Tokens: Introduction
Tokens serve as an integral part of the blockchains. They encourage a diverse group of individuals to organize themselves around the purpose of a specific blockchain or decentralized application. There are various aspects that lead to the purpose of tokens. First is the currency aspect. Tokens serve as fungible stores of value that can be transferred P2P without a bank or middlemen. Second, it serves the purpose of fuel for the blockchain network. A token is needed to pay for the usage of the network. For example, Ether serves as the fuel or the computing power for running Ethereum Blockchain. Third, being an integral part of the incentive scheme. Tokens are directly proportional to network economics. The stakeholders of the blockchain network (miners/validators or token holders) are incentivized to contribute to the network by being rewarded with a stake in the network. The proof of work version of Ethereum was an example. The miners were rewarded with Ether for adding new blocks to the Ethereum blockchain.
You might have encountered real-life situations such as getting a coupon that is worth a meal or getting a purchase coupon worth a certain amount of fiat currency. The tokens work the same way. Just like a restaurant coupon represents a meal, a token can represent anything. Tokens can be used to represent a specific amount of digital assets that you could own, transfer, or redeem later. You can also represent physical assets such as gold, fiat currencies, or any similar items you prefer using tokens. For instance, you can tokenize a house and distribute the shares in the form of tokens.
Tokenization is the process of creating and issuing tokens that digitally represent a tradable asset. So in some cases, a token acts as security for properties. The following are some forms of tokens.
Security Tokens: Represent assets that require compliance with financial law. Gives securities to the investor which can be anything from a share in the company to dividends to assets. An example of a security token is the shares of a company. They cannot be freely transferred, it has to follow regulatory guidelines or trade laws. Owning a security token of a company means that you have rights over that company.
Utility Tokens: It is offered by a company or organization in order to use their service or products. These tokens are only applicable inside the corresponding company. Basic Attention Tokens (BAT), Uniswap (UNI) are some of the popular utility tokens.
Asset Tokens: Represents real assets like houses, gold, or bonds. If we create a token that is backed by gold, the token will have the value of gold. We can use these tokens for trading gold.
Currency Tokens: We can use currency tokens in the same way we are using fiat currencies. Just like how we use fiat currency for purchasing, we can use currency tokens with merchants who accept them. Ether is an example of a currency token.
Apart from these classifications, we have some categories to represent different types of digital assets- Fungible and Non-Fungible Tokens (NFT).
Fungibility is the feature of goods or assets to be merged, split, and interchanged with each other. An example is fiat currency. A higher denomination currency note may be replaced with an equivalent value of lower denomination notes. Both have the same value.
Non-fungible tokens are non-replicable and non-divisible. Therefore non-fungible tokens are used to represent collectibles and unique assets like identity, certificates, etc. For example, let's consider the case of a birth certificate, which is a unique asset with an owner. Although the birth certificates may look to be identical at a glance, each birth certificate will have distinctive attributes that make them irreplaceable or impossible to swap. Therefore, you cannot exchange your birth certificate with another person's birth certificate.
Ethereum offers several easy options to create and maintain various types of tokens.
ERC stands for Ethereum Request for Comments. ERC Protocol is an official way of introducing certain improvement proposals to the Ethereum network. These are used for requesting suggestions for improving Ethereum generally. Some of these suggestions are related to tokens. If anyone made any request or suggestions then the other members of the community can comment on it. Comments either get accepted or rejected by the general community. There are many ERC token standards available in Ethereum. ERC token standards are just interfaces that are used or implemented in a contract to create Ethereum Tokens.
Following are some of the popular token standards on Ethereum:
- ERC-20 - A standard interface for fungible tokens
- ERC-721 - A standard interface for non-fungible tokens
- ERC-1155 - A standard interface for contracts managing multiple token types
These are not the only token standards in Ethereum. To know more, go here.
If We Have Ether – Why Do We Need Tokens?
Now that we have learned about Ethereum, you might be wondering about the need for the token standards. If we have Ether why do we need tokens? Can't DApps use Ether rather than tokens?
Do you remember video games like Arcades and Casinos where we need to convert our money to either coins or chips before starting the game. If these are implemented as DApps, the coins/chips can be implemented as tokens. The usage of tokens to execute certain functions in the smart contract of the DApps makes the process much more simple and seamless.
Crypto tokens are similar to cryptocurrencies except that they don’t have their own blockchain. Crypto tokens can be created on top of the Ethereum blockchain. To understand the functioning of DApps and Tokens, let’s take the example of an amusement park. Now, how do you get into an amusement park? Purchasing tickets is probably the only way to enter the premises. However, here, instead of fiat currency, one pays Ether to get the tickets to access the refreshments and exciting rides in the park. In this scenario, the amusement park is our DApp, and the ticket is our token.
The smart contracts efficiently perform the storing and retrieving of information in a blockchain. Likewise, they are also responsible for the creation of tokens in the existing blockchain, precisely saying the token contracts. Now let's see what are the use cases for the token standards: ERC-20, ERC-721 and ERC-1155.
The token standards provide functionalities like transferring tokens from one account to another, finding the current token balance of an account, identifying the owner of a specific token, and also the total supply of the token available on the network. Along with these basic functions, they also provide certain additional functionalities like approving token transfers by third-party accounts.
