What Are Ethereum Tokens? What Types of Tokens Are There? Guide to Asset Types in DeFi

Ethereum allows any person or organization to create their tokens on its blockchain. Technology is completely open. All you need to do is create a smart contract and upload it to the chain. There are various dApps and web apps that automate this process, and there are plenty of guides online so no special knowledge is required. The main question is how to get the audience you need for your DeFi project to grow.

As a result, several hundred thousand (!) tokens were created on Ethereum, almost all of them different in their purpose and functionality. But basically all of them fall under five main categories. Understanding them is almost mandatory to navigate the world of DeFi. This is the basis from which the immersion into the world of cryptocurrencies starts. Let’s take a closer look at these tokens.

What Are Blockchain Tokens and How Do They Differ From the ETH Token?

Blockchain tokens are digital assets that can be transferred within a blockchain. They are created in order to be able to interact with projects in the ecosystem and to attract the biggest possible audience (since ETH is now the most popular platform, with Tezos, Polkadot and others lagging behind).

The Ethereum blockchain currently contains a very large number of such tokens — the Etherscan.io website finds about 600,000 different smart contracts for token creation only on the ERC20 network. The number is pretty crazy, considering all of these developments are very recent. But of these, only about a thousand can be considered large projects that have a significant user base and play a valuable role in the overall ecosystem.

Importantly, all these 600 thousand tokens were created according to the same principles, on the same technology, so in theory they are very easy to integrate with any other DeFi platforms and dApps built on Ethereum. They are able to interact with each other and many services. Therefore, it is easier for such projects to raise money and find an audience. Everyone benefits from this compatibility.

One token is different from all these 600 thousand, though. And that is an ETH (Ether) token. It is the only one native to the blockchain. With its help, the whole ecosystem can function, and in the end everything is tied to it. ETH is currently generated by the network to reward miners who help verify ongoing transactions. But with the introduction of Ethereum 2.0, this scheme will be changed, and the very fact of owning ETH will become the decisive factor, potentially making the token even more valuable.

But the essence in the end does not change: ETH token ensures the operation of the entire system. At the same time, the creators made sure that the token was not only created, but also removed from the network: it is burned as a fee for “gas”, that is, for each transaction. This ensures that the token never becomes too plentiful and that its price (and hence the value of all other assets in the Ethereum ecosystem that are associated with it) remains high.

What Types of Blockchain Tokens Are There?

Over time, the DeFi sector is becoming larger and more important. The total cost of all projects is already more than $40 billion. And all this value is stored in various tokens. Each of them serves users in its own way and plays its own unique role (except, of course, scam tokens that simply copy other people’s smart contracts and try to force a wave of hype around themselves).

There are more and more tokens, and more and more types of them. For example, it is only relatively recently that liquidity provider tokens have emerged. They quickly filled their important market niche because there was a real need for them. And in response to the growing number of layer 2 protocols, blockchain bridge projects emerged, each eventually creating a “wrapped” version of a regular token. There are now almost a hundred such tokens in existence.

But most often, DeFi users encounter five main types of blockchain tokens. Everyone needs to know about them. They are:

1. Transactional tokens

Transaction tokens are used to conduct money transfers on blockchains. They act as a means of payment or a store of value. These are, for example, stablecoins, including BUSD, USDC and USDT, whose value is always equal to 1 USD, which makes them a convenient payment unit. “Wrapped” assets such as wETH and WBTC, which are needed purely to conduct transactions in another blockchain network, are also transactional tokens. Such tokens have no other use cases, except for making money transfers with them.

2. Utility Tokens

These are tokens that perform some function — for example, they can serve as a form of payment on some platform. ETH is a utility token because it is needed to pay for gas fees and various DeFi services in that ecosystem. BNB is a utility token, because it is needed to have discounted trading fees on Binance and to pay for transaction fees on the Binance Smart Chain, among other things. Siacoin and Filecoin are utility tokens because they are needed to pay for decentralized storage. Bitcoin, however, is not a utility token, since it doesn’t have an inherent use case and is mostly there to store value and conduct operations (making it a classical transaction token).

It should be noted that utility tokens have become less popular in the last two years. They are not developed in such numbers as before. The ecosystem is slowly coming to understand that creating a separate utility token for interacting with a DeFi service is not always necessary, and may alienate new users.

3. Governance tokens

They are needed to provide decision making by a decentralized community. They allow their holders to participate in project management votes or otherwise exercise power. For example, the owners of the Compound protocol token, COMP, can influence its development by jointly making decisions. Their votes are automatically taken into account by the blockchain.

Most often, governance tokens are used by various DAOs (decentralized autonomous organizations). One of the earliest governance tokens was issued by MakerDAO. The holders of this token, MKR, vote on the direction in which the project should go. One token — one vote. The decision with the most votes is accepted.

The distribution of governance tokens is usually carried out by the project itself, including sales, airdrops, liquidity rewards, and so on. Users also often buy them from exchanges and DEXs. Some governance tokens, similarly to stocks, pay dividends to their owners, so they are very profitable. Uniswap, Aave, PancakeSwap and others are a few examples of very successful projects issuing governance tokens on Ethereum chain.

4. Liquidity Provider Tokens (LP tokens)

The ability of a DeFi platform to make a profit often depends on the amount of liquidity it has. Large liquidity pool allows it to more freely conduct operations, and for its audience to switch between the cryptocurrencies they need. Therefore, there are liquidity provider (LP) tokens that can be obtained from this platform by investors who have left part of their tokens in its liquidity pool. These work like IOUs, proving that the platform undertakes to return your tokens to you. And often with a good percentage earned from commissions from its users.

These LP tokens are provided by various DeFi exchanges that offer token swaps such as UniSwap, SushiSwap and PancakeSwap.

In technical terms, these tokens are no different from any other tokens on Ethereum. Like any other ERC20 tokens, they can be sold, bought, transferred and staked. Many of them are accepted by other exchanges and projects.

5. NFTs

The word that was on everyone’s lips in 2021. Non-fungible token (NFT) is a unique, one-of-a-kind token that is essentially a receipt of ownership. It is transmitted over the blockchain, which allows you to guarantee its authenticity, unlike a regular paper or electronic receipt, which can be forged.

NFTs can act as a receipt for both a physical and a digital object. For example, Kevin O’Leary says he now only buys paintings for his home with NFTs attached to them. That turns out to be an easy way to confirm the authenticity of this painting, to find out its characteristics, its author, the date of creation and the history of its transfers from hand to hand. For digital paintings, NFTs work in exactly the same way, and with the same success. They can offer protection for any digital art and make it as unique as physical paintings.

There are already more than 100,000 kinds of NFTs, judging by the amount of smart contracts created. Usually when creating NFTs, the Ethereum ERC721 standard is used, instead of regular ERC20 standard, but these tokens are still operating on the Ethereum network, and therefore can be transferred between wallets and used in various DeFi applications. Some platforms even allow these tokens to be used as collateral by issuing other assets against them.

The Many Types of Ethereum Tokens: Why It Matters

It is certain that, over time, even more types of Ethereum tokens will appear. All of them make the DeFi world brighter and more diverse. Thanks to open standards, they are easy to develop and implement, and various services, protocols, dApps and platforms can instantly use them.

This is one of the advantages of cryptocurrencies, which makes them different from stocks or other kinds of assets, — they can all work together, reinforcing each other and creating even more value. As the DeFi community grows and develops, new types of tokens are sure to emerge that will further improve existing services and projects, enriching the whole ecosystem.

If you want to help this new Web3 world grow, why not try to launch a project? This is not as difficult as it sounds. We here at Polkapad help new projects develop, launch, and find their audience. We can help your product be successful and popular with real users. Read more about us here.