Often, I notice inconsistencies in the way people perceive the capability and value of cryptocurrencies (examples: Bitcoin, Ether, Monero) and tokens (examples: Maker, Basic Attention Token, Augur). These two concepts are as different in implementation as they are in philosophy, and shouldn’t be considered interchangeable. I’ve even heard would-be blockchain experts call Ethereum a non-decentralized system due to the non-decentralized nature of some tokens. Ether is the cryptocurrency that powers the Ethereum blockchain, and smart contracts are the software that power decentralized applications running on that blockchain, including all Ethereum tokens.
First, to cover what a cryptocurrency really is. Cryptocurrencies have only one characteristic: they exist as the economic incentive mechanism for a blockchain. These incentive structures vary, but in general follow a template of rewarding those supporting the network (miners) with a cryptocurrency of a finite supply, or otherwise made to be scarce. I am not an economist, so my method of “evaluating” a cryptocurrency is pragmatic and rooted in technology.
A cryptocurrency is a vital necessity to a blockchain, and represents the value of the combined efforts of all of a blockchain’s stakeholders. This includes hardware dedicated to the network, companies such as my own that work to accelerate the adoption cycle of blockchain technology, and all kinds of entities seeking to increase adoption of a cryptocurrency. The functional aspects of a cryptocurrency are authorized by the blockchain itself, which is a required concept in a decentralized financial system. I often hear newcomers to our industry appalled to discover there is no concept of “undo” in cryptocurrency, but unfortunately, removing a central authority has its drawbacks - there is no fraud department to call about your incident. Imagine if one could “undo” the loss, spending, or theft of paper cash - if this was possible, cash would hold no value. No worries, though: it is far easier to secure cryptocurrency than paper currency.
So, what’s a token? A token is a type of smart contract, or application running on a blockchain. For the purposes of this article, we’ll focus on Ethereum, the blockchain and leading smart contract development platform. A smart contract is to Ethereum what an app is to an iPhone. The Ethereum blockchain is both the operating system and physical device that houses a smart contract.
The core principle that differentiates a token from a cryptocurrency is that a token is not directly tied to the value of a blockchain. Thus, the value of a token comes from the economic systems built for them, which vary and are defined by the creator of a token. Most are bad, even more don’t make sense, and the vast majority of tokens hold no potential value whatsoever, damaging the reputations of valuable tokens and the Ethereum blockchain itself. However, there are some great uses for tokens! Because tokens are built on top of a blockchain, they can inherit many characteristics of it. A token can be built with the same security measures and decentralized access that the Ethereum blockchain offers.
This isn’t always the case, and many tokens are built in a way that introduce centralized concepts such as administrative access and permissions. This isn’t necessarily a bad thing. Tokens offer a straightforward means to reproduce many financial systems in a far more efficient manner. For example, take security tokens. Using a token, it is possible to reproduce the complex, cumbersome, process of managing shared ownership in an automated fashion. This saves large amounts of money and time. There are many other applications for tokens such as in-game currency and loyalty points. As any developer familiar with smart contracts will tell you, it is much easier to build these applications using the Ethereum blockchain as a framework, than to build the software that deals with concepts such as ownership, transfer, and secure access yourself. I find tokens to be most useful to businesses when used to rebuild existing systems in a more efficient manner, and most useful to individuals when used to build cooperative, decentralized versions of flawed systems.
To give clarity: a token is an application that lives on your iPhone. A cryptocurrency is the electricity that powers it, and a blockchain encompasses the entire iPhone, from the silicon processor inside to the designers that gave it beauty.
So, cryptocurrencies and tokens are different, interesting, and valuable. Both are revolutionary technologies that, when applied different ways, have a profound impact on the world around us. It will be exciting to see where this road leads, and the tokens created in the future.