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What are Ethereum tokens: beyond the ERC20 standard

May 18, 2022

7 min

What are Ethereum tokens: beyond the ERC20 standard
Intermediate

Ethereum is not just a blockchain, but a “world computer” on which any application or asset, including crypto tokens, can be developed. It is the first ecosystem that has widely popularised smart contracts and, through its development tools, has helped shed light on DeFi. This is why programmers choose to create Ethereum tokens to power blockchain solutions. So let’s find out what these tokens are, how many exist on Ethereum, and what possibilities the corresponding “rules,” called ERC standards, open up to.

What are tokens and coins? The differences

Is there a difference between tokens and cryptocurrencies? Not really, actually a coin based on an existing blockchain is still a crypto token. Rather we should question what the difference is between tokens and coins. When approaching the world of cryptocurrencies, these two terms are often used synonymously but incorrectly. Let’s give a definition to clarify our ideas:

  • Coins are very similar to traditional coins in that they fulfil at least two of the three basic functions of currency: medium of exchange and unit of account. The store-of-value function is not always feasible, given the volatility of cryptocurrencies. The most frequent use case for coins is for payments; in fact, a synonym for coin is “transactional token.” Coins, moreover, are native to the blockchain on which they are based, that is, they do not exploit existing codes.
  • Token – a crypto token is created for a specific product or service based on a third-party blockchain, of which it leverages a smart contract to be distributed and recognized with its specific metadata. Tokens, as a rule, arise in response to specific needs and go beyond the classic definition of money. Just like carousel or festival tokens, crypto tokens also have applications confined to particular blockchain ecosystems, the only difference being that they are exchangeable in the broad crypto market.

The importance of rules

All known forms of society have always needed standards to respond to the chaos of human nature as well as nature itself. Common conventions and reference standards exist, even for small things: think about when you leave your house in the morning and it is still dark, this is due to a standard, namely the UNI 13201-2  standard on public street lighting .

Standards serve to codify actions, set rules of reference to facilitate cooperation .

In fact, we know that composability is  also key for blockchain technology: cryptocurrencies, smart contracts and dapps are like pieces of lego that go to make up all new solutions on blockchain, and they could not build complex solutions without standards to ensure compatibility. These “money legos” are what Ethereum has achieved precisely by setting standards: rules that do not involve waivers or compromises, but open up new possibilities.

Ethereum: the empire of standards

All cryptocurrencies (both coins and tokens) meet standards; however, to date the most popular ones are certainly those proposed by the Ethereum Foundation, from which other projects have since been inspired or adapted. Of course there are many other blockchains with their respective standards for example, Tezos has developed the FA2 standard token.

Smart Contracts are the “books of law” in which these standards have been codified in order to define every aspect of crypto tokens. Focusing on Vitalik Buterin‘s blockchain, there are 5 main types of standards for creating ethereum tokens, let’s analyse them together .

Smart Contract

A software on a blockchain that allows actions to be automatically triggered if certain conditions occur. The most common use case is to mediate a financial transaction between two entities on the blockchain. Ethereum is the first project to have provided a language and platform to allow anyone to develop smart contracts more easily.

Fungible Token ERC-20

The ERC-20 is the standard token par excellence. It’s currently the most widely used, and was the first one proposed by the developer community. The main feature is fungibility: in a nutshell, an ERC-20 token is divisible into equivalent fractions and thus can be easily exchanged and disseminated. This is the most common standard for cryptocurrencies from projects that do not have their own blockchain and particularly for utility tokens.

Non Fungible Token ERC-721

This standard was created for crypto tokens that need not be fungible, that need not be equivalent or perfectly divisible, but rather unique and with richer metadata. Owning a digital asset based on this standard means having ownership of it registered on blockchain. With NFTs, it is indeed possible to exchange digital artistic works or contracts on a dedicated marketplace and record their entire history on blockchain. So while ERC-20s are exchangeable with each other, as well as with goods and services, on the other hand NFTs can only be exchanged with cryptocurrencies, as one NFT is not equivalent to another, except in the case we illustrate immediately below.

Fungible and Non-Fungible Token ERC-1155

This smart contract combines the typical features of ERC-20 and ERC-721 in a token that can be fungible, non-fungible or semi-fungible. Imagine a digital artwork: it can be unique and non-fungible(NFT), or it can be created in a number of copies, which will be equivalent to each other and thus fungible. Both of these options are possible with the ERC-1155 standard.

Security Token ERC-1400 and ERC-3643

Security tokens share some of the characteristics of fungible tokens, but are different from utility tokens. In general, security tokens represent ownership, either total or fractional, over the interest generated by an asset or the entity that issued them (such as organisations or companies) .

The “profit” purpose is what differentiates security from utility tokens, according to the Howey Test, however, the former are also fungible, thus interchangeable. Think of stocks and bonds, two types of security: each share will be equivalent to any other having equal value, even if tokenized.

For security tokens, there are two ethereum standards: the 1400 and the 3643.  Each ERC-1400 token is programmed to represent a “piece” of the company that established it, as well as all the rights and obligations that come with it, such as profit sharing or the right to vote on the board of directors. ERC-1400 contains other standards so as to regulate different aspects of the token (e.g., ERC-1594 for adding real data off-chain, or ERC-1643 for attaching documents)

However, ERC-1400 is not the only “security standard,” in fact there is also ERC-3643, formerly called T-REX protocol. What differentiates them is the way their owners execute transactions: the former requires the use of cryptographic keys generated off-chain, while the latter relies on an automated, blockchain-based system.

So how many types of tokens exist on Ethereum? We have addressed the most important and common ones, but potentially there is one for every application and use case of blockchain. If you wanted to propose a new Ethereum standard, you would have to follow a particular process to get it approved: there is a standard even for proposing ideas, the Ethereum Improvement Proposals (EIPs). In the case of new smart contracts, EIPs are named Ethereum Requests for Comment (ERC), like tokens. To give you an idea of how dynamic the standards are, just consider that the creator of the ERC-20, Fabian Vogelsteller, has already implemented a better version: the ERC-725.

Dive into the world of standards and discover the rule behind every blockchain secret.

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