencies, or even valuable commodities like precious metals. The purpose of stablecoins is to minimize price volatility so their value doesn’t fluctuate significantly.
These coins are backed by an underlying asset, typically the one they represent digitally, in order to maintain a stable price similar to traditional fiat currencies.
There are four main types of stablecoins:
1. Fiat-collateralized stablecoins, such as USDT, USDC, and BUSD, which are backed by reserves of fiat currency.
2. Commodity-collateralized stablecoins, like DigixGlobal, which are backed by commodities like gold.
3. Crypto-collateralized stablecoins, such as MakerDAO’s Dai token, which are backed by other cryptocurrencies.
4. Non-collateralized stablecoins, which use algorithms to control the token supply and maintain a fixed price. These coins adjust their circulating supply based on market conditions.
Companies that issue collateralized stablecoins are expected to hold the assets that back their coins, such as U.S. dollars or gold. They create new tokens based on the value of their holdings, following a 1:1 ratio. This model is commonly used for most stablecoins.
The aim of stablecoins is to provide stability and reliable value within the volatile cryptocurrency market.
Asset-backed tokens are digital tokens that serve as representations of real-world assets such as gold, crude oil, real estate, equity, and soybeans. The value of these tokens is directly linked to the value of the underlying physical asset they represent. These tokens are typically classified as securities by financial regulators.
When you own an asset-backed token, it means you have a claim on the corresponding physical asset. Depending on the asset, you may also expect future returns as the asset appreciates in value. The tokens allow for the transfer of ownership without the need to physically move the assets, making transactions more efficient and cost-effective.
Businesses can use asset-backed tokens to raise capital by offering them as equity instruments, following financial regulations. Alternatively, existing assets can be tokenized and sold to individual investors, offering them the opportunity to invest in real-world assets without the hassle of physical storage or exchange. This reduces trade friction and logistics costs.
Asset-backed tokens provide an alternative financial option that combines digital liquidity with the value of tangible assets, offering a solution to problems caused by unstable currencies or unpredictable stock markets. They enable investors to store value independent of traditional fiat currencies that are prone to inflation.
Governance tokens are tokens specifically designed by developers to enable token holders to actively contribute to the development and decision-making processes of a protocol or project. Organizations that embrace user control are often referred to as decentralized autonomous organizations (DAOs).
With governance tokens, holders have the power to influence decisions related to the project, such as proposing new features or making changes to the governance system itself.
In the context of DAOs and decentralized finance (DeFi), governance tokens provide a more fair, decentralized, and transparent approach to governance. These systems utilize smart contracts to execute actions based on predefined conditions, creating trustless environments for transactions and information sharing. Through governance tokens, members of DAOs and DeFis can have an equal say in the decision-making process.
Different projects have their own rules and models for how governance tokens function. Tokens are allocated to different individuals or groups involved in a project using specific calculation methods. Some governance tokens focus on voting for specific governance issues, while others cover a broader range of decisions.
A Non-Fungible Token (NFT) is a virtual token that provides verifiable proof of authenticity and ownership of a specific asset using cryptography.
NFTs are primarily recognized for their association with virtual art pieces, but their utility extends beyond that. NFTs can be used to represent a wide range of assets, including: real estate, domain name, event ticket, intellectual property, luxury watches, etc.
Traditionally, cryptocurrencies are interchangeable, which means that each unit of Ether, for example is exactly the same as another Ether, and they can be exchanged.
Interchangeability is also a fundamental characteristic of traditional fiat currencies like the USD. However, there are cases where tokens can be unique and not interchangeable, especially when they represent digital proof of ownership of assets.
An NFT is a virtual token that provides verifiable proof of authenticity and ownership of an asset using cryptography. For instance, if you own a virtual piece of art, you can create an NFT to tokenize that artwork, and the NFT will reflect your ownership of the unique artwork. The NFT is stored on the blockchain as proof of your ownership.
Similar to the existence of replica luxury watches or bags, the cryptocurrency market also has its share of counterfeit tokens. Scammers create fake tokens that look similar to popular ones, tricking users who are unaware of such scams.
You can avoid falling victim to fake token schemes by following these two steps:
It is essential to exercise caution and refrain from engaging with randomly received tokens in your wallet address. It is advisable to treat them similarly to spam emails: avoid interacting with them and leave them untouched. Interacting with such tokens can potentially result in the loss of all the tokens present in that particular wallet.
Prior to purchasing any tokens from any source, it is crucial to take the necessary precautions. Ensure that you double-check the token contract address using at least two official sources. By doing so, you can protect yourself from becoming a victim of fraudulent token schemes.
Testnets are available for every available blockchain platform, providing a trial version for testing purposes. As the name implies, testnet tokens are a unique form of cryptocurrency that is specifically created for the purpose of testing.
Testnet tokens are used to try out new features and functionalities without risking tokens with real value. They provide a safe way to learn about blockchain technology without the fear of losing actual funds.
These tokens are commonly distributed at no cost through online faucets or can be acquired by engaging in blockchain development projects. Once you have them, you can use them to experiment with wallets, conduct transactions, and even engage with decentralized applications on the blockchain.
It’s important to note that testnet tokens have no real value. They are solely intended for testing and development purposes, not for actual transactions. Tokens created on testnets cannot be exchanged for their equivalent value on the main network.
Testnet tokens can be obtained at no cost through dedicated online faucets designed for each testnet. Simply provide your preferred wallet address, and within minutes, the testnet token will be deposited into your designated wallet address.
As a first step, it is indeed recommended to generate a new address in your self-custodial wallet (or even a new wallet on a separate device), such as MetaMask, specifically for testing purposes. Creating a separate address for testing helps maintain the separation between your actual funds and any tokens or transactions used during testing. This practice ensures that you can experiment and test without the risk of accidentally sending or receiving real tokens on the mainnet.
The next step is to obtain testnet tokens. You can either mine testnet tokens or request them from testnet faucets. These faucets are online services established by individuals or organizations that have spare testnet coins.
After obtaining your testnet address and tokens, you can begin making transactions. Ensuring the use of the appropriate network when sending and receiving tokens is crucial.
Utilize the testnet network: Now that you have your testnet wallet and tokens, you can start utilizing the testnet. This provides you with the opportunity to explore and test new features and applications before implementing them on the main network.
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