Cryptocurrency Coins vs Tokens: Key Differences Explained

Many novice users sincerely believe that “coin” and “token” can used interchangeably in crypto. And that is a mistake, as they are not the same. More advanced users often think that coins function as a form of money, while tokens can be used for a variety of purposes. That is correct, but there is more to it.

The gurus will say that a coin is native to its Layer 1 blockchain, whereas tokens are created on top of existing chains.

That is true.

But even these two definitions aren't enough to paint the whole picture.

Understanding the distinction between coins and tokens is crucial for investors, developers, and enthusiasts alike.

These two terms are often used interchangeably, but they represent fundamentally different concepts within the blockchain ecosystem. Let's take a look into the technical and functional differences between cryptocurrency coins and tokens, providing a comprehensive overview of their roles in the digital asset landscape.

Cryptocurrency Coins: Native Assets of Blockchain Networks

Let's start with the basics.

Cryptocurrency coins, often referred to as "native coins" or simply "cryptocurrencies," are the primary assets of their respective blockchain networks.

The easiest way to show how they work is to speak of Bitcoin (BTC). Yes, the first (and still the most influential) cryptocurrency is the most well-known example of a coin.

It operates on its own purpose-built blockchain and serves as the network's native currency. Once again, Bitcoin exists inside the blockchain network that was created solely for the purpose of Bitcoin to function. It's that simple.

Key characteristics of cryptocurrency coins include:

1. Independent Blockchain: Coins have their own dedicated blockchain. Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Cardano (ADA) are other prominent examples of coins with native blockchains.

2. Medium of Exchange: Coins are primarily designed to function as digital money. They can be used to transfer value within their network and, increasingly, in the broader digital economy.

3. Store of Value: Many coins, particularly Bitcoin, are viewed as digital assets that can potentially preserve or increase in value over time.

4. Mining or Staking Rewards: In most cases, new coins are created through mining (in PoW systems) or staking (in PoS systems) as rewards for network participants who help maintain the blockchain's integrity.

5. Governance: Some coin-based systems, like Decred (DCR), incorporate governance mechanisms that allow coin holders to vote on protocol changes and network upgrades.

Now, while coins have similar characteristics and purposes, there are some differences in the way they operate. In other words, the technical implementation of coins varies depending on the blockchain. Bitcoin, for example, uses the Unspent Transaction Output (UTXO) model, where each transaction consumes previous transaction outputs and creates new ones.

Ethereum, on the other hand, uses an account-based model, which tracks the balance of each address directly.

Tokens: Built on Existing Blockchains

Tokens, in contrast to coins, are created and operate on pre-existing blockchain platforms.

Feel the difference? Whole blockchains have been created to allow standalone coins to exist. Meanwhile, there are huge blockchain networks that allow for multiple tokens to co-exist there.

The most common platform for token creation is Ethereum. Think of USDT, the most popular stablecoin now. Or Dogecoin - the most influential meme coin.

Since the introduction of the concept of smart contracts - one of the most revolutionary innovations there ever was - thousands of tokens have been created on the Ethereum blockchain.

Thanks to these self-executing agreements developers can easily create custom tokens with specific functionalities and use cases.

Key characteristics of tokens include:

1. Dependent on Host Blockchain: Tokens rely on another blockchain's infrastructure. For instance, many popular tokens like USDT, LINK, and UNI are built on Ethereum as ERC-20 tokens.

2. Diverse Use Cases: Tokens can represent a wide range of assets or utilities beyond simple value transfer. This includes security tokens, utility tokens, governance tokens, and non-fungible tokens (NFTs).

3. Smart Contract-Based: Most tokens are created and managed through smart contracts, which define their supply, distribution, and functionality.

4. Easier to Create: Launching a token is generally simpler and less resource-intensive than creating a new blockchain for a coin.

5. Interoperability: Tokens built on the same standard (e.g., ERC-20) can easily interact with each other and with decentralized applications (dApps) on their host blockchain.

The technical implementation of tokens varies depending on the standard used.

For instance, on Ethereum, the ERC-20 standard defines a set of functions that allow tokens to be transferred and managed consistently across different applications.

But there are other different token standards, like ERC-721 for NFTs and ERC-1155 for multi-token contracts. And this field is constantly evolving and developing. Thus, new tokens with unique attributes and characteristics.

Technical Deep Dive: Coins vs Tokens

In short, we've figured the main difference between coins and tokens.

Yet, some technical aspects remain to be unveiled.

Consensus Mechanisms

As we mentioned above, coins typically require their own consensus mechanism to validate transactions and maintain network security.

Bitcoin's PoW system, for example, involves miners solving complex mathematical problems to add new blocks to the chain. Ethereum's PoS system requires validators to stake ETH to participate in block creation and validation.

Tokens live in a different realm. They inherit the consensus mechanism of their host blockchain. Simply put, a token, regardless of the kind of blockchain it is based on, doesn't require its own consensus mechanism. It simply uses the one the main blockchain is using.

An ERC-20 token on Ethereum (like, USDT) doesn't need its own consensus protocol; it relies on Ethereum's existing network of validators to process transactions. So when you send or receive USDT from your wallet the transaction is operated by the underlying Ethereum blockchain. And Ethereum consensus mechanism is used.

Transaction Processing

Now, there is another big difference between coins and tokens.

For coins, transaction processing occurs directly on their native blockchain. When you send Bitcoin, the transaction is broadcast to the network, verified by nodes, and then added to a block by miners. Using BTC you never leave the world of Bitcoin.

It might seem to end-user that token transaction work the same way, but that's nothing but illusion.

Token transactions involve an additional layer of complexity.

When you transfer an ERC-20 token (let's keep using USDT as an example), you're actually interacting with the token's smart contract (Tether's, in this case) on the Ethereum blockchain. The contract updates its internal state to reflect the new token balances, and this state change is then recorded on the Ethereum blockchain.

Scalability and Network Congestion

There is an area where tokens can have a clear advantage over coins.

Let's talk about scalability.

Coins face scalability challenges directly, as every transaction must be processed by the entire network.

For instance, Bitcoin's limited block size and 10-minute block time have led to congestion and high fees during peak usage periods.

Tokens - as you remember, they are built upon the existing blockchains - can potentially offer better scalability, as multiple token transactions can be bundled into a single transaction on the host blockchain.

Of course, this is an advantage, but it might have a reverse effect. Ethereum has faced significant congestion issues due to the high volume of token transactions, particularly during the DeFi boom and NFT crazes. Many USDT users are gradually leaning towards TRON blockchain because it has much less congestions than Ethereum.

Smart Contract Functionality

While some coin-based blockchains like Ethereum and Cardano support smart contracts natively, many early cryptocurrencies like Bitcoin have limited programmability.

Bitcoin's Script language, for instance, is intentionally restricted to prevent potential security vulnerabilities.

Tokens, by their nature, are deeply integrated with smart contract functionality. This allows for complex behaviors and interactions, such as automatic distribution of dividends to token holders or conditional transfers based on predefined criteria.

Use Cases: Coins vs Tokens in Action

Now it's time to describe the differences in use cases. The distinct characteristics of coins and tokens lead to different applications in the cryptocurrency ecosystem.

Cryptocurrency Coins

Think of money, but in digital form. That's what coins are typically used for.

1. Digital Gold: Bitcoin, often called "digital gold," is primarily used as a store of value and hedge against inflation. Its fixed supply of 21 million coins and decentralized nature make it attractive as a long-term investment.

2. Global Payments: Litecoin and Bitcoin Cash focus on fast, low-cost transactions, positioning themselves as alternatives to traditional payment systems.

3. Smart Contract Platforms: Ethereum's native coin, Ether, fuels the entire Ethereum ecosystem, paying for computation and storage on the world's largest smart contract platform.

4. Privacy-Focused Transactions: Coins like Monero (XMR) and Zcash (ZEC) use advanced cryptographic techniques to offer enhanced privacy for financial transactions.

Tokens

Here we see a different story. Tokens are not money (though, of course, they can represent digital assets, like stablecoins and meme coins). But they are mostly tools.

1. Decentralized Finance (DeFi): Tokens are the lifeblood of the DeFi ecosystem. Examples include:

   • Dai (DAI): A decentralized stablecoin maintained through smart contracts.
   • Aave (AAVE): Governance token for the Aave lending protocol.
   • Uniswap (UNI): Represents ownership in the Uniswap decentralized exchange.

2. Utility Tokens: These provide access to specific products or services within a blockchain ecosystem. Filecoin (FIL), for instance, is used to pay for decentralized storage services.

3. Security Tokens: Representing ownership in real-world assets, security tokens like tZERO aim to tokenize traditional securities.

4. Non-Fungible Tokens (NFTs): Unique tokens representing ownership of digital or physical assets, popular in art, collectibles, and gaming.

5. Governance Tokens: Allow holders to participate in decentralized decision-making. Compound's COMP token, for example, gives users voting rights on protocol changes.

The Blurring Lines: Coins, Tokens, and Interoperability

Finally, there is one more point to be made. And it can mess up things for you after all you've read everything above. But that's the world of crypto, you know, ever evolving and fickle.

As the cryptocurrency space evolves, the distinction between coins and tokens is becoming less clear-cut.

1. Wrapped Tokens: Bitcoin can be represented on the Ethereum blockchain as Wrapped Bitcoin (WBTC), an ERC-20 token. This allows Bitcoin to interact with Ethereum's DeFi ecosystem. Pretty slick innovation that attracts many users.

2. Cross-Chain Bridges: Projects like Polkadot and Cosmos are creating interoperable networks where assets can move seamlessly between different blockchains. That kind of innovation has a potential to become the true blood of the crypto world, some experts think.

3. Layer 2 Solutions: Scaling solutions like Bitcoin's Lightning Network or Ethereum's Optimistic Rollups create new paradigms for transaction processing that don't neatly fit the traditional coin/token dichotomy. And there is Layer 3 on the horizon already.

4. Tokenization of Protocols: Some projects that started as tokens are launching their own blockchains. Binance Coin (BNB), for example, began as an ERC-20 token but now operates on its own Binance Chain. It's just an example of how tokens can evolve to become coins.