Definition
The token is technically simply another phrase for “cryptocurrency” or “crypto asset.” However, depending on the context, it has taken on a handful of more particular connotations. The first step is to define all cryptocurrencies other than Bitcoin and Ethereum (even though they are technically also tokens). The second is to characterize digital assets that operate on top of the blockchain of another cryptocurrency, as much decentralized finance (or DeFi) tokens do. Tokens may serve a wide variety of purposes, from facilitating decentralized exchanges to selling rare things in video games. However, they may all be exchanged or owned in the same way as any other cryptocurrency.
What is a Token?
The term “token” is often used in the cryptocurrency industry. In reality, you may hear Bitcoin referred to as a “crypto token” or something similar, since all crypto assets may be defined as tokens. However, the term has progressively taken on two distinct meanings, both of which are wide enough that you’re likely to come across them.
A “token” is often used to refer to any cryptocurrency other than Bitcoin and Ethereum (even though they are also technically tokens). Because Bitcoin and Ethereum are by far the most popular cryptocurrencies, having a term to describe the universe of other coins is helpful. (Another term with much the same meaning is “altcoin.”)
The second increasingly popular definition for “token” has an even more particular connotation: crypto assets that operate on top of the blockchain of another coin. If you get interested in decentralized finance, you will come across this use (or DeFi). While Bitcoin has its own dedicated blockchain, DeFi tokens like Chainlink and Aave operate on top of, or leverage, an existing blockchain, most often Ethereum’s.
Tokens in this second category assist decentralized programs in doing tasks ranging from automating interest rates to selling virtual real estate. But they can also be held or traded like any other cryptocurrency.
Why are tokens important?
Given that you’ll see the term often when investigating cryptocurrencies, it’s essential to be aware of certain typical meanings. But besides the big-picture definitions in the section above, there are also some categories of crypto assets that actually have “token” in their name. Here are a few examples of those:
DeFi tokens A new world of cryptocurrency-based protocols that aim to reproduce traditional financial-system functions (lending and saving, insurance, trading) has emerged in recent years. These protocols generate tokens that serve a variety of roles but can also be exchanged or kept in the same way that any other cryptocurrency may.
Tokens of governance These are specialized DeFi tokens that give holders a say in the future of a protocol or app, which (being decentralized) don’t have boards of directors or any other central authority. The popular savings protocol Compound, for example, issues all users a token called COMP. This token gives holders a vote in how Compound is upgraded. The more COMP tokens you have, the more votes you get.
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Non-Fungible Tokens (NFTs) NFTs represent ownership rights to a unique digital or real-world asset. They can be used to make it more difficult for digital creations to be copied and shared (an issue anyone who has ever visited a Torrent site full of the latest movies and video games understands). They’ve also been used to issue a limited number of digital artworks or sell unique virtual assets like rare items in a video game.
Security tokens are a new class of assets that aim to be the crypto equivalent of traditional securities like stocks and bonds. Their main use case is to sell shares in a company (very much like the shares or fractional shares sold via conventional markets) or other enterprises (for instance, real estate) without the need for a broker. Major companies and startups have been reported to be investigating security tokens as a potential alternative to other methods of fundraising.