The world of cryptocurrencies and blockchain is full of new terms which can appear familiar but have been adapted to take on a new meaning, such as mining or token. Even if your interest in blockchain is purely academic, it’s still important to understand the distinction between different terminologies. But if you’re interested in investing, then it becomes crucial to get your facts right.
A lot of people use cryptocurrency and token interchangeably, which causes a great deal of confusion. Although it appears they refer to the same thing, the fact is they don’t. Tokens are a subset of cryptocurrencies.
In this guide, we’ll define the terms cryptocurrency and token, and analyse what distinguishes them from one another.
What are cryptocurrencies?
A cryptocurrency is a digital currency that uses cryptography to secure and verify its transactions, recording them in a decentralised and immutable ledger known as blockchain.
There are currently around 2,500 cryptocurrencies, a number which is guaranteed to grow over the coming years. They can be used as a medium of exchange or a store of value, and are traded in many exchanges around the world.
Cryptocurrencies can be divided into two categories: those that are supported by their own blockchains, like Ethereum and Bitcoin (BTC), and those that are built on top of other blockchains, also known as tokens.
A useful way to distinguish between an independent cryptocurrency and a token is to ask the question: Is this crypto independent from other platforms or is it supported by a pre-existing blockchain?
While Ethereum is an independent cryptocurrency with its own native token, Ether (ETH), ERC20 tokens such as 0x, JNT, and OmiseGo (OMG) are tokens that would not exist without Ethereum’s platform.
Within the independent cryptocurrencies, there is a further distinction. They can either be Bitcoin-derived blockchains, like Litecoin, Dogecoin, or Dash, or they can have their own native blockchains, like Ripple or the aforementioned Ethereum.
All cryptos in these two categories can also be called altcoins, as they’re an alternative to the original cryptocurrency: Bitcoin.
What are tokens?
A token is a unit of value issued by an organisation, accepted by a community, and supported by an existing blockchain. Tokens are merely a subset of cryptocurrencies which are built on top of other blockchains.
An organisation creates tokens in the context of a specific business model so that it can encourage user interaction and distribute rewards among its network’s participants. These tokens have several uses, but they can be divided into security tokens and utility tokens.
Security tokens are similar to traditional shares because their value is derived from a tradable external asset.
They are issued in Initial Coin Offerings (ICOs) and, once regulators and governments decide on a regulatory framework, they will most likely be treated as regular securities.
A utility token grants its holders access to a company’s future product or service before it can be delivered, much like when a bookstore accepts pre-orders for a book that’s yet to come out.
Because their value isn’t directly associated with ownership, these tokens could also be exempt from the laws that will probably be applied to their security counterparts. They can be a popular fundraising method where a company bypasses traditional institutional investors and venture capitals by going straight to its customers.
Why does the distinction between the two terms matter?
If you want to understand the world of cryptocurrency and blockchain, you need to be aware of the terminology and definitions. Token and cryptocurrency are very often used interchangeably in the mainstream, which only adds to the confusion, but at least now you’ll be able to discern which is which.
While a cryptocurrency operates independently and uses its own platform, a token is merely a cryptocurrency built on top of another pre-existing blockchain. All tokens are cryptos, but not all cryptos are tokens.
From the investors’ point of view, this is an essential difference, because it provides a key measure to assess the potential of any crypto-asset.
If you’re analysing an independent crypto that has multiple projects, each with their native tokens built on its blockchain, you know it’s a reliable product trusted by many developers, which increases your earning potential. The more applications that are built on that blockchain, the better.
That doesn’t mean it’s the only thing you need to look out for, but it’s usually a good predictor of the medium-term success of that crypto – other projects looked at the market and decided it was their best choice, so in a way, you can co-opt their option.
Conversely, if you’re assessing the potential value of a token-based project, it helps if it’s supported by a highly respected blockchain such as EOS or Ethereum.
Never neglect the value of doing your own research. Now you know the difference between tokens and cryptocurrencies, but there is much more to discover.
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Find out more about cryptocurrencies in the rest of our guides here.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.