"Token" is a word often heard in the realm of cryptocurrencies. You might even hear Bitcoin described as a "crypto token" or something similar, as – in principle – all crypto assets can also be described as tokens. However, the word has increasingly taken on two specific meanings that are used frequently enough that you can expect to encounter them.
A "token" often refers to any cryptocurrency aside from Bitcoin and Ethereum (though these are technically tokens as well). Since Bitcoin and Ethereum are by far the two largest cryptocurrencies, it's useful to have a term that describes the realm of other crypto coins. (Another term with almost the same meaning that you might hear is "altcoin.")
The other, increasingly used meaning of "token" has an even more specific connotation. It describes crypto assets that run on the blockchain of another cryptocurrency. You will encounter this meaning when dealing with decentralized finance (DeFi). While a cryptocurrency like Bitcoin has its own dedicated blockchain, DeFi tokens like Chainlink and Aave operate on, or leverage, an existing blockchain. This is most often the Ethereum blockchain.
Thanks to tokens in this second category, decentralized applications can perform everything from automating interest payments to selling virtual real estate. Additionally, these tokens can also be traded or held like any other cryptocurrency.
Why are tokens important?
Since you will undoubtedly come across this word frequently in your research on cryptocurrencies, it's worthwhile to understand some of the most common connotations. Besides the broad definitions in the section above, there are also specific categories of crypto assets that are actually named "tokens." Here are some examples:
DeFi Tokens In recent years, a new world of cryptocurrency-based protocols has emerged, aiming to replicate the functions of traditional financial systems (lending, saving, insurance, trading). These protocols issue tokens that can perform a wide variety of functions but can also be traded or held like any other cryptocurrency.
Governance Tokens These are specialized DeFi tokens that give their holders the ability to influence the future of a protocol or an app, as they lack boards of directors or other centralized oversight bodies (because they are decentralized). For instance, the popular saving protocol Compound issues a token called COMP to all users. This token gives holders a vote in deciding how Compound should be updated or upgraded. The more COMP tokens you own, the more votes you have.
Non-fungible Tokens (NFTs) NFTs represent ownership rights over a unique digital asset or a real-world asset. They can be used to make it more difficult to copy or share digital works (a problem anyone who has ever visited a torrent site with the latest movies and video games will understand). They have also been used to issue a limited number of digital artworks or to sell unique virtual assets, such as rare items in video games.
Security Tokens Security tokens are a new category of assets that aim to be the crypto equivalent of traditional securities like stocks and bonds. They are primarily used for selling shares in a company (similar to the stocks or shares sold in traditional markets) or other enterprises (e.g., real estate), without needing a broker. Reports indicate that large companies and startups are now considering security tokens as a potential alternative for raising capital.
