What is a token? We have heard the term so many times. The truth is that it is not a recent technological innovation, it has been used for several decades, but in recent years the concept has experienced a boom. The reason? Its use within cryptocurrencies and the blockchain.
Within this framework of technological tools and utilities for the world of finance, tokens are used to digitize assets and financial figures and register them within a blockchain scheme. In this sense, three fundamental classes of tokens are used: security token, utility token and equity token.
Each of them has different qualities and uses, are designed for different purposes and are used under different circumstances. However, some aspects are a bit vague from a technical or legal point of view, as is the case of the thin line that separates a security from a utility. We will clarify all these points, and more, within this article.
The token inside the blockchain
The first tokens, used in banking and security systems, were validation codes, fleeting alphanumeric figures used to check the validity and legitimacy of an operation.
The codes that Google or the bank sends to your phone sometimes when you perform some kind of special operation or a transaction, fall into this category. In fact, the code is sometimes called directly “token”.
However, the tokens within the blockchain operate in a different way. Blockchain networks establish their high level of security thanks to the cryptographic algorithms that they use to encrypt their transactions, as well as to encrypt the access and content of the different wallets that make it up. A token would be that code generated during operations and that identifies a unit of currency or asset that we trade in the operation.
Technically speaking, the generated currency is a token, but the prevailing convention does not call it that. In fact, Bitcoin and other currencies based on its scheme (what is called a first generation blockchain) are not usually called Tokens. Actually, the term “cryptocurrency” is given only to those electronic currencies that have their own blockchain network, while the term “token” only applies to tokens generated within existing blockchain networks that have their own crypto.
In general, these networks were of the Ethereum type, but this condition has begun to open up with the appearance of new technologies that have created other paradigms. However, for tokens, Ethereum remains critical.
A token is always developed on the blockchain of a third party. This blockchain can be Bitcoin (although technically it is not used for this purpose), NEM, TRON, BSC, among others. However, the dominant standard is the Ethereum network. Why use this network?
Ethereum bases the architecture of its network on the Ethereum Virtual Machine (EVM), a kind of computer or software distributed within its blockchain. The great advantage of the EVM is that it can execute programs, called Smart Contracts. To do so, it has its own programming language, called Solidity.
The Ethereum community has created a series of standards for programming in the EVM. These standards are codes in solidity that, when deployed on the network (deploy is like the equivalent of installing on Windows or Linux), are executed by all EVMs. Specifically, two of these standards are the most famous: ERC-20 and ERC-721, for the creation of smart contracts for conventional tokens and NFTs (non-fungible tokens), respectively.
Specifically, Ethereum currently has more than 280,000 different tokens of the ERC-20 type. Of those, close to 40 are in the top 100 coins by market cap.
Other networks, such as Binance Smart Chain (BSC) have literally duplicated the Ethereum code and created their own EVM with slight modifications. Currently, BSC competes with Ethereum, offering its own services for token creation and with its own, only slightly different, standards: BEP-20 and BEP-721.
Types of tokens
Tokens have been developed primarily within the field of financial technology, which is why they are often classified with this kind of criteria. There are basically 3 kinds of tokens:
- Security Token
- Utility Token
- Equity Token
In addition, outside the financial field, there is a class of blockchain token that is used with organizational criteria within the DAO (Decentralized Autonomous Organization). These are the governance tokens, which are used for decision-making within the DAO, and which may or may not play a financial role as well.
These are cryptographic tokens similar to any other known token but tied to traditional security (i.e. financial assets) and their characteristics.
Utility tokens are application tokens or user tokens. They allow future access to the products or services offered by a business, like MigraCoin. Therefore, utility tokens are not created to be an investment.
Equity tokens are a very special type of token closely related to security tokens. These work like a traditional stock asset. They represent ownership of some third-party asset or company. In addition, its value is associated with the success or failure of that property.
In general, the difference between a Security Token and an Equity Token is very difficult to define and legal advice is usually required before one or the other is issued, since many times the line between the two categories changes depending on the legislation of the country where it is emitted.