A token is an object that represents something else. They operate in many different fields including gaming, economics, and computing.
In relation to a board game, they are pieces used by the different players. When it comes to gambling establishments, chips and other objects created by the casinos are called tokens. Video games can also use tokens to represent assets.
These systems are closed. Exiting the ecosystem means the tokens, in most cases, have little value. Some games became so popular that secondary exchanges formed around the in-game assets. This is not commonplace.
It is now a concept that is extending with cryptocurrency.
Token is another word for cryptocurrency or, more specifically, cryptoasset.
With cryptocurrency, there are no physical versions of the tokens. They were created and exist solely as a digital asset. This is likely a part of the growing digital economy that is form as we proceed deeper into a world that is increasingly impacted by the Internet.
Within cryptocurrency, tokens represent an asset that carry certain properties as programmed into them. This is usually done through the use of a smart contract although can apply to base layer code.
There is some debate about what constitutes a token within the cryptocurrency industry. Some claim that anything is a token with the exception of Bitcoin or Ethereum. These are typically called altcoins.
Bitcoin maximalists take exception to this viewpoint. Their view is that only Bitcoin is the legitimate cryptocurrency and everything else is an altcoin. That would dictate that Ethereum is also considered a token by this definition.
We have another school of thought that views a coin as anything that is tied to the base layer of a blockchain. That means anything native to the network and not created through a smart contract or second layer would apply. This would also pertain to sidechains. All those currencies would be considered tokens.
Tokens essentially run on top of blockchains allowing for the creation of many financial services.
Blockchain networks tend to be designed in isolation. This means it uses separate code and node systems. These networks do not interact. Part of the future evolution of the industry is interoperability between the separate chains.
Sidechains are becoming an important component since they can scale much easier than the blockchains themselves. One of the key features is the ability to recreate the value of a token (or coin) on another network. These are called wrapped tokens.
The value is locked on the original chain, is duplicated on the sidechain, transferred there to another destination (wallet), and then can be swapped back to the main chain.
Wrapped tokens maintain a two-way peg. The value of the original and the wrapped version are pegged. This eliminates the arbitrage between on the assets themselves. This can be done within different liquidity pools or exchanges but not among the assets directly.
Unlike gaming tokens, cryptocurrency offers individual ownership outside of a closed system.
Cryptoassets are often held in a digital wallet. This means that assets are still present even after the game is exited (or the casino is left). This extends the ecosystem tied to the token along with creating the potential for an economy to form.
The protocol that the token was created upon is what determines the wallets and exchanges that can be utilized. For example, tokens in smart contracts on Ethereum utilize the ERC-20 protocol. This allows wallets such as Metamask to house the assets that are developed.
This allows for the formation of markets. Centralized exchanges (CEX) were established early on, mirroring what we see in the existing financial systems. These provide the swapping of digital assets similar to how people trade stocks or bonds.
One drawback to these exchanges is the idea of not your keys, not your cryptocurrency. The recent failures of CEX such as FTX awoke people to the fact that tokens or coins on an exchange are not in one's possession. The one who controls the private key is actually in possession of the cryptocurrency.
Decentralized Finance (DeFi)
Tokens are an important part of decentralized finance (DeFi). This is built using smart contracts to create liquidity pools that are accessed by different wallets. There are also decentralized exchanges (DEX) that are built.
Types of Tokens
There are many types of tokens being experimented with.
It is also theorized that most financial assets will end up as tokens. Stocks, bonds, and derivatives all could be designed with an associated token. This would reduce the friction in trading while also expanding the reach of each asset. It also could be used to automate interest rates.