We previously discussed cryptocurrencies and categorized them as either coins or tokens. Coins are used as money and have their own blockchain network. Tokens, on the other hand, are different. They utilize different networks to execute various tasks. Knowing more about tokens will assist you in assessing their potential and determining the significance of blockchain networks where they operate.
Coins vs Blockchain Network Platforms
A coin has its own blockchain network. A transaction happens where two people send money to each other, and the blockchain records it and stores the event forever. But what if this money transfer is the result of a contract breach, following a lot of back-and-forths arguing? Couldn’t the blockchain concept also be utilized to verify and automate the terms of the agreement? For example, if a good or service isn’t delivered as agreed, the blockchain would immediately verify a contract breach and instantly transfer the money owed. Unfortunately, a coin alone can’t perform this functionality. A platform is still required to execute the terms of this contract, and that platform is a blockchain network platform.
A blockchain platform (also called a “blockchain operating system”) hosts a blockchain network that supports tokens and smart contracts. It can be public and decentralized or private and centrally maintained by an organization. Ethereum and NEO are examples of public blockchain platforms, while Hyperledger Fabric and Ripple are examples of private, centralized blockchain platforms. Public blockchain platforms are open for anyone to join and use. Decentralization is achieved by relying on public miners and validators, who get rewarded with coins that are native to the platform, sometimes called the platform’s “gas” or “fuel.“ Transaction fees on the platform are paid with the platform’s native coin. For Ethereum, the native coin is Ether; for NEO, the native coin is Gas.
We’ve thus far explained the architecture of blockchain network platforms. They exist because platforms perform functionalities that coins cannot. Each public platform has its own distinct coin for rewarding miners and validators; in return, they release coins back into circulation on the platform when paying for transactions.
Now that we’ve covered blockchain platforms, the next question to consider is where tokens fit in a platform’s ecosystem.
Definition and Purpose of Tokens
Tokens are cryptocurrency units that run on a specific blockchain. People can use them for nearly anything. For example, take web hosting. You can purchase the company’s tokens if you join a web host firm that uses tokens as payment. You acquire more tokens if you want additional storage space or bandwidth. Paying in cryptocurrency allows for (possible) anonymity and other advantages from the firm. Applications that use public blockchain networks are called dapps (short for decentralized applications, and sometimes pronounced as “d”-” apps”). Some of them issue proprietary tokens that run on blockchain networks (note: dapps have a further meaning and purpose, but this is the most straightforward definition). Tokens are the currency used within a dapp to enable users to execute an operation. You must pay transaction fees in the platform’s native coin to undertake any action with a token.
What are the common uses of tokens? Let’s find out.
The term “defi” refers to decentralized financial dapps built on the blockchain. Areas of finance include but are not limited to: trading, lending, investment, wealth management, payment, and insurance. Due to smart contracts, defi is the most widely used function of blockchain networks. Since 2019, there’s been a surge of smart contracts and defi DEXs on Ethereum, Tezos, Cosmos, Solana, and most recently Cardano – according to DefiPulse.com.
There are a couple of projects attempting to use a decentralized blockchain to implement storage and file sharing. Filecoin and BitTorrent tokens are attempts to reward nodes (computers) for providing extra storage space.
Advertising and social media
Tokens based on a visitor’s attention? Yup, that’s what BAT (Basic Attention Token) attempts to solve. Through the Brave internet browser, website visitors and publishers earn BAT for viewing or creating content. Another cryptocurrency attempting this effort is STEEM, which is more focused on social media content.
There are attempts to replicate the current DNS system for website IP addresses but replacing it with a decentralized system. Two blockchain attempts are trying to create this system: Namebase and Unstoppable Domains. Namebase has created its own blockchain supported by the Handshake coin, while Unstoppable Domains has its token on the Ethereum network.
A DAO/DRC (decentralized autonomous organization/corporation) entirely runs by smart contracts and tokens to reward activities or decide on organization protocols. Unfortunately, the concept slowed a bit due to an Ethereum hack, but it has been popular lately. ShapeShift, for example, recently closed its corporate HQ and switched the project to a DAO structure to encourage additional decentralization and community control.
Cryptosecurities is a recent concept being solved with cryptocurrency. One such company tackling this solution is Polymath, which plans to issue security tokens for other companies in its dapps and blockchain network.
These are just a few examples showing how tokens may be used and developed on blockchain networks.
The following section explains how a blockchain works and the procedures for validating transactions (ex: proof of work vs. proof of stake), to help you understand the benefits of a blockchain platform.
How Blockchains and Transaction Methods Work
A blockchain is a type of distributed ledger technology. It’s a cluster of individual nodes (computers or servers) networked together. When a network receives a transaction, it broadcasts to all other nodes, collaborating to verify it. When the nodes agree, each node records the transaction. Every blockchain has different technical protocols for network communication, calculating transactions, and storing records. Transactions are written to a block (a group of data that has been confirmed and committed to the blockchain). Miners and validators generate blocks for transaction storage, as well as verifying transaction validity—the blockchain rewards the nodes with cryptocurrency coins. The blockchain network determines the reward amount.
The algorithms used by public blockchain networks are called “proofs.” Five of them are common in the cryptocurrency space: proof of works, proof of stake, proof of burn, proof of importance, and proof of signature.
Proof of Work (PoW)
The general public understands this approach. Miners solve increasingly complex problems to confirm a transaction. The disadvantage of PoW is that transactions take a long time to validate. There’s the possibility of a mining pool obtaining control and altering transactions – known as a 51-percent attack. As the blockchain expands, scalability becomes an issue. Bitcoin is attempting to solve this problem with the lightning network – a way to record transactions between two parties without constantly using the blockchain.
Proof of Stake (PoS)
The proof of stake system rewards validators who stake (“hold”) the blockchain’s native currency. Validator nodes are looking for a specific value to solve an equation and validate a transaction or block. The more cryptocurrency the staker has, the more opportunities they have to find the correct value. Rewards are dispersed according to their percentage of the overall stake. A validator can either purchase more native coins or create a stake pool to gather cryptocurrency from other non-validators to increase their stake size; in return, the stake pool (including the validator) receives the rewards. Currently, two PoS algorithms exist: “delegated proof of stake” and “trustless proof of stake.”
More reading about how Proof of Stake works:
- https://www.investopedia.com/terms/p/proof-stake-pos.asp: Provides a technical overview of the Proof-of-Stake algorithm and how it differs from PoW. Delves into the weaknesses of Proof-of-Work and how PoS is a stronger validation mechanism.
- https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/: This website delves deeper into PoS mechanisms and details the major differences between PoW vs. PoS. Contains visual representations and video embeds to help you quickly understand key concepts.
One popular Proof-of-Staking topic is Ethereum 2.0. It’s a major network upgrade for the decentralized blockchain to switch from PoW to PoS and allow delegated staking alongside the change. Delegated staking is live on the network today as it transitions from Eth 1.0 PoW to Eth 2.0 PoS. Here are additional resources to learn more:
- https://ethereum.org/en/eth2/staking/: This is Ethereum’s friendly introduction to Eth 2.0. The webpage describes the staking mechanism and how to become a validator. If you don’t have 32 ETH and access to server equipment, the page talks about stake delegation (delegating your Ethereum to stake pools to receive validation rewards in return). According to the organization: “Ethereum will have a proof-of-stake Beacon Chain and a proof-of-work Mainnet for the forseeable future…[it] will fully transition to a proof-of-stake system once the Ethereum mainnet merges with the Beacon Chain.”
- https://cointelegraph.com/explained/staking-on-ethereum-20-explained: If Ethereum’s website is too confusing, then this explanation from Cointelegraph provides a summary. Plus, the article explains the necessity for Ethereum 2.0 (high gas fees, slow transaction speeds) and summarizes the benefits for all participants in the ecosystem.
- https://www.ledger.com/academy/what-is-lido: Ledger goes into detail about how you can receive rewards from Ethereum 2.0 if you don’t have 32 ETH coins, by using a platform called Lido and receiving their staking claim token. There are details in this blog post which aren’t present in the aforementioned articles. How does the Ledger Nano allow you to delegate staking for Eth 2.0? How do you get started with a Ledger Nano? Find out by reading the click link!
Proof-of-Stake is an increasing mechanism being used to validate transactions on up-and-coming blockchains such as Solana, Avalance, and Cardano. However, Cardano’s staking mechanism stands out due to one particular feature: you retain your keys. When you delegate your stake, normally the funds leave your wallet (and in Lido’s case, you receive a staking claim token). In Cardano’s ecosystem, the funds don’t leave your wallet and you keep your claim to staking rewards without giving up your key. Here are some articles and blog posts that are easy reads and explains Cardano’s staking mechanism further (and how to get started if you have ADA coins):
- https://money.usnews.com/investing/cryptocurrency/articles/how-to-stake-cardano: An article that introduces the reader to basic features of Cardano staking and why it’s easy to get started. Features quotes from various financial professionals.
- https://staking-cardano.com/staking-guide/: In-depth guide that explains how Cardano staking works and how to research stake pools. Note: this website belongs to a stake pool so keep that in mind when you see call-to-action links.
Proof of Burn (PoB)
The miner sends coins to an empty address in proof of burn blockchains and receives points as a reward. Points are equivalent to the hash rate of mining, which makes the proof useful for validating blocks and transactions.
Proof of Importance (PoI)
The proof of importance algorithm is rarely employed, and it’s all about your importance rating. All miners begin with a zero value and must improve it by validating actual transactions, and false validities lower their score. So far, the only cryptocurrency using PoI is NEM.
Proof of Signature (PoSign)
Actual and virtual network nodes run a blockchain in proof of signature. The transactions are independently verified by the nodes online and offline at the time of transmission.
Proof of Work is the most demanding resource consumption, whereas the other proofs use far less energy. The second most-used algorithm after proof of work is the Proof of Stake (PoS) protocol, which has recently gained popularity and relevance. More obscure or experimental cryptocurrencies employ other proofs, but they might rise in usage as PoW becomes less popular and declines in prominence over time.
Top Centralized Blockchain Platforms
Here’s a table that lists the top five decentralized blockchain networks, along with their native cryptocurrency coins and the type of proof used on their blockchains.
|Crypto Coin (SYMBOL)
|Proof of Work
|Proof of Stake
|Proof of Stake
|Proof of Stake
|Delegated Proof of Stake
|Proof of History
|Proof of Stake
We hope you now understand cryptocurrency tokens and blockchains better. Some of the information in this article can be found in a book called Cryptocurrency: A Trader’s Handbook by Marvin Nevefeind and Marcin Kacperczyk, which explains a lot more concepts in detail.