# Understanding Crypto Tokens: How They Function and Their Impact

![Crypto Token](https://www.investopedia.com/thmb/l2j8YJCSMMDYfs7KTjUUvRx9Lf4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/crypto-token.asp-v5-6774f213bd3b4deaac537f196990edff.png)

*Investopedia / Zoe Hansen.*

## What Are Crypto Tokens?

A crypto token represents an asset or stake and is built on an existing blockchain. While similar to cryptocurrencies, tokens are not the native assets of blockchains. They are pivotal in fundraising for projects through initial coin offerings (ICOs). However, the ICO landscape has seen both legitimate endeavors and scams, necessitating careful consideration by potential investors.

### Key Takeaways

*   Crypto tokens are digital representations of assets built on existing blockchains, distinct from cryptocurrencies which are the native assets of a blockchain.
*   Tokens can be used for investments, transactions, or to represent a stake in a project and are often distributed via initial coin offerings (ICOs).
*   The ICO boom between 2012 and 2017 led to a spike in token offerings, but also increased scams, prompting regulatory alerts.
*   Crypto tokens utilize existing blockchain technology and smart contracts to automate transactions and secure online payments.
*   Differentiating between legitimate crypto token offers and scams can be challenging, requiring diligent research into the project team and documentation.

## The Evolution of Crypto Tokens

Before the 2017 ICO boom, there were cryptocurrencies that forked from Bitcoin and Ethereum. Mastercoin was the first recognized ICO and token. Mastercoin was created by J.R. Willet and announced on January 2012 via Bitcoin Forum. He titled his whitepaper "The Second Bitcoin Whitepaper."

Mastercoin was one of the first projects to describe using layers to enhance a cryptocurrency's functionality. The project linked Mastercoin's value to Bitcoin and explained using funds to help developers create a way for users to make new coins from their Mastercoins.

### The Rise of Initial Coin Offerings

Between 2012 and 2016, crypto token creation and ICO increased until 2017—token offerings skyrocketed as investors seemed to become aware of them and the possible increase in value they promised. Developers, businesses, and scammers rapidly created tokens to take advantage of the fundraising boom, prompting regulatory agencies to warn investors about ICO risks.

> **Important**
>
> Not all crypto tokens and ICOs are scams. Many are legitimate efforts to raise funds for projects or startups.

### Post-ICO Bubble: The Emergence of IEOs

In 2018, the ICO bubble burst, and shortly after, initial exchange offerings (IEO) emerged where exchanges started facilitating token offerings. Exchanges claimed to vet token offerings to reduce risks for investors, but scammers still used them to promote scams.

Regulatory agencies issued alerts to investors about the risks involved in participating in an IEO; they also alerted exchanges that they were required to register with the authorities if they were facilitating these fund-raising efforts. The logic was that the exchanges might be acting as alternative trading systems or broker/dealers, which by law are required to register.

Crypto tokens continue to be created and used to raise funds for projects via ICOs. Whitepapers read like pitchbooks, outlining the token's purpose, how it will be sold, how the funds will be used, and how investors will benefit.

## Addressing Risks and Concerns of Crypto Tokens

The main concern about crypto tokens is that scammers use them to steal money from investors during fundraising.

However, it can be difficult to distinguish between a scam token and one representing an actual business endeavor.

Consider these factors when evaluating a crypto token:

*   [Based on jurisdiction](https://www.investopedia.com/does-crypto-pass-the-howey-test-8385183), it might need to be registered. In the United States, the SEC considers tokens securities and requires them to be registered unless they qualify for an exemption.
*   Look at the team behind the ICO and their backgrounds. Determine if they are a legitimate business by checking the address and phone numbers, and visit the website of the Secretary of State for the state they claim to be registered in and search for them. If you can't find information about it other than in a white paper and custom website, it might be a scam.
*   ICOs from outside of the U.S. might be difficult to research. One such token was BananaCoin, issued as a fundraiser for banana plantations in Laos. Investors were told they could exchange their tokens for an equal value of bananas or funds after launch.
*   Many crypto tokens are listed on non-regulated exchanges outside of the United States. If it isn't listed on a regulated exchange, the odds of it being a scam are much higher.
*   Even crypto tokens listed on a registered exchange can be scams.

## Understanding the Functioning of Crypto Tokens

Crypto or cryptography refers to the various encryption [algorithms](https://www.investopedia.com/terms/a/algorithm.asp) and cryptographic techniques that safeguard crypto tokens and currencies, such as elliptical curve encryption, public-private key pairs, and hashing functions. Cryptocurrencies, on the other hand, are virtual currencies on a blockchain. These systems allow for secure online payments and storing of value.

Blockchain companies or projects create crypto tokens as transactional units on existing blockchains. They are created using standard templates like that of the [Ethereum](https://www.investopedia.com/terms/e/ethereum.asp) network. Such blockchains work on the concept of [smart contracts](https://www.investopedia.com/terms/s/smart-contracts.asp) or [decentralized applications](https://www.investopedia.com/terms/d/decentralized-applications-dapps.asp), wherein the programmable, self-executing code is used to process and manage the various transactions that occur.

> **Fast Fact**
>
> A smart contract is a self-executing program that automates transactions. Two parties agree on terms. Then code is written to execute the transaction once the agreed upon terms are met.

For example, you might receive a crypto token representing a certain number of customer loyalty points on a blockchain that manages such details for a retail chain. Another crypto token might give the token holder the entitlement to view 10 hours of streaming content on a video-sharing blockchain. A token can even represent other cryptocurrencies, such as a crypto token equalling 15 bitcoins on a particular blockchain. Such crypto tokens are tradable and transferrable among the various participants of the blockchain

Investors can use crypto tokens for any number of reasons. They can hold onto them to represent a [stake](https://www.investopedia.com/terms/s/stakeholder.asp) in the cryptocurrency company or for an economic reason—to trade or make purchases of goods and services. As a practical example, decentralized storage provider Bluzelle allows you to stake your [tokens](https://www.investopedia.com/what-are-native-tokens-6754173) to help secure its network while earning transaction fees and rewards.

> **Warning**
>
> The Financial Industry Regulatory Authority (FINRA) continues to issue alerts about cryptocurrency and token fraud, so be sure you research before investing in any cryptocurrency—the same way you would with any stock.

## Comparing Crypto Tokens and Cryptocurrencies

The term crypto token is often erroneously used interchangeably with "cryptocurrency." However, these terms are distinct from one another.

A cryptocurrency is used for making or receiving payments using a blockchain, with the most popular cryptocurrency being [Bitcoin](https://www.investopedia.com/terms/b/bitcoin.asp) ([BTCUSD](https://www.investopedia.com/markets/quote?tvwidgetsymbol=btcusd)). Altcoins are alternative cryptocurrencies that were launched after the massive success achieved by Bitcoin. The term means alternative coins—that is—cryptocurrency other than Bitcoin. They were launched as enhanced Bitcoin substitutes that have claimed to overcome some of Bitcoin's pain points. [Litecoin](https://www.investopedia.com/terms/l/litecoin.asp) ([LTCUSD](https://www.investopedia.com/markets/quote?tvwidgetsymbol=ltcusd)), [Bitcoin Cash](https://www.investopedia.com/terms/b/bitcoin-cash.asp) ([BCHUSD](https://www.investopedia.com/markets/quote?tvwidgetsymbol=bchusd)), [Namecoin](https://www.investopedia.com/terms/n/namecoin.asp), and [Dogecoin](https://www.investopedia.com/terms/d/dogecoin.asp) ([DOGEUSD](https://www.investopedia.com/markets/quote?tvwidgetsymbol=dogeusd)) are typical examples of altcoins. Though each has tasted varying levels of success, none have managed to gain popularity akin to Bitcoin's.

While cryptocurrencies have their own blockchain and are its native asset, crypto tokens are built on an existing blockchain, which acts as a medium for the creation and execution of decentralized apps and smart contracts. The tokens are used to facilitate [transactions](https://www.investopedia.com/terms/t/transaction.asp) on the blockchain. In many cases, tokens go through an ICO and then transistion to this stage after the ICO completes.

## What Is the Purpose of Tokens?

Crypto tokens generally facilitate transactions on a blockchain but can represent an investor's stake in a company or serve an economic purpose, similar to [legal tender](https://www.investopedia.com/terms/l/legal-tender.asp). However, tokens are not legal tender. This means token holders can use them to make purchases or trades just like other securities to make a profit.

## Is Bitcoin a Token or a Coin?

Bitcoin is a coin also known as a cryptocurrency. It can be used to trade, store value, or make purchases.

## What Is the Difference Between a Crypto Coin and a Crypto Token?

The main difference is that crypto coins have their own independent blockchain, whereas tokens are built on an existing blockchain. Crypto coins are designed to be used as currency, while crypto tokens are intended to represent an interest in an asset and facilitate transactions on a blockchain.

## What Are Some of the Different Types of Tokens That Reside on Blockchains?

Blockchain tokens include reward, utility, security, governance, and asset tokens.

## The Bottom Line

Crypto tokens represent digital assets or interests built on existing blockchains, facilitating transactions and project funding. Unlike cryptocurrencies, which are native to their blockchains, tokens are created through processes like ICOs, often serving as fundraising tools. While ICOs offer legitimate funding opportunities, they have also been exploited for scams. Before investing in crypto tokens, thoroughly research the issuing team or company to avoid potential fraud.

_Cryptocurrency and ICO investments carry substantial risks and uncertainties. Consult a qualified financial professional to align any investment decisions with your personal circumstances. This article provides information only and is not an investment recommendation by Investopedia._

> **Article Sources**
>
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>     
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>     
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>     
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>     
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>     
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