What are tokens and what are the main types

In the world of blockchain and decentralized finance, the concept of a token is widely used. However, it is often unclear what a token is…

In the world of blockchain and decentralized finance, the concept of a token is widely used. However, it is often unclear what a token is and the various functions it can have.

In this article we will explain what a token is and what are the main types of tokens present in decentralized finance.

To begin with, we must be clear that a token is not the same as a cryptocurrency.

A cryptocurrency is the digital asset that is used as a payment method in a blockchain.

A blockchain, as the most basic service, allows two users to send cryptocurrencies to each other from anywhere in the world at any time without the need for an intermediary. The price for carrying out these transactions is paid in the form of the cryptocurrency of the blockchain in question. For example, if you want to use the Ethereum blockchain, you must buy its cryptocurrency to pay the cost of transactions, which is ETH.

In contrast, a token is a digital asset created by a company or platform built on a blockchain. Tokens have their role within those platforms by which they are issued, but they do not serve as a payment method to pay for transactions on a blockchain.

For example, the UNI token of Uniswap (platform created on the Ethereum blockchain) cannot be used as a payment method on this blockchain.

We can classify tokens according to their purpose within their issuing company.

Utility tokens: they allow access to certain products or services offered by the issuing company that are not available to the rest of the users. They can also offer access to certain features or some kind of advantage over the rest of the platform’s clients.

These advantages can be discounts on the commissions they have to pay for a service. For example, on a platform for lending and borrowing tokens, having the platform’s utility token may mean paying lower fees than users who do not have the token. Or on a platform for financial strategies, holders of the utility token may have access to certain strategies on the platform that are not available to other customers.

Governance tokens: These play the same role as a company’s shares. Users with governance tokens can vote on the future of the company and what is done with the company’s profits and capital.

Governance tokens can offer advantages in the same way as utility tokens, however, the difference between these two types of tokens is that a utility token will never give a vote on fundamental decisions that can shape the direction of the company, whereas a governance token does.

Liquidity provider tokens: These are tokens that users receive when they contribute their funds as liquidity in a company, for example, to lend them. Companies use these tokens to reward users who provide them with liquidity. They are also used by companies that offer financial strategies to represent customer participation in these strategies.

Some of these tokens can be bought and sold in the market and some companies offer the option for users to lock their liquidity provider tokens into the company for a certain period of time in exchange for an interest rate, thus obtaining another source of revenue.

WTokens: Wrapped tokens are versions of existing tokens or cryptocurrencies that open the doors to a range of possibilities that the original version does not have.

The most basic and clear example is Bitcoin and its wrapped token wBTC. The Bitcoin cryptocurrency can only be sent and received on the Bitcoin blockchain, while wBTC can be used on the Ethereum blockchain. Moreover, not only can it be sent and received, but it can also be lent and borrowed, used to provide liquidity on any financial strategy platform or whatever type on the Ethereum blockchain and in general you have full compatibility with the ecosystem of decentralized finance.

These tokens are issued by companies and seek to have the value of the wrapped token anchored to the underlying asset. A wBTC is worth the same as a Bitcoin.

With the above mentioned in this article it is very likely that when you invest in decentralized finance you will know at all times what you are buying and what you can do with it.