Learning how to distinguish between crypto coins and crypto tokens can make or break an investment strategy. A few key factors make the difference between a profitable investment and a mistake resulting in a loss. Other details don't make an immediate difference, but can be the determining element in the broader strategy of a trader or investor.
The easiest way to understand the nuanced difference between all cryptocurrencies is to think of them in terms of coins and tokens. Coins and tokens are just two high-level types of cryptocurrency that make categorizing easier.
1. Crypto coins
Crypto coins are cryptocurrencies that have their own dedicated network or platform. At a minimum, crypto coins have a use within the network they belong to. This is because the platform requires the coins for transaction fees.
However, in an ideal situation, crypto coins can also be spent in brick-and-mortar stores, or online at e-commerce sites. Bitcoin (BTC 0.53%) is the most popular cryptocurrency that fits this description. Ethereum (ETH -0.12%) is another example but is different from Bitcoin in a couple of key ways. Let's dive into both of these coins in a little more detail. A concrete understanding of both will guide your comprehension of all crypto coins.
Crypto coins are usually created progressively by issuing them as block rewards. A block reward is a monetary compensation received by the computers that contribute to the network. That reward is typically paid in the crypto coin in question. Both Bitcoin and Ethereum work this way.
Although every crypto coin has a different way of issuing coins, it is common to follow Bitcoin's path and set a static supply. This is a fundamentally different approach than the one taken by central banks, which are the issuers of fiat currency. Central banks reserve the right to dynamically expand or contract the supply of currency on an as-needed basis to support the country's economy.
Ethereum mimics fiat currencies and central banks a little more directly by having a dynamic monetary policy. When Ethereum began, there was no upper limit on the number of ether coins (ETH) that could exist. As time progressed, Ethereum's monetary policy changed such that the supply is now being reduced. There are pros and cons to each approach, and every crypto coin aims to implement the scheme that works best for its network and users.
The takeaway for investors is to carefully contemplate the monetary policy of a particular coin. A project like Bitcoin creates the perception of scarcity with its limited supply and the confidence that the supply won't change. On the flip side, Ethereum is more flexible and can change its monetary policy to respond to changing economic circumstances. While this works out in the investors' favor when the coin supply is decreasing, it's possible for the monetary policy to shift against the interests of the investor at a later date.
2. Crypto tokens
The best way to think about crypto tokens is as equity in a crypto project or decentralized application. Along this vein of thinking, tokens are typically created through a process called an initial coin offering (ICO).
Crypto tokens exist as cryptocurrencies that belong to a broader platform, network, or ecosystem. The most common platform for hosting crypto tokens is Ethereum. The creation and distribution of crypto tokens is very simple on Ethereum. It drastically reduces the barrier to entry for new projects to begin. Since the tokens don't exist on their own bespoke platform, they inherit all the features and security of the platform they exist upon.
The ability to create a token without simultaneously creating a whole new blockchain or platform is a boon for project administrators. They don't have to worry about node count, network decentralization, or creating a dedicated wallet. Instead, this is all inherited simply by building and launching on an already established token platform such as Ethereum.
In the context of crypto tokens, ETH is money for the ecosystem. Ethereum requires a fee in the form of ETH for the creation, trading, and transferring of crypto tokens on Ethereum. This fee structure highlights one key difference between crypto tokens and crypto coins. Crypto tokens are not usually required as fees but serve other important functions within the application or ecosystem for which they're built.
Crypto coins and tokens for investors
From an investor's perspective, some of the distinctions covered within this article are essential to incorporate into the broader investment strategy. Step 1 should be to determine whether the coin or token in question is a sub-token belonging to a larger platform or if it is a stand-alone crypto coin like Bitcoin.
This distinction can deliver insights such as whether or not the coin or token inherits its monetary policy or security from its parent platform. Although this might seem trivial, the implication is that a token could face difficulties or termination if the platform it belongs to crashes.
So while tokens are great for new projects, they are inherently dependent on the parent platform. All of this amounts to risks and trade-offs, which are what investing in cryptocurrency is all about.