Coins Vs. Tokens: What Investors Need to Know Before Buying Crypto
Learning to distinguish between cryptocurrencies and cryptocurrencies can create or break an investment strategy. A few key factors make the difference between a profitable investment and a mistake that results in a loss. Other details do not make an immediate difference, but can be the crucial element in the broader strategy of a trader or investor.
The easiest way to understand the nuance difference between all cryptocurrencies is to think of them in terms of coins and tokens. Coins and tokens are just two types of high-level cryptocurrencies that make categorization easier.
1. Cryptocurrencies
Cryptocurrencies are cryptocurrencies that have their own dedicated network or platform. At a minimum, cryptocurrencies have a use within the network to which they belong. This is because the platform requires the coins for transaction fees.
However, in an ideal situation, cryptocurrencies can also be used in physical stores, or online on e-commerce sites. Bitcoin (BTC 3.93%) is the most popular cryptocurrency that fits this description. Ethereum (ETH 4.63%) is another example, but differs from Bitcoin in a few important ways. Let’s dive into both of these coins in a little more detail. A concrete understanding of both will guide your understanding of all cryptocurrencies.
Cryptocurrencies are usually made gradually by issuing them as block rewards. A block reward is a financial compensation received by the computers that contribute to the network. This reward is usually paid in the relevant cryptocurrency. Both Bitcoin and Ethereum work this way.
Although each cryptocurrency has a different way of issuing coins, it is common to follow the path of Bitcoin and set a static supply. This is a fundamentally different approach than that used by central banks, which are issuers of fiat currency. Central banks reserve the right to dynamically expand or contract the supply of currency as needed 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 to the number of ether coins (ETH) that could exist. As time went on, Ethereum’s monetary policy changed so that the offer is now reduced. There are pros and cons to each approach, and each cryptocurrency aims to implement the scheme that works best for the network and users.
The starting point for investors is to carefully consider the monetary policy of a particular currency. A project like Bitcoin creates a perception of scarcity with its limited offerings and the confidence that the offerings will not change. On the flip side, Ethereum is more flexible and can change monetary policy to respond to changing economic conditions. Although this works in investors’ favor when the currency supply decreases, it is possible for monetary policy to switch to the investor’s interests at a later date.
2. Crypto tokens
The best way to think of cryptocurrencies is as equity in a crypto project or decentralized application. Along this line of thinking, symbols are usually 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 easy on Ethereum. It drastically reduces the entry barrier to start new projects. Since the tokens do not exist on their own custom platform, they inherit all the features and security of the platform on which they exist.
The ability to create a token without simultaneously creating a brand new blockchain or platform is a boon for project administrators. They do not have to worry about the number of nodes, network decentralization or the creation of a dedicated wallet. Instead, all of this is inherited simply by building and launching on an already established token platform such as Ethereum.
In the context of cryptocurrencies, ETH is money for the ecosystem. Ethereum charges a fee in the form of ETH for creating, trading and transferring crypto tokens on Ethereum. This fee structure highlights a key difference between cryptocurrencies and cryptocurrencies. Crypto-tokens are not usually required as fees, but serve other important functions in the application or ecosystem for which they are built.
Cryptocurrencies and tokens for investors
From an investor’s perspective, some of the distinctions covered in this article are crucial to incorporating into the broader investment strategy. Step 1 should be to determine if the coin or token in question is a sub-token belonging to a larger platform or if it is a standalone cryptocurrency such as Bitcoin.
This difference can provide insight into whether the coin or token inherits monetary policy or security from the overall platform. While this may seem trivial, the implication is that a token could get into trouble or termination if the platform to which it belongs crashes.
So while tokens are great for new projects, they are inherently dependent on the parent platform. All of this constitutes risk and trade-offs, which is what investing in cryptocurrency is all about.
