Why Do Blockchains Need Coins?
by Katherine Webb
What Does A Digital Asset Represent?
The internet and Web 2.0 revolution was all about the transfer of data, where the unit byte was used to represent the amount of data being transferred between two points. For digital assets and Web 3.0 we are now transferring value using blockchain technology. In the same way that data needed a unit of measure to represent how much data was being transferred, we use a digital asset as a unit of measure for the amount of value being transferred between two entities. Data is still being transferred but the real innovation of this technology is the underlying principle that the person sharing the data can monetize it. This breaks from the current model where “Big Tech” companies such as Google, Meta (formally Facebook) and Twitter collect data from their users with the company then monetizing the collected data which is then sold to 3rd parties as part of their business model.
What Is The Difference Between A Token And Coin?
Coins operate on their own blockchain. For example Bitcoin and Ethereum, with their functions defined by the network protocol. Coins can be used to represent “money” with the ability to be sent and received, used as a store of value or as a unit of account. Coins can be mined, how they are mined depends on their consensus mechanism – with the most common being proof-of-work (PoW) and proof-of-stake (PoS). It is also possible to add additional functionality on top of coins. For example, Ethereum is used to power the ethereum virtual machine and used to pay for transaction “gas” fees. Coins such as Cardano, Polkadot and Solana can be staked on their blockchain to earn additional coins as rewards for helping to secure the blockchain. This will also be true for Ethereum, when the blockchain migrates to proof of stake, which will allow Ethereum 2.0 staking.
Tokens represent digital assets and their functionally depends on the protocol or a smart contract, which governs the token. Tokens are built on top of an existing blockchain. The most popular platform for creating tokens on top of is the Ethereum network. There are currently 478,889 tokens with contracts live on the Ethereum network. Tokens created on the Ethereum blockchain must comply with the ERC-20 standards initially proposed by Fabian Vogelsteller in November 2015. Tokens are used on top of existing blockchains and interact with decentralized applications and smart contracts or operate on their own side chains offering scaling solutions for the blockchain. Fees for transferring tokens are paid in the native token of the blockchain they are built on top of. For example transferring an ERC-20 token on the Ethereum network requires transaction fees to be paid using Ethereum. For scaling solutions such as MATIC, users will still need to pay Ethereum gas fees when bridging from Ethereum onto the MATIC network. Once tokens are on the MATIC network any future transaction fees are paid using the MATIC token. Tokens, unlike coins don’t need to represent money, they can be used to represent an asset or an NFT which can represent an image, song, ownership deeds for properties, certificates as well as many additional use cases. A token can be thought of as a digital unit used to represent an asset or a specific use case on a blockchain. Tokens can also become coins, this happens when a token is migrated to their own blockchain, examples of such tokens which have become coins are Binance coin, Tron and Zilliqa which were all previously ERC-20 tokens on the Ethereum blockchain.
Key Differences Between Coins And Tokens:
Why Does A Blockchain Require A Coin?
A token or coin is simply a digital unit of a cryptocurrency, which is used to represent a digital asset or a specific use case on a blockchain, and can be used to power the blockchain. At the core, a cryptocurrency is simply a unit of measurement for the ledger used in distributed ledger technology (DLT). In order to calculate the value of a blockchain there needs to be some underlying unit of measurement. A token can have an added element within it. For example, it can contain some digital identity information for a person on a blockchain that can be used to implement Know-Your-Customer (KYC), Anti-Money-Laundering (AML) and counter terrorist laws within the tokens. Using this digital identity method a person can be whitelisted or blacklisted from owning a token, however the blockchain itself would need to allow this functionality.
When discussing public blockchains, the need for tokens becomes clear to prevent spamming and malicious attacks on the network, via the introduction of gas fees for transactions. This added expense provides the blockchain with an increased level of security, as it is costly to spam the network, and ensures that only transactions that the users are willing to pay for get processed. Tokens also provide users with incentives to join the network, which is needed for a decentralized model, to help prevent 51% attacks on the network and to solve the double spend problem. Projects can raise capital for future development by issuing tokens and they allow token holders to claim their stake in the blockchain and any other projects that will be built on top of that blockchain.
Are There Blockchains Without Their Own Native Coin?
There are blockchains which function without their own native coin, these are private blockchains. The two main examples of these are IBM’s Hyperledger Fabric and R3’s Corda.
IBM Hyperledger Fabric which is a permissioned (all network participants must have known identities), enterprise grade DLT platform, which acts as a framework for developing blockchain applications using plug and play components which can be customized to specific use cases. There is no need for a coin on this blockchain as each project hosts its own private nodes to store their data and process transactions.
Corda is a distributed system which combines some blockchain features including privacy, identity, business models and the consensus of a distributed network. Transaction consensus is reached on Corda at the transaction level and only involves parties privy to a transaction. There is no “proof of work” or “miners” in order to verify transactions, this is done based on transactions being both valid and unique. Where the transaction is verified via a smart contract, which checks for the required signatures and verifies that any previous dependent transactions are valid. No other transaction can exist with the same initial input states to avoid the double spend problem. Therefore there is no requirement for this blockchain to have its own network coin.
For public blockchain to operate in an open, permission-less manner tokens are fundamentally required. A native coin or token is simply a unit of measure for that blockchain, and a way to define the value being transferred during a transaction. For a blockchain to function without a token, a private blockchain is needed, where the user pays for the service via a subscription to access the functionality of the blockchain. Service or use charges can also include hosting your own private nodes in order to validate transactions. One could consider these costs as some representation of the value of the network, which is what a coin represents for public blockchains. In a world where transparency is key, the benefits of public blockchains which allow anyone to see all the network transactions and token balances is fundamental for openness and something that regulatory bodies should embrace.
The opinions expressed in the CrossTower Classroom are those of the author(s) and not necessarily that of CrossTower. We appreciate diverse perspectives of our employees and we thank them for having a voice.
CrossTower Inc. provides this content for general information purposes, to better inform you on your digital asset investment journey. We do not provide investment recommendations or provide tax advice. Please consult your investment professional or tax advisor if you require assistance in these areas.
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