What is a crypto token?

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The world of crypto uses a whole lot of jargon, from cryptocurrencies to crypto coins—not to mention crypto tokens. But what does “token” mean, exactly? And what is a crypto token specifically? 

In the simplest of terms, tokens are digital assets. They operate off the back of a pre-existing blockchain, rather than being an innate, integral part of one, as most cryptocurrencies currently are. They can be used in many ways—like if you want access to a product or service (via utility tokens), if you want to buy and sell digital artworks (via non-fungible tokens), or even if you want to speculate on the price of coffee (via commodity tokens).

So, what is a token? Technically, you can call any cryptocurrency a token. But in practice, this isn't how people usually use the word nowadays. Instead, it’s used to describe any currency except Bitcoin or Ethereum. Or, it’s used to describe digital assets that run on the basis of pre-existing blockchain infrastructure. This last definition is the one we'll explore more in this article. 

Let’s take a closer look at what tokens are and how they work. Speaking in very general terms, crypto tokens are created to fulfill a particular purpose. This purpose is up to the organization or individual who brought the token into being, and can be anything from raising money to enabling access to services. These tokens are decentralized, act as a medium of exchange, and use cryptographic signatures for the purposes of security and record-keeping, much like other crypto assets. But, there are some key differences. 

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Tokens and currencies are very similar (both function decentrally, for example), but they differ significantly when it comes to their structure. Cryptocurrencies are an in-built part of the blockchain itself (the cryptocurrency Ethereum, for example, is an inextricable part of the Ethereum blockchain). Whereas tokens are not an in-built part of a particular blockchain, and their behavior is instead regulated by smart contracts, which are software protocols that determine how transactions take place. 

Coins, like Bitcoin or Litecoin, share certain similarities with tokens—they both represent value and can be used in transactions. But what are the differences between crypto tokens and coins? As subdivisions of cryptocurrencies, coins are native to the blockchain in question, whereas tokens function off the back of a blockchain. Coins are essentially a digital representation of the currency in question, but tokens have a much wider definition, since they can represent any asset of value.

f we want to explore the difference between crypto tokens and altcoins, we first need to understand what an altcoin is. Altcoins, which stand for “alternative coins”, are any cryptocurrencies other than Bitcoin—and there are almost 14,000 altcoins, as of November 2021. The difference between crypto tokens and altcoins, then, is the same as the difference between tokens and coins generally. Namely, that coins and altcoins have their own blockchain, but tokens run on a coin's blockchain instead of their own.

So, we’ve got a sense of what a token is. But how do crypto tokens work? To understand tokens, you need to first understand the blockchain. This blockchain links (or “chains”) together “blocks” of transactions, recording information. The rules that govern each token are set out in a smart contract, essentially a program which is stored on the blockchain in question. This blockchain also logs the transactions undertaken with this token.

Let’s illustrate this with an example. Say you’re an organization looking to raise capital by means of an initial coin offering (ICO). Every investor who puts money into your enterprise receives tokens, specifically utility tokens, in exchange for their investment, which are stored in their crypto wallet and regulated via a smart contract. Down the line, investors can exchange these tokens for services or products offered by the company in question—which, in this example, might even include the opportunity to swap them for fractions of the cryptocurrency in question.

Utility tokens are the most common form of crypto token. Their primary function is granting holders access to a product or service. This is why utility tokens are often used during an initial coin offering—new enterprises looking to raise money can offer investors utility tokens. These utility tokens can be used however the company in question determines, such as to purchase goods or services it provides.

Unlike utility tokens, which are usually used like a gift card to purchase a product or service, security tokens are linked to ownership of assets that already exist. Each security token represents a fraction of a tradable asset, such as a car, a painting, a share or real estate. Security tokens enable transactions involving these assets to be recorded on the blockchain, so holders can trace them.

Commodity tokens, like security tokens, are a kind of crypto token that’s backed by specific, pre-existing assets. While security tokens can theoretically be linked to almost anything that has value, commodity tokens can only be based on the type of assets known as “commodities” – think things like coffee, oil, or gold. This enables commodities transactions to be processed and stored on the blockchain.

Non-fungible tokens represent digital assets. They’re a way for people to own, and record their ownership of, assets via the blockchain. The “non-fungible” part of their name means that the tokens aren’t mutually interchangeable—if you own one, that token represents ownership of one specific, unique non-interchangeable asset, such as a specific piece of art. NFTs have hit the headlines with some jaw-dropping sales, so it’s worth finding out more about what an NFT is.

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We’ve answered the question “what is a token?”, and looked at how crypto tokens work, but why are they so important? Crypto tokens can be used to represent almost any asset in the world in digitized form, logging all the transactions involving that asset on the blockchain. This is a new and important way of recording ownership and creating transparency, which is only just beginning to be explored.