This post is part of a series on how everyday investors can understand the word token in the context of blockchain networks.
Blockchains are ledgers. Ledgers record the transfer of assets between two parties. In the case of blockchains, these assets are generally cryptocurrencies or tokens. This is, in part, why people often think cryptocurrencies and tokens are the same thing. They both trade on blockchains. They are both, generally, assets on blockchains. They can both be held in blockchain wallets.
But token and cryptocurrency are not interchangeable terms. The distinction is subtle. It is important, however, for understanding tokens and how blockchains actually work. Two birds, one stone.
In short, the primary distinction is that cryptocurrencies have a native blockchain, while tokens are built on existing blockchains. Ether is a cryptocurrency on the Ethereum network. The stablecoin USDC is a token on the Ethereum network. Continue reading for the full breakdown.
What is a cryptocurrency?
At a high level, blockchains are cryptography-based ledgers replicated across many computers. This replication and cryptography allow for nice qualities like immutability and verifiability. However, what incentivizes all those computers to keep a record of the ledger?
A cryptocurrency is used to incentivize people to maintain the network. Compute is required for the network to keep creating new blocks. Computers are required to store past information and perform calculations to propose or mine new blocks. They are rewarded for this work through the cryptocurrency, giving them an economic incentive to keep maintaining the network. On the other side, users of the network pay fees in the base cryptocurrency for access to this compute. Each blockchain has a different economic model for how the nodes (computers maintaining the network) are compensated and how much users are charged.
What is true across all cryptocurrencies is that they exist to maintain the functioning of the associated blockchain network. Without a cryptocurrency, the underlying blockchain doesn't work. The two are interdependent.
Tokens use blockchain networks
A token is an asset that lives on top of an existing blockchain. Instead of playing a central role in the function of a blockchain network, it uses the blockchain network. Blockchain networks have built-in security, consensus, compute, and access methods. Tokens use all of this to maintain a record of ownership.
Cryptocurrencies and their associated blockchain networks are interdependent. For tokens, the dependency goes in one direction. Tokens depend on the underlying blockchain. Blockchains can exist without any tokens.
Tokens are flexible technical primitives
Importantly, the rules of a token are defined in code, usually through smart contracts. These rules specify how tokens are created, transferred, destroyed, or used. This allows tokens to have very different behaviors from one another, even though they all rely on the same underlying blockchain for security and settlement. Tokens are just code deployed on a blockchain that anyone can use.
A cryptocurrency, on the other hand, is associated with a given blockchain. Blockchains and cryptocurrencies, like tokens, are also code. However, blockchains and cryptocurrencies are much more complex to implement and are more than just ledgers. They are distributed computers.
Tokens are a simple ledger primitive, while cryptocurrencies are a necessary part of a distributed computer system with ledger functionality.
Tokens represent many things
Tokens can represent many different things. Some represent claims on a product or service, such as governance rights in a protocol or access to a platform. Others are designed to track value, like stablecoins that aim to stay pegged to a currency such as the US dollar. Still others represent ownership, such as NFTs, which can correspond to digital art.
Cryptocurrencies are part of the functioning of a blockchain. Their purpose is to allow a network of independent computers to coordinate and operate as a single, reliable system. Where tokens are defined by their flexibility and the wide range of things they can represent, cryptocurrencies are defined by their role in keeping a specific blockchain secure and operational.
Conclusion
In short, a token is an asset issued and managed using an existing blockchain, while a cryptocurrency is the native asset that keeps that blockchain running. Understanding this difference helps clarify why some assets exist to secure networks, while others exist to enable applications, communities, and financial products built on top of those networks.