What Are Crypto Tokens?

What Are Crypto Tokens, and How Do They Work?

What Are Crypto Tokens?

The term crypto token refers to a special virtual currency token or how cryptocurrencies are denominated. These tokens represent fungible and tradable assets or utilities that reside on their own blockchains. Crypto tokens are often used to fundraise for crowd sales, but they can also serve as a substitute for other things. These tokens are usually created, distributed, sold, and circulated through the standard initial coin offering (ICO) process, which involves a crowdfunding exercise to fund project development.

KEY TAKEAWAYS

• Crypto tokens are a type of cryptocurrency that represents an asset or specific use and reside on their own blockchain.
• Tokens can be used for investment purposes, to store value, or to make purchases.
• Cryptocurrencies are digital currencies used to facilitate transactions (making and receiving payments) along the blockchain.
• Altcoins and crypto tokens are types of cryptocurrencies with different functions.
• Created through an initial coin offering, crypto tokens are often used to raise funds for crowd sales.

How Crypto Tokens Work

As noted above, crypto tokens are cryptocurrency tokens. Cryptocurrencies or virtual currencies are denominated into these tokens, which reside on their own blockchains. Blockchains are special databases that store information in blocks that are then chained or linked together. This means that crypto tokens, which are also called crypto assets, represent a certain unit of value.

Here's how it all works. Crypto refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions. Cryptocurrencies, on the other hand, are systems that allow for secure payments online which are denominated in virtual tokens. These tokens are represented by ledger entries internal to the system.

These crypto assets often serve as the transaction units on the blockchains that are created using the standard templates like that of the Ethereum network, which allows a user to create tokens. Such blockchains work on the concept of smart contracts or decentralized applications, wherein the programmable, self-executing code is used to process and manage the various transactions that occur on the blockchain.

A smart contract is a self-executing contract with the terms of the agreement between buyer and seller directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible.

For example, you can have a crypto token that represents a certain number of customer loyalty points on a blockchain that is used to manage such details for a retail chain. There can be another crypto token that gives entitlement to the token holder to view 10 hours of streaming content on a video-sharing blockchain. Another crypto token may even represent other cryptocurrencies, such as a crypto token being equal to 15 bitcoins on a particular blockchain. Such crypto tokens are tradable and transferrable among the various participants of the blockchain.

Crypto coins are forms of currency that can be used to make purchases, but you can use a crypto token for many other reasons as well, including as investments and to store value.

Special Considerations

Tokens are created through an initial coin offering, which represents the cryptocurrency version of an initial public offering (IPO). Tokens are created by cryptocurrency companies that want to raise money. Investors who are interested in the company can purchase these tokens.

Investors can use crypto tokens for any number of reasons. They can hold onto them to represent a stake in the cryptocurrency company or for an economic reason—to trade or make purchases of goods and services. As a practical example, decentralized storage provider Bluzelle allows investors to stake their native tokens that help secure its network and earn transaction fees and rewards.

Crypto Tokens vs. Cryptocurrencies vs. Altcoins

The term crypto token is often erroneously used interchangeably with the words cryptocurrency and altcoins in the virtual currency world. But these terms are distinct from one another.

A cryptocurrency is a standard currency used for making or receiving payments on a blockchain, with the most popular cryptocurrency being Bitcoin (BTCUSD). The cryptocurrency is the superset, while altcoins (and crypto tokens) are two subset categories.

Altcoins are alternative cryptocurrencies that were launched after the massive success achieved by Bitcoin. The term means alternative coins—that is—other than bitcoins. They were launched as enhanced Bitcoin substitutes that have claimed to overcome some of Bitcoin's pain points. Lite coin (LTCUSD), Bitcoin Cash (BCHUSD), Namecoin, and Dogecoin (DOGEUSD) are common examples of altcoins. Though each has tasted varying levels of success, none have managed to gain popularity akin to Bitcoin's.

Cryptocurrencies and altcoins are essentially specific virtual currencies that have their own dedicated blockchains and are primarily used as a medium for digital payments. On the other hand, crypto tokens operate on top of a blockchain that acts as a medium for the creation and execution of decentralized apps and smart contracts, and the tokens are used to facilitate the transactions.

According to the Financial Industry Regulatory Authority (FINRA), regulators continue to crack down on ICO fraud, so be sure you do your research before investing in any cryptocurrency—the same way you would with any stock.

Crypto Token FAQs

What Is a Crypto Token?

A crypto token is a virtual currency token or a denomination of a cryptocurrency. It represents a tradable asset or utility that resides on its own blockchain and allows the holder to use it for investment or economic purposes.

What Is the Purpose of Tokens?

Crypto tokens can represent an investor's stake in the company or they can serve an economic purpose, just like legal tender. This means token holders can use them to make purchases or they can trade tokens just like other securities to make a profit.

Is Bitcoin a Token or a Coin?

Bitcoin is a cryptocurrency, which has virtual tokens or coins that can be used to trade or make purchases.

What Is the Difference Between a Crypto Coin and a Crypto Token?

Crypto coins allow individuals to make payments using their digital currency. People can use tokens, though, for many more reasons. They can use them for trading, to hold as a store of value, and of course, to use as a form of currency.

A store of value is an asset, commodity, or currency that maintains its value without depreciating. 

What Are Some of the Different Types of Tokens That Reside on Blockchains?

Tokens that reside on blockchains include reward tokens, currency tokens, utility tokens, security tokens, and asset tokens.