A Token by Any Other Name: Digital Tokens Explained

Join us on this enlightening journey as we uncover the many different shades of digital tokens.

In the ever-vibrant crypto cosmos, the words 'cryptocurrency', 'coins', and 'tokens' tend to huddle together more often than not. Many a crypto enthusiast has nonchalantly labeled all assets on crypto exchanges as 'a coin', but let's not get carried away with this oversimplification.

Yes, these terms do love to masquerade as each other, adding a delightful dash of confusion to the mix, especially for the crypto greenhorns. But fear not, for we're here to untangle this cryptic conundrum.

In this article, we'll shine a light on the elusive nature of tokens and explain how they fit into the grand crypto jigsaw puzzle.

Understanding Digital Tokens

It's a favored pastime for many to dub every asset traded on crypto exchanges as 'a coin'. However, this rampant name-calling is a widespread misunderstanding. Brace yourself for the revelation that the 'coins' you've been dealing with on your go-to crypto exchange are, in reality, far fewer.

The pivotal factor that sets a coin apart from a token is rooted in the technology it's built upon. Coins have their own independent blockchain. Bitcoin (BTC), the poster child of digital coins, often serves as the benchmark against which the value of other digital coins (or altcoins) and most tokens are measured.

👉 If an asset has its own blockchain, it's safe to call it a coin.

In the footsteps of Bitcoin, we have altcoins like Litecoin (LTC), Monero (XMR), Dash (DASH), and Stellar (XLM), designed primarily to act as mediums of exchange.

👉 For a deeper dive into altcoins, check out this article: Your Ultimate Altcoin Guide.

Then, there's a distinct breed of digital assets like Ethereum (ETH), Tron (TRX), Cardano (ADA), Neo (NEO), and Solana (SOL). They set themselves apart with the capacity to execute smart contracts on their blockchains, serving not just as exchange mediums but also as the 'gas' that powers these smart contracts.

And with that, we cross over into the intriguing world of tokens.

What Differs Tokens From Coins

Smart contracts have ushered in a new era, enabling anyone to birth their own token atop an existing blockchain. These tokens, thanks to the adaptability of smart contracts and unique features of the host blockchains, can symbolize almost anything. Think of it as a representation of cloud storage disk space, a piece of art, or even an authenticity certificate.

The Ethereum blockchain, with its band of ERC20 tokens, was the poster child of tokenization platforms for a long while. Nowadays, however, the market is more diversified, offering a broader palette of platforms like Cardano, Tron, Binance Smart Chain, and the list goes on.

Here's where tokens differ from coins: While coins operate on their own blockchain, tokens operate on someone else’s blockchain and pay transaction fees in the native currency of the blockchain they reside on. In simpler terms, if an asset's transaction fee is paid in a different currency, then it's a token.

👉 For a deeper dive into tokens vs coins, please refer to this article: Crypto Token vs Coin Explained.

Types of Digital Tokens

Tokens come in various hues, each representing a different purpose. Grasping these fundamental distinctions is not just a fancy party trick, but a crucial skill for navigating the crypto market.

Utility Tokens

In the heady days of 2017, utility tokens were the golden goose of a quick cash influx without the pesky need to trade off the company's autonomy. These tokens, birthed by a specific project, promised a cornucopia of benefits to their holders, ranging from services to the tantalizing prospect of future profits.

Another ingenious use case was the good old 'carrot' approach to coax audiences into using a platform. Take for instance the privacy-centric Brave browser, which showers users with Basic Attention Tokens (BAT) for watching ads. Other notable mentions include Filecoin (FIL), dishing out cloud storage space to token holders, and Civic (CVC), offering a smooth-as-silk identity validation service.

Among the utility token hall of fame, BNB, the native token of the Binance crypto exchange, stands tall. Launched as an ERC-20 token on the Ethereum blockchain in 2017, it has since evolved into a native cryptocurrency of the Binance Smart Chain, gaining popularity for transactions, travel bookings, entertainment, online services, and more. And although, since then, BNB has taken a regulatory hit, it still boasts a whopping $34.29 billion.

Raising capital through utility tokens allowed fledgling companies to dodge the red tape, costs, and liabilities of traditional finance. But let's face it, the capricious nature of the crypto market hardly makes for stable ground for a token-backed economy.

To stay afloat and secure a safety net, many companies made a beeline to cash out tokens as soon as they hit the market. This, unsurprisingly, didn't do any favors for the already shaky reputation of the ICO market, which was teeming with questionable projects, unworkable ideas, and blatant scams.

In a nutshell, utility tokens are blockchain-bred tokens that serve a specific purpose — they're the worker bees of the token hive. Born on the blockchain, they are inherent to the platform they operate on. They're not seen as financial instruments, thus slipping through the regulatory net that ensnares securities. Limited to their bespoke ecosystem, they're like a species adapted to a unique habitat. Imagine if Spotify forged its own utility token — these tokens could then be used exclusively for subscribing to premium features or purchasing exclusive content on their platform.

Security Tokens

Security tokens, as opposed to their utility siblings, parade around like tokenized property, taking cues from bonds and stocks. In essence, these digital assets stand for ownership rights and transfer value from an asset or a bundle of assets to a token.

Picture a company plotting to raise funds for a growth project. Rather than issuing stock, it could opt to dish out digital tokens representing fractional ownership of itself. These tokens can then be offered to investors on a digital security tokens-friendly exchange.

Security tokens don many hats based on their purpose:

• Debt tokens are the digital avatars of debt instruments like real estate mortgages or corporate bonds.
• Equity tokens are the digital stand-ins for an equity position in an underlying asset.
• Derivative tokens are the shape-shifters, deriving their value from an underlying asset.

These tokens are tagged as 'investments', and the issuing companies are expected to roll out detailed reports and adhere to a slew of stringent regulatory requirements. This makes the emission and distribution process during security token offerings (STOs) bear a striking resemblance to IPOs.

Interestingly, many cryptocurrencies that weren't originally intended as investment instruments have been commandeered as such by investors. Bitcoin, for instance, is treated as a security token by many, despite not being designed as one. However, since bitcoin doesn't serve the typical functions of a security token and there is no profit expectation from its developers, it doesn't pass muster as a security under SEC criteria.

Governance Tokens

Governance tokens, which became the talk of the town during the 2020 DeFi eruption, endow holders with the ability to shape the destiny of a specific project. Armed with these tokens, holders can navigate the protocol's future, without having to rely on the whims of developers or demand their involvement.

Token holders can choose to pass the baton of their voting rights to other users, specialists, or even applications. They can table suggestions such as welcoming new assets or tweaking the lending interest rate on a DeFi platform.

Such propositions can be plugged directly into the system in the guise of digital code and seamlessly rolled out when the majority of token holders give a thumbs up.

While governance tokens might sometimes be dangled as incentives for staking and, in some systems, can be used to endorse transactions, not all governance tokens boast these features. These tokens can rub shoulders with other token types and may be swapped at advantageous rates. For instance, the Zilliqa protocol doles out interest payments in both typical ZIL and governance gZIL tokens.

Notable mentions of governance tokens include UniSwap's UNI and Compound's COMP. These tokens entitle holders to vote on amendments to the respective protocols, with UniSwap serving as a decentralized exchange and Compound acting as the world's behemoth algorithmic money market protocol on the Ethereum blockchain.

Asset-Backed Tokens

Asset-backed, or commodity tokens, linked to tangible and readily acquirable assets, have played a pivotal role in moulding the blockchain economy to its present form.

While traditional stablecoins like USDT, BUSD, USDC, and a plethora of others are anchored to the value of the US dollar or other fiat currencies, there are also ones that stand for more offbeat, non-financial assets.

Take, for instance, tokens such as El Petro, which is tethered to the value of a barrel of Venezuelan oil, and CaskCoin, which is underpinned by barrels of Scotch whiskey.

In addition, existing digital currencies can be morphed into tokens for use on alternate blockchains. A case in point is WBTC (Wrapped Bitcoin), which is Bitcoin tokenized in line with the ERC20 standard on the Ethereum network.

Non-Fungible Tokens (NFTs)

Non-Fungible Tokens, or NFTs, are the blockchain's way of codifying the ownership rights of distinctive items. They unlock the possibility of tokenizing almost everything: from artwork and collectibles to tweets, songs, and even real estate. The ownership record is etched into a smart contract and is immune to alterations or duplication.

The term 'non-fungible' in NFT implies that each token on the blockchain is unique and irreplaceable due to its distinct properties. While you can swap a USDT token with another cryptocurrency and back at will, owing to their identical properties like value to the US dollar, finding two identical NFTs is akin to finding a needle in a haystack.

In its early days, the NFT market was all about digital art and collectibles, but it has since blossomed into a much broader ecosystem. For instance, the well-known NFT marketplace OpenSea has a smorgasbord of NFT categories: photography, sports, trading cards, art, collectibles, domain names, music, virtual worlds.

Perhaps the most illustrious application of NFTs is cryptokitties. Each kitty is distinctive and carries a different price tag. They 'multiply', giving birth to new offspring boasting different attributes and valuations compared to their 'ancestors'. Within mere weeks of their debut, these digital kitties had a legion of fans who splurged $20 million worth of ether to buy, cater, and care for them. More recently, the Bored Ape Yacht Club has made waves for its astronomical prices, star-studded fan base, and high-profile pilfering of some of its 10,000 NFTs.

So All Those Tokens and Coins Are All Programmable Digital Money, Right?

Well, yes. Think of programmable money as currency with inbuilt instructions. These commands are embedded in a self-executing (or ‘smart’) contract that's triggered when certain conditions are met.

👉Picture a robot lawyer, but instead of wearing a suit and arguing in court, it's lines of code in a computer.

The contract defines how the money operates. For instance, it could be designed to change hands when a specific condition is met. Over time, smart contracts have become more sophisticated. A smart contract can now interact with another smart contract, thereby constructing something akin to a financial services Lego set.

It's worth noting that banks and financial institutions can facilitate automated payments too, like using direct debit for utilities. However, with programmable money, a third party like a bank isn't necessary to initiate and settle the transaction. Consider bitcoin as an example, which eradicates the requirement for a centralized institution such as a bank.

Central Banks across the globe are also exploring the potential of Central Bank Digital Currency (CBDC). A stable coin, on the other hand, is a fiat-backed crypto asset that pegs its value to a fiat currency. This is achieved by backing every unit of the stable coin with a cash or cash equivalent deposit. Both CBDCs and stable coins are types of programmable money whose value is dictated by the fiat currency it is issued against.

Digital Tokens a Legal Perspective

Although we’ve got these shiny new toys called tokens out of their tech-bubble wrappers for a while already, the law is having a bit of a slow day and hasn't quite caught up to them yet. Good thing we've got a bunch of academics, policy wonks, and organizations like UNCITRAL and UNIDROIT who are trying to wrangle these slippery digital beasts into a legal framework, with mixed results.

The U.S., always pragmatic, is treating tokens like property, despite their shape-shifting nature. But defining these tokens legally is like trying to nail jelly to a wall. Because of their connection with Distributed Ledger Technology (DLT) and smart contracts, they're more complex than a 3D puzzle.

Countries like Singapore, England, and New Zealand have bravely considered tokens as digital assets that can be owned, while other countries like Germany, playing it safe, are more reticent.

But here's the kicker. Classifying tokens as securities is like inviting a bull into a china shop. It means a whole lot of legal and regulatory implications, and the potential for hefty fines.

Countries have different ideas about what can be classified as a security. Some have a checklist as precise as a Swiss watch, while others, like the U.S. and Canada, have a more 'anything goes' approach.

To bring some order in the digital token rodeo, some systems, including Germany's BaFin and Switzerland's FINMA, have decided to exclude utility tokens from securities laws, with Singapore, Malta, and Wyoming following suit.

Meanwhile, the EU is still trying to wrestle the crypto beast into submission. Switzerland, the cool kid, has already rolled out its DLT Act, while Germany is preparing a new home for electronic securities, including tokens.

Tokens as securities could be a goldmine for financial markets, but there are obstacles like technical glitches, legal ambiguities, and the never-ending energy consumption. Securities laws and regulations need to do a serious yoga session to accommodate tokens. Also, let's not forget the toddler-stage interoperability among different DLTs.

Regulators are busy issuing warnings about token sales, telling the public to tread carefully. Warnings are useful, but they tend to lump all tokens together, the good, the bad, and the speculative.

The IMF is all about comprehensive regulations for crypto assets, focusing on unbacked tokens and stablecoins. Some countries have crafted their own token regulations, offering a real smorgasbord of voluntary, binding, and comprehensive rules.

Every system could use crystal-clear legal definitions to decide if a token is a security. It's about rights — financial rights make it a security. Tokens tied to an asset's property are a different ballgame. If the asset makes money or people expect its value to rise, it could be a security. And if tokens are deemed securities, they should play by securities laws. But remember, protective measures only work when the token risks align with typical investment risks.

So, as you can see, these regulations are in a state of flux, and changes are inevitable. Ensure you stay current by regularly visiting pertinent websites for detailed updates.

How to Buy Digital Tokens

Your journey into the realm of digital tokens begins with finding a suitable platform for your transactions. There are numerous options available, including well-known cryptocurrency exchanges such as Binance, Coinbase, and Kraken. The choice of platform will likely hinge on various factors such as the specific tokens you're interested in, associated fees, user-friendliness of the interface, and the security protocols in place.

Once you've chosen an exchange, the next step is to set up an account, which may include undergoing a Know Your Customer (KYC) process.

You'll find that most exchanges provide the option to deposit funds either in traditional fiat currencies like USD, EUR, among others, or in established cryptocurrencies like BTC or ETH. Each exchange has its own specific methods for depositing funds, which commonly include bank transfers, debit or credit card transactions, or transfers of cryptocurrency from a different wallet.

With your account funded, you're ready to purchase your chosen digital tokens. This process typically involves selecting the desired token, inputting the quantity you wish to acquire, and confirming the purchase.

Upon completion of the purchase, it's advisable to transfer your tokens to a secure wallet. Despite the convenience of keeping your tokens on the exchange, the risk of potential hacking makes this option less favorable. A hardware wallet, a physical device that stores your tokens in an offline environment, is often deemed the safest choice.

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FAQs

What Is Tokenization?

Tokenization is the process of representing real-world assets like real estate, art, or stocks as digital tokens on a blockchain. It involves converting the rights to an asset into a digital token that can be easily traded. Tokenization allows for fractional ownership of assets, increased liquidity, greater efficiency and transparency, enhanced security, and expanded access to global markets. By putting asset ownership on a blockchain as digital tokens, tokenization opens up new opportunities for managing and trading all types of tangible and intangible assets.

What Gold Backed Digital Tokens Are There?

Every gold-backed asset is typically assigned a value equivalent to a specific amount of gold in grams or troy ounces, implying that a corresponding amount of physical gold is held in the company's reserves or by a trusted custodian as collateral. Currently, the top five cryptocurrencies that are backed by gold include Paxos Gold (PAXG), Perth Mint Gold Token (PMGT), Digix Global (DGX), Meld Gold by Algorand, and Tether Gold (XAUT).