Looking from outside the crypto world today, blockchains and their tokens seem to be interchangeable. But reports suggest blockchains existed decades before tokens/coins, so why don’t they commonly exist by themselves nowadays? Does the blockchain need tokens or coins?
A public blockchain needs tokens or coins to reward miners. These node operators are the backbone of the blockchain and ensure its security through their proof of work. Without this incentive, there would be little interest in partaking in this proof of work, leaving the blockchain prone to hacking.
Read on to learn more about blockchain tokens and the two essential meanings they’ve adopted over the years. I will also discuss their classifications and uses, as well as the reasons blockchains need them.
Why The Blockchain Needs Tokens or Coins
Technically, the blockchain doesn’t depend on its tokens or coins for existence. Cryptographers already conceived and established blockchain technology before cryptocurrency even became a thing.
Then, the blockchain was just a data structure in sequence “blocks” for storage. Every block contained a cryptographic hash and timestamps of the previous block.
But in 2012, Satoshi Nakamoto improved the blockchain model in a way that allowed for decentralization. This ground-breaking model was necessary for ensuring its practicality as a public ledger for online transactions, which was Satoshi’s overarching goal.
But there’s a caveat.
Various computers run by anonymous people need to verify the transactions of a decentralized blockchain to make it secure. These participants also need to get paid for their work, which eventually gave rise to tokens or coins—their incentive.
If there were no methods to reward these anonymous ‘workers,’ there won’t be much interest in participating. Fewer participants would mean an increased possibility of hacking, which contradicts the goal of achieving a secure mode of transaction.
How Node Operators Secure the Blockchain
The blockchain has vastly evolved from its infancy of storing regular data to storing and hence facilitating online transactions. The blockchain needs security, which is ensured by anonymous people running “node operators”.
Unlike physical cash, people can falsify digital transactions by duplication. The job of the node operators is to avert this flaw. They do this by verifying transactions. It’s also what avoids problems such as double-spending.
A new transaction creates a block in the blockchain, identifiable by its unique ‘hash.’ The operators compete to find the hash less than or equal to the target one using specialized computer setups.
The first operator to get the hash earns the new tokens or coins, and this whole activity is generalized as proof of work.
‘Miners’ are another popular name for node operators because they bring more tokens or coins into the ecosystem.
How Tokens or Coins Work
Tokens have become so popular today that most holders aren’t even interested in the underlying technology behind them. And although you may also be more concerned about their practical applications, understanding their basics is still vital.
What Are Blockchain Tokens or Coins?
Depending on the context, blockchain coins can connote two different concepts.
Tokens or coins are denominations of cryptocurrency that run on their blockchain. They represent a particular unit of value in order to quantify them easily. More recently, people have also used the phrase “tokens” to refer to crypto-assets that reside on a third-party blockchain, such as Ethereum.
The tokens or coins discussed earlier as miners’ rewards connote the first concept, which was the initial meaning of the word. Examples include altcoins like Ethereum, Bitcoin Cash, Dogecoin, Litecoin, Polkadot, USD Coin, and XRP.
On the other hand, CryptoKitties, CryptoPunks, and Aave are examples of the second and more-recent meaning. You cannot mine this kind of token as specific companies create and control their availability.
What Is Initial Coin Offering?
Aside from the automatic creation use for paying node operators, companies create blockchain tokens or coins by other means.
The Initial Coin Offering (ICO) is a process that creates tokens or coins. Startup companies employ this method to significantly crowdfund their project, making it an excellent source of capital. During this stage, tokens are valueless but hopefully valuable in the future.
As of March 2020, various companies have run roughly 2300 ICOs. The first one, held by Mastercoin for Ethereum in July 2013, raised $18.3 million.
Classification of Tokens or Coins
Blockchain initiates classify tokens of the second kind by functionality and fungibility. The categories are generally subjective, but you just need to understand their meanings to know why they are useful.
Here’s how tokes are classified by functionality:
- Utility tokens. These represent a function specific to an ecosystem where it predominantly exists. An example is the BNB token used as a discount only within the Binance Exchange.
- Security tokens. These epresent a financial asset, especially shares during an ICO. The holder would receive it as some privilege, ownership rights, or dividends.
Here’s how they’re classified by fungibility:
- Fungible tokens. Just as you can swap a ten-dollar bill for another and still retain the same value, all fungible tokens in this category are interchangeable.
- Non-fungible tokens. Also known as NFTs. Each non-fungible token has unique properties, which means they aren’t interchangeable. CryptoKitties are one example.
Uses of Tokens or Coins
The first use of tokens was to reward node operators who kept the blockchain secure. However, many enthusiasts from all walks of life have employed tokens or coins in various inventive ways—today, it’s almost impossible to keep track of them all.
Here are a few significant benefits blockchain tokens provide:
- Tokens or coins provide some unit of measure/denomination of digital currency.
- You can trade and exchange them. This is how they become currencies.
- You can hold them as a store of value.
- They help to prove the ownership of a digital asset.
- They can represent a stake or equity in a company, especially if it’s blockchain-based.
The blockchain needs tokens or coins to reward node operators for keeping them secure. They can also act as digital currencies, store value, and represent a blockchain-based company stake.
An Initial Coin Offering (ICO) is a process that begins a token’s circulation, hoping it becomes more valuable over time. Startup companies use this medium to secure funds.
- Harvard Business Review: The Truth About Blockchain
- Coursera: What Is a Cryptographer? 2022 Career Guide
- Cryptology ePrint Archive: Cryptographic Hash Functions: Recent Design Trends and Security Notions
- Wikipedia: Satoshi Nakamoto
- Wikipedia: Double-spending
- Wikipedia:Cryptographic hash function
- U.S. Securities and Exchange Commission: Spotlight on Initial Coin Offerings (ICOs)
- Statista: Number of cryptocurrency initial coin offering (ICO) projects worldwide as of March 2020, by industry
- Binance Academy: BNB