A token is a crypto asset that is issued on top of an existing blockchain, rather than running on a blockchain of its own. Bitcoin and ether are native coins: they are the currency of the networks they belong to. A token is created by a smart contract on another network, and its ownership is recorded by that network. Many thousands of tokens exist, and they serve very different purposes, from representing a share of a fund to paying for access to an app.
The word "token" is used loosely, and people often say "coin" for both. The distinction matters because a token depends on the network it runs on, and that dependency is a risk in its own right. This guide explains the difference, the common token standards, and the questions to ask about a token's supply and purpose.
Coins and tokens
A coin is native to its blockchain. Bitcoin pays the miners of the bitcoin network, and it is the unit in which that network records value. The coin is part of the network's own design and security.
A token is issued by a smart contract on a host blockchain. It can be created by anyone who can deploy a contract, and it is recorded in the host network's ledger. The token does not secure the network it runs on. It depends on the host for security, fees and the reliability of its transactions.
This matters in practice. If the host network suffers an outage or a bug, every token on it is affected. If the host network's fees rise, the cost of moving every token rises too. The token's own team cannot change those facts.
Token standards
A token standard is a shared set of rules that tokens follow, so that wallets, exchanges and applications can handle them in the same way. On Ethereum, the most widely used standard for fungible tokens is ERC-20, which defines how a token records balances and how transfers work. Other standards cover unique items, such as collectables, and tokens with special features.
A standard does not make a token valuable. It makes the token easier to use. Many tokens that follow the same standard have nothing in common in purpose or quality. Check what the token does, not only which standard it uses.
What tokens are for
Tokens are used for many purposes, and the purpose shapes the risk.
Utility tokens give access to a product or service on a network. They are meant to be used, and their value depends on demand for that use.
Governance tokens give holders a vote on decisions about a protocol, such as fee changes or upgrades. Voting power can be concentrated in a few holders, which can weaken the protection the vote is supposed to give.
Asset-backed tokens represent a claim on something else, such as a commodity or a fund. Their value depends on that backing and on the issuer.
Stablecoins aim to hold a steady value, as covered in the guide on stablecoins.
Meme tokens have little purpose beyond trading interest. Their prices are driven by attention, and they are among the most volatile and risky.
Some tokens combine several of these roles, and the marketing may describe a token in more flattering terms than its design supports. Read what the token gives you, and who decides its rules.
Supply: the question most people skip
A token's supply sets how many units can exist and when they enter the market. Check the total supply, the circulating supply and any release schedule. Many tokens are allocated to the team, early investors and advisers, with a vesting period before they can be sold. When those tokens unlock, the supply on the market can rise sharply, and the price can fall as new holders sell.
Look for the vesting schedule and the unlock dates. A token where a large share is held by insiders and unlocks soon carries a different risk from one where most supply is held by the community and locked for longer.
The guide on circulating and total supply explains how to read these figures, and why they can differ between price sites.
Worked example: an unlock
Suppose a token has a total supply of 1 billion. Of that, 100 million is in circulation, and 300 million belongs to the team and investors, unlocking over the next year.
| Measure | Value |
|---|---|
| Total supply | 1,000 million |
| Circulating supply today | 100 million |
| Locked to insiders | 300 million |
| Share of total supply circulating today | 10% |
At a price of 2, the circulating market cap is 200 million. The fully diluted value is 2 billion. If the insiders' 300 million unlock and are sold, the circulating supply quadruples, and the market cap rises with it if the price holds. In practice, the new supply often pushes the price down. The gap between the circulating market cap and the fully diluted value is the warning sign.
Token risks
Dependence on the host. A token is only as secure as the network it runs on.
Smart contract risk. A bug or exploit in the contract can drain the token or freeze transfers. Many tokens have been lost to flaws in their code.
Concentration. A small number of holders can control most of the supply and the votes, which affects both price and governance.
Unlocks. A large release of insider tokens can add supply quickly.
Liquidity. Some tokens trade on a few exchanges with thin volume, so selling a large holding can move the price sharply.
Legal status. The regulatory treatment of tokens differs by country. Some tokens may be treated as securities, and the rules can change.
Tokens and the law
Whether a token is treated as a security, a commodity, a payment instrument or something else depends on the country and on how the token is sold and used. Some regulators have said that tokens sold to raise money from the public can fall under securities rules, and others have set separate regimes for stablecoins and exchanges. The rules are still changing in many places.
A token that is legal to hold in one country may be restricted in another, and the issuer's marketing can change how a regulator sees it. Check the status in your own country before you buy, and be cautious of any token whose sellers avoid questions about its legal status.
What to check before you buy a token
- The host blockchain, and its record of reliability and fees.
- What the token does, and whether that use exists today.
- Who controls the contract and its upgrades, and whether the code has been audited.
- The supply: total, circulating, and the vesting and unlock schedule.
- Who holds the largest share of the supply.
- The liquidity on the exchanges you would use.
- The legal status where you live.
Key takeaways
A token is a crypto asset issued on top of another blockchain, rather than a coin native to its own network. It depends on the host network for security and fees, and on its own smart contract for its rules. Token standards make tokens easy to use, but they do not make them valuable. Check the token's purpose, its supply and unlock schedule, its concentration of holders, its contract and its liquidity before you buy, and remember that many tokens have failed.
This guide is for general information, not financial advice. See the disclaimer.