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What are actually ... coins, tokens and NFTs?

17 April 2024

In this series "What is actually ...?", Oliver Völkel explains various terms and concepts relating to blockchain and distributed ledger technology (DLT). This article is dedicated to another fundamental concept, namely the concept of coins, tokens and NFTs.

1. Coins

Coins are units of value that are provided for in the respective blockchain from the outset. The term coin is therefore used for crypto assets such as Bitcoin or Ether. No additional design or programming of the blockchain is required to use coins. You could also say that coins are inherent to the respective blockchain.

In public blockchains such as Bitcoin or Ethereum, coins are not created by a central body (such as a central bank), but are distributed by those people who participate in the network of the respective blockchain. New coins are not created at will. Instead, the protocol of a blockchain stipulates that new units can only be created by those who fulfill a specific task that is important for the network. In the thought experiment discussed in this series' article What is actually ... a public blockchain?, for example, new points or coins could only be created by a ‘recorder’ for him- or herself if they had correctly recorded all transfers. In the digital implementations of the blockchain, the situation is very similar. Only those who generate a valid block of transaction data and thus contribute to the functioning of the blockchain are allowed to generate new coins for themselves.

In summary, coins can therefore be described as units of value that are intrinsic to a particular blockchain and that are not issued by a central authority, but are generated by the people participating in the network themselves. They can then be transferred between users, which is why they are used as a means of exchange, for example.

2. Tokens

In contrast, the term token is used for units of value that are not intrinsic to the respective blockchain. This means that tokens are not provided for in the protocol of the respective blockchain from the outset, but are only added later by the users. Tokens are therefore added units of value based on an existing blockchain.

Not every blockchain supports tokens. One example of a blockchain that supports tokens is Ethereum. On the basis of the Ethereum blockchain, users can, among other things, subsequently create new tokens and transfer them from one person to another. At the same time, Ethereum also has a unit of value inherent to this blockchain in the form of the Ether coin. For the use of the Ethereum blockchain and the associated load on the network, participants pay a certain fee in the form of Ether, for example for recording the transactions of tokens.

A key difference to coins is that tokens are created with a freely definable quantity. Technically, this merely involves setting a variable value. The technical effort involved in creating 50 tokens is therefore the same as creating 50,000 tokens.

Also, in contrast to coins, the creation of further tokens by other users is often not intended. They can therefore not be created by mining. If the creation of new tokens is possible, this is generally not an incentive system intended to encourage users to provide a specific useful service for the blockchain, unlike the creation of new coins.

Overall, it can be stated that tokens can be designed in very different ways. The reason for this is that their creators can set very detailed specifications for the management of the tokens. These specifications are defined in a computer program, the smart contract, which is responsible for issuing and managing the tokens. For example, the smart contract can contain rules on when a transfer may be made, by whom and to whom, or whether a token should remain valid. A function that allows tokens to be transferred to other people against the will of their holders would also be conceivable.

As tokens can be designed in very different ways, it seems sensible to start from the lowest common denominator when defining them. Tokens are units of value that use an existing blockchain as a carrier medium, are not intrinsic to this blockchain, but have been added subsequently. What tokens and coins have in common is that they are both digital units of value that can be transferred between their respective users.

3. NFTs

The distinction between non-fungible tokens (NFTs) and fungible tokens is based on their interchangeability (fungibility). A distinction must be made between the technical design on the one hand and the respective function of the NFT on the other. An example from the real world can be used to illustrate the difference: Imagine a 10-euro bill that you lay out for someone else. The 10-euro bill has a serial number, so it is unique and differs in its technical design from all other 10-euro bills. NFTs can also be designed uniquely in a similar way. Of course, you don't expect to get back exactly the same 10-euro bill, but just any one (or even two 5-euro bills). So, while the banknote is technically non-fungible, its function—namely to represent a euro value of 10 euros—is very much fungible. The same applies to fungible tokens and NFTs.

Oliver Völkel

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