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Cryptocurrency

What is a token and how does it work?

One of the most common words we see in the world of cryptocurrencies is the word token . The reason behind this is that these are a fundamental part of the nature of cryptocurrencies. But what exactly are tokens? Where are you from? How do they work? These are some of the most basic questions that we usually ask ourselves around this concept.

Well, in this article we will focus on explaining each of the previous questions. But also, we will answer some more with the firm purpose that you can know what a token is and its importance in the world of cryptocurrencies.

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Surely you have already got an idea of ​​what a token is after reading this short definition. But let’s make this a little more practical. Let’s take a casino token as an example of a token. Think about it a bit, a casino chip is worthless on the street. With them you can not buy anything in a store, nor can you pay absolutely nothing outside the casino. This because the chips of a casino have no legal tender value.

And in this “legal tender value” is the trick. The concept of legal tender value refers to what we use to pay, is widely accepted and is legally admissible as a means of payment. The currencies of countries such as the dollar or the euro, are tokens that have legal tender value. But not a casino chip. That is the reason why you cannot use them to pay for things in stores.

However, casino chips can be exchanged for legal money at the casino that issued them. This because the casino accepts that the chips have a value and will pay you that value in legal tender. Now what about tokens that work under blockchain technology? Well, we will explain that below.

Cryptographic digital tokens, the evolution of the traditional token

For many years, a large number of individuals wanted to design digital tokens to use as a secure medium of exchange. For many years this work was simply unsuccessful. Creating a token and a database that will keep your accounting was a simple task. The really difficult thing was creating a secure system. One that would avoid such detestable things as double spending or counterfeiting.

But this story changed with the appearance of Bitcoin and the technology that made it work, the blockchain . The creator of Bitcoin, an anonymous character under the pseudonym Satoshi Nakamoto , revolutionized the world with his creation. This by opening the doors for the creation of a digital, secure, transparent, private, censorship resistant and pseudo anonymous token. With Bitcoin, cryptographic digital tokens were born.

Basically crypto digital tokens are the same as a traditional token. That is, they can be created by private parties, they lack legal tender value and they can be exchanged. But crypto digital tokens have something that traditional tokens don’t, they work using blockchain technology. This allows you to control the known weaknesses of traditional tokens, such as counterfeiting and double spending.

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Thus a whole new vision for the world was opened. It was now possible to create digital tokens to represent anything with them. The extent of this after the appearance of Bitcoin was unknown. And in fact, even today we still understand the possibilities. Either way, tokens opened doors for a universe of things, just as they did in the beginning.

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Origin of the tokens

The beginnings and exact origin of tokens are lost in time. Humankind has used tokens from the very beginning of the first commercial transactions. But we know that its conceptualization as a token or currency dates back to the times of the Roman Empire. Back then, these tokens were used as payment tokens in gaming centers.

Centuries later with the expansion of the Spanish and English empires throughout the New World, the need to create money to enable exchanges was quickly born. The colonizers thus created tokens that were used to be exchanged later for food, supplies or legal tender. Thus tokens were a fundamental part of the population settlement in the New World.

But even in modern times like the 19th and 20th centuries, tokens were used by private parties to create means of exchange that they could control. However, the use of said tokens was decreasing in favor of legal tender and a more orderly economic system.

The latter makes us wonder why look for ways to create new types of tokens such as cryptographic digital tokens? The simple answer to this is that digital tokens can be used to represent different objects and goods in the real world in a more concrete and secure way. In an increasingly interconnected real and digital world this makes perfect sense. Especially for the characteristics that cryptographic digital tokens offer us. But what are the characteristics of the tokens? Well, we’ll see that below.

Characteristics of tokens

Now that we know that it is a token and the interest it has aroused for centuries, it is good to know its characteristics. In this sense we can mention:

They have no value. Tokens have no value, since they are creations without any value according to the laws.

They are issued by private. The issuance of tokens is generally carried out by a person or company. The endorsement and acceptance of these tokens to make exchanges is subject to those who issue the token.

They are created using materials of very little value. From the origin of the same, the tokens were minted in materials of very little value. After all, no one would want to use gold or silver to issue a limited-use token. In the case of crypto digital tokens, issuing a token is as simple and cheap as running a program.

Their use is subject to the existence of a system that controls their operations. Those who issue a token create a series of rules that allow operations and exchanges of tokens for legal goods, services or money. In the case of cryptographic digital tokens, these rules and operation are controlled by the blockchain where they are run. As well as the contract or programming that gives rise to the token itself.

They are safe and not falsifiable. This feature applies only to the case of cryptographic digital tokens, and it is a feature that they inherit from the blockchain.

How do tokens work?

As we have already explained, how tokens work depends on two things:

  • A blockchain and a cryptocurrency that allow the token to be developed.
  • A contract or schedule that makes clear everything that can and cannot be done with the token.

Now let’s explain this. First of all, a token needs a platform to develop. This is so because the purpose of a token is to represent anything that exists in the real world. With that in mind, the token needs a space or platform to develop and represent what it will be created for. In this case, that platform is an existing blockchain, on which we can program our token.

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At this point comes the second and most important thing, defining the token itself. This definition involves creating the token, giving it its characteristics, defining what information it can or cannot store, and creating the protocols that will define its operation. To do this, we must use the programming tools available to the blockchain that we choose.

But this last point changes radically according to the blockchain we choose. For example, if we use Bitcoin to create a token, the token contract or programming must be done using the Bitcoin Script language. If, on the other hand, we choose Ethereum, we must use the Solidity language to program the smart contracts that will give life to our tokens.

Example of how a token works

For example, the Tether token is the digital representation of a US dollar. One that runs on the Ethereum blockchain . Although there is also an implementation on Bitcoin that uses Omni Layer. In any case, the existence of this token on Ethereum serves two points:

We want to represent the possession of a dollar on the Ethereum blockchain.

The Tether token is manageable within the parameters that allows its programming created especially for Ethereum, using a smart contract and the Ethereum ERC-20 token standard .

Thus, every time we have a Tether token, we know that we have the digital possession of a dollar. We can trade and exchange that digital dollar on the Ethereum blockchain. When we do a Tether transaction, what happens is that a certain amount of Tether is moved from our address to the destination address. In the process, we create a special transaction that is processed by Ethereum and charged a commission. Once the transaction is accepted by the network, the Tether token that we have sent will change from being ours to being the property of the owner of the destination address.

In that simple way, a token works on Ethereum, and this structure works basically the same on any other blockchain.

Differences between token and cryptocurrency

Now at this point you will surely be confused between what is a token and a cryptocurrency. And the short answer to end this confusion is that a token and a cryptocurrency are different things. Very different actually.

On the one hand, a cryptocurrency is created from the beginning with the firm intention of being a medium of exchange. One that has its own blockchain and that does not depend on another system for its operation. Ultimately, a cryptocurrency is a self-sustaining value exchange system.

A token on the contrary is neither of these things. First of all, a token is created to represent anything. It can be a house, a company stock, a collectible, or the parts that make up the whole of an airplane production line, including the aircraft themselves. They can be used as a means of payment or exchange, but their goal is to be a means of representing things from the real world.

The second is that a token depends on another system to function, that is, they are not self-sustainable. For example, Ethereum tokens would be nothing if the Ethereum blockchain and its cryptocurrency Ether did not exist.

These differences in turn give rise to the different types of tokens that we will see below.

Types of tokens

Tokens can be divided into three types or categories which are:

Security Token

A security token is a type of cryptographic digital token that is tied to traditional financial security or securities. Understanding by traditional value, any interchangeable financial asset such as bonds, swaps or futures.

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As we have explained, the intention behind the creation of the tokens is to digitally represent things using blockchain technology. Well, a security token represents these assets within a blockchain. The purpose of this is to allow companies decentralized control of them, in addition to greater security, cost reduction and easier management.

Because these tokens represent values ​​in the real world, countries enforce their laws on these creations. A situation that has greatly increased interest in them, due to the security they provide both at a technological and legal level.

Utility Token

The utility tokens, on the other hand, are a type of utility token that allows anyone with one in their possession to access products and services that are provided by a private party. However, unlike security tokens, utility tokens are unregulated and more of a promise than something tangible.

Utility tokens were widely used by different crypto projects in 2017, during the well-known “Boom ICO”. An ICO (Initial Coin Offering) or Initial Coin Offering, is a kind of token pre-sale, in which people buy utility tokens from a company. The objective is to finance the company for the development of a project. In exchange for this, the company gives us a certain amount of utility token that we can use when the company starts its project. Simply put, a utility token is an access coupon.

Because they are unregulated, utility tokens were widely used for malicious purposes. During the ICO Boom, many companies used these to scam thousands of people. But on the other hand, many companies that used this method if they managed to carry out their projects and are today a success.

Equity Token

Equity tokens are a type of token that is closely related to security tokens. An equity token works like a digital representation of a traditional stock asset. In other words, an equity token represents the ownership of some third-party asset or company. Due to this property, the equity tokens are also regulated by the securities laws of many countries.

However, regulations at this point are more flexible and that has sparked interest to use them in place of security tokens.

Keep reading: ERC20 Tokens: What are they and how do they work?

Most famous token platforms

Now that we have a deeper understanding of tokens, their types, features, and more, it’s time to get to know some of the most famous crypto digital token platforms.

Bitcoin

The blockchain and cryptocurrency that started the revolution, is also one of the most used platforms to create tokens. The well-known colored coins are the clearest example of the implementation of tokens on Bitcoin. Currently, projects like Omni Layer and RSK execute tokens on the Bitcoin blockchain successfully.

It may interest you: What is a Colored Coin?

Ethereum

The Ethereum blockchain is the blockchain with the highest number of tokens running on it. The reason? Ethereum was created in order to become a platform for developing tokens. We see this clearly in the creation of standards such as the ERC-20 token, which greatly facilitates the task of creating and deploying a cryptographic token.

The result of this is that Ethereum contains at least 250 thousand different tokens running on its blockchain, and the number continues to grow.

Bitcoin and Ethereum are without a doubt the most famous platforms for the creation and deployment of tokens, but they are not the only ones. Projects like EOS , TRON , Ethereum Classic , NEO or Waves , also allow tokens to be created quickly and easily. This gives us a taste of how important and useful tokens are in the world of cryptocurrencies.

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