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With so many Web3 tokens out there, it can be complicated to know what distinguishes one from another. In this guide, we’ll walk through the various types of tokens in the market today, what they’re for, and how they work. Note that these different types of tokens are not mutually exclusive labels: some tokens can fit into several categories depending on their purpose and design. Let’s dig in.
Cryptocurrencies
Cryptocurrencies, sometimes called blockchain tokens, refer to the native token of a blockchain—like Bitcoin’s BTC, Ethereum’s ETH, and Stacks’ STX. Blockchains are the foundational layer of Web3 architecture, and these tokens are a core function of that foundation. Cryptocurrency is the umbrella term for most Web3 tokens.
The first cryptocurrency, Bitcoin, was created as “a purely peer-to-peer version of electronic cash”, and while these tokens can be used as payment, they are also more than that. More often than not, cryptocurrencies are integral to the running of the network itself: users pay transaction fees in these tokens to send transactions over the network. Miners/stakers/validators earn fees in cryptocurrencies for their work to validate transactions and package them in blocks. In other words, cryptocurrencies are the incentive structure that drives rational behavior and participation from the public.
This is why cryptocurrencies are sometimes called “gas tokens”—they are the fuel that powers the network. Without them, there is no incentive for the network to process transactions. Most cryptocurrencies are inflationary; every new block of transactions introduces new tokens to the network (hence the term “mining” of new blocks). These new mined tokens are an additional incentive for network participants to process transactions.
However, there is often a cap on how many tokens will be minted, and those rewards diminish over time. For example, Bitcoin’s supply is capped at 21 million BTC. Once the cap is reached, the network depends on transaction fees to incentivize miners to continue to package new blocks.
Stablecoins
While cryptocurrencies were originally designed to function as digital money, they’ve struggled to gain mass adoption because of a fatal flaw—their prices are very volatile. Token prices are a function of supply and demand, and whether price fluctuations are caused by changes in supply or demand, the regular price volatility in Web3 makes it hard to build a payment network around. Why would you pay with an asset that could double in value tomorrow? And why would a merchant accept an asset that could be worth half of its value in an hour? That’s why stablecoins were created.
Stablecoins are Web3 tokens that maintain a stable price and are usually pegged 1:1 to another asset, most commonly the US dollar. While the value of other tokens can fluctuate wildly, the value of stablecoins doesn’t change (1 USDT is always worth $1), hence the name “stable.” Examples of stablecoins include USDT, USDC, and DAI. Learn more about how stablecoins maintain price stability.
That price stability is a huge advantage for payment applications, and stablecoin adoption has soared. After legacy cryptocurrencies Bitcoin and Ethereum, the stablecoin USDT has the largest marketcap of any token at $119B, and in the past 12 months, stablecoin transaction volume is at an eye-watering $21.1T across 188.8M different addresses. In fact, stablecoins are the dominant crypto use case that has undeniably found product-market-fit.
And this space isn’t just gaining traction with crypto companies and users in countries with unstable currencies. It’s catching the eye of institutional fintech companies:
- Paypal recently launched their own stablecoin.
- Stripe just brought back stablecoin payments.
- Visa is planning to launch a platform to help banks issue their own stablecoins globally.
If there’s any doubt around the use of blockchains, stablecoins are a definitive tonic.
Utility Tokens
Utility tokens are digital assets used to access specific services or products within a Web3 ecosystem. Examples of utility tokens include Chainlink’s LINK, Filecoin’s FIL, and Arweave’s AR. Like cryptocurrencies, utility tokens are native to a particular blockchain/ network. Unlike “gas tokens,” utility tokens tend to provide an additional function beyond simply incentivizing network participants to process transactions.
Utility tokens became popular during the build-up to the 2017 ICO rush. The stated purpose of these tokens was to enable users to utilize a new network once it launched, however, they were sold before the network went live. In practice, many teams sold tokens to raise funds for new crypto projects, and people bought them as speculative assets, anticipating the value of these tokens would increase with the launch of the new network. Many tokens sold in the 2017 ICO rush ended up qualifying as unregulated security offerings, i.e.security tokens, not utility tokens (more on that below).
Utility tokens are how users access the utility of a particular app, whether to purchase its services or as a mechanism to incentivize certain kinds of behavior. For example, Filecoin’s users buy and sell data storage with FIL tokens, and Chainlink uses LINK to incentivize its oracle network. In short, utility tokens are the medium of exchange between users and the app, and between different users on the app.
Utility tokens have seen a spike in interest recently thanks to a surge in DePIN startups, where DePIN stands for decentralized physical infrastructure. DePIN use cases include more traditional sectors such as telecommunications, energy and transportation, and these tokens incentivize more efficient and resilient networks for “last-mile” problems related to these industries.
Security Tokens
Security tokens represent financial securities onchain, like stocks, bonds, and real estate. Unlike utility tokens, which are used to access services on a platform, security tokens offer holders ownership rights in an underlying asset, which might be the protocol they are using or some off-chain asset.
As mentioned earlier, many ICOs (initial coin offerings) from the 2017 bull run sold “utility tokens” to investors, but in fact were unregistered securities and closer to security tokens (something the SEC has since gone and fined many companies for) in large part because the token’s utility did not yet exist. The basic rule of thumb to identify a security token is to put it to the Howey test, a four-part framework generally accepted by regulators and industry leaders. If a token requires an investment of money, sets an expectation of profits, is run by a single common enterprise, and relies on the efforts of others for promotion and distribution, it will probably count as a security. Today, projects building in the security token space include tZERO, Securitize, and Polymath.
Security tokens can improve the efficiency and liquidity of traditional securities markets. By digitizing securities, security tokens can reduce the need for intermediaries, streamline the trading process, and lower the barriers to investment opportunities by offering fractional ownership and lower issuing costs.
Governance Tokens
Governance tokens enable decentralized decision making related to a project’s roadmap, network, and design. They let the community manage the network instead of a centralized authority.
These tokens give users voting rights to decide how a Web3 network or app runs and how it may evolve in the future—such as approving protocol changes, setting priorities for the feature roadmap, or allocating funding to projects and new initiatives. Examples of governance tokens include Uniswap’s UNI and Maker’s MKR.
In many cases, the blockchain’s native token is used to make governance decisions for an ecosystem - such as the Token House in Optimism’s governance process or coin-weighted community polls such as Zcash’s Founder’s Reward discussions. Similarly, governance tokens are often combined with utility tokens (so the same token offers both functionality and voting rights for a particular app). In some apps and protocols, token holders can also delegate their voting rights to other users.
Governance tokens are a critical part of how decentralized autonomous organizations (DAOs) function, and they enable networks of users to make decisions efficiently. In just a few short years, we’ve seen governance tokens evolve into much more complex modes of governance than simple on-chain democracy, such as Athenian sortition or quadratic voting, and as Web3 ecosystems continue to mature, so will the role of governance tokens in them.
Non-Fungible Tokens (NFTs)
An NFT is a one-of-a-kind digital asset that can be verified as the original. At the core of the NFT concept is the idea of fungibility. Most other tokens (cryptocurrencies, stablecoins, utility tokens, etc) are fungible, meaning that they are interchangeable (like fiat—a $1 bill can be swapped with any other $1 bill, and the value and function is the same). In contrast, NFTs are unique: each asset is a 1 of 1 and can be verified on-chain.
The uniqueness of each NFT makes it possible to leverage digital scarcity and enables all kinds of use cases, ranging from art collections like Megapont to identity solutions like BNS (your_name.btc). These assets are liquid and can be traded just like physical goods or a currency, but you are able to verify their authenticity and trace their provenance.
NFTs are redefining the idea of ownership and authenticity in the digital age, while they are down from the peak in 2022, NFTs still have $1-4B in trading volume every quarter. Learn more about the potential of NFTs.
Semi-Fungible Tokens
Semi-fungible tokens (SFTs) are a hybrid token structure that embraces parts of both FTs (fungible tokens) and NFTs. SFTs are interchangeable (like FTs) and can be traded between users like cash—1 SFT has the same value as another SFT in the same collection. But each SFT also has a unique identifier (like NFTs).
Translating that into a use case, consider concert tickets, coupons, or gift vouchers. Each category can have items of the same face value (1 floor ticket to a concert = another floor ticket, 1 $10 coupon = another $10 coupon, etc), but once that item is redeemed, its value goes to zero. SFTs enable that behavior onchain. Examples of semi-fungible tokens include DeFrogs and Genopets.
SFTs are also particularly well suited for Web3 gaming and applications that need to issue lots of different tokens because SFTs enable different asset classes to be managed by a single smart contract (which as a developer is easier to manage and as a user results in cheaper transaction fees). Learn more about semi-fungible tokens in the video breakdown below:
Privacy Coins
Privacy or anonymous coins are digital assets that enable users to hide their onchain footprint. Blockchains are public-ledger technologies, which mean that by default, all transactions are observable to the public—anyone can see the sender, recipient, amount sent, and other metadata of the transaction. This creates a need for solutions that can mask that data and provide better privacy and anonymity to onchain users.
That’s where privacy coins come in. These tokens protect user identity and behavior by making it much more difficult, or even impossible, to know the originating wallet for a transaction, how much was sent, and who the recipient is. To do this, privacy tokens use a range of cutting-edge cryptography, from Ring Signatures or stealth addresses, to batching transactions and zero-knowledge proofs. Examples of privacy coins include Monero and Zcash.
The privacy created by these tokens aids financial freedom by preventing third parties from monitoring or tracking users’ transactions. Financial privacy also makes users less vulnerable to extortion or blackmail.
Learn More About Web3 Development Beyond Web3 Tokens
Many Web3 projects need tokens to establish membership or as an incentive for building a thriving Web3 community. When building a Web3 project, you need to not only think about whether your project needs a token (and if so, what type), but also what other Web3 tokens your app will need to interact with.
However, tokens are only one part of what’s involved in the development of Web3 apps. You also need to consider what blockchain you want to build on, smart contract development, and more. To learn more about Web3 development, check out our free guide that covers the basics: start building, check out our recent guide to Web3 development.
