What Are ERC-20 Tokens?

Basics

Founded by Vitalik Buterin in 2014, Ethereum emerged as an open-source platform designed for the development of decentralized applications (DApps). Buterin aimed to address the Bitcoin protocol's rigidity by creating a more adaptable blockchain. Ethereum's blockchain has since become a magnet for developers, businesses, and entrepreneurs, fostering a thriving ecosystem of smart contracts and distributed applications.

Understanding the ERC-20 Standard

An ERC, or Ethereum Request for Comments, is a technical document outlining programming standards on the Ethereum platform. Unlike Ethereum Improvement Proposals (EIPs), which propose changes to the protocol itself, ERCs establish conventions to facilitate interaction between applications and contracts.

In 2015, Vitalik Buterin and Fabian Vogelsteller introduced ERC-20, a straightforward framework for creating Ethereum-based tokens. This standard allows developers to leverage an existing foundation, streamlining token development and ensuring compatibility with services and software that support ERC-20, such as wallets and exchanges. Although ERC-20 was later formalized as EIP-20 due to its widespread adoption, the original name remains prevalent in the industry.

Overview of Ethereum Tokens

ERC-20 tokens differ from Ethereum's native cryptocurrency, ETH, as they exist solely within a contract, a self-contained database specifying rules like name, symbol, and divisibility while tracking user balances linked to Ethereum addresses.

To transfer tokens, users send a transaction to the contract, requesting that it allocate a portion of their balance to another address (Transaction Action — Transfer). A practical example can be observed on Etherscan: someone is calling the USDT contract. You can see Tether tokens being transferred to another address and a fee being paid in ETH, despite the Value field indicating that 0 ETH has been sent.

Functions and Applications of ERC-20 Tokens

ERC-20 tokens, governed by a set of functions, allow querying total supply, checking balances, transferring funds, and authorizing DApps to manage tokens. This standard's flexibility lets developers add features and set parameters to fit their needs.

Stablecoins

Stablecoins, often pegged to fiat currencies, commonly use the ERC-20 standard. For instance, major stablecoins like BUSD operate under this format. An issuer backs each token with a fiat reserve, such as dollars or euros. If an issuer holds $10,000, they can issue 10,000 tokens, each redeemable for $1. Users can use these tokens for transactions, DApps, or redeem them for fiat, with the issuer burning the tokens upon redemption.

Security Tokens

Security tokens, similar at the contract level to stablecoins, represent assets like stocks, bonds, or real estate. These tokens often provide holders with a stake in a business or asset, distinguishing them from other token types.

Utility Tokens

Utility tokens, the most common type, aren't backed by physical assets. They function like frequent-flyer miles, offering value within specific ecosystems. Uses include in-game currency, DApp fuel, loyalty points, and more, without external value.

How Do New ERC-20 Tokens Appear?

ERC-20 tokens cannot be mined; instead, they are minted when new tokens are created. Upon launching a contract, developers allocate the supply according to their roadmap and plans.

This distribution typically occurs through mechanisms like Initial Coin Offerings (ICOs), Initial Exchange Offerings (IEOs), or Security Token Offerings (STOs). Despite variations in these terms, the core concept remains the same: investors send ETH to the contract address and receive new tokens in return. The funds raised support further project development, with users anticipating immediate or future utility or the potential to resell tokens at a profit as the project progresses. Token distribution doesn't always need automation. Crowdfunding events often accept multiple digital currencies, such as BNB, BTC, ETH, and USDT, with balances allocated to user-provided addresses.

Advantages of ERC-20 Tokens

Fungibility

ERC-20 tokens are fungible, meaning each unit is identical and interchangeable with another. For instance, if you owned a USDT token, it wouldn't matter which specific token you had. You could trade it for someone else's, and they would still be functionally identical, just like a dollar.

If your token is intended to function as a type of currency, it's best for individual units to be indistinguishable. Having unique traits would make them non-fungible, potentially leading to some tokens being more or less valuable than others, which goes against their intended purpose.

Flexibility

ERC-20 tokens offer significant customization options, making them suitable for various applications. They can function as in-game currency, loyalty points, digital collectibles, or represent assets like fine art and property rights.

Popularity

The widespread adoption of the ERC-20 standard in the cryptocurrency industry is a strong incentive for its use. Numerous exchanges, wallets, and smart contracts are already compatible with ERC-20 tokens. Furthermore, there is extensive developer support and documentation available.

Disadvantages of ERC-20 Tokens

Scalability

Ethereum, like many cryptocurrency networks, struggles with scalability. High transaction volumes can lead to increased fees and delays. If an ERC-20 token is launched during network congestion, its usability might suffer. 

Susceptibility to Scams

The simplicity of creating an ERC-20 token can be a double-edged sword. While it encourages innovation, it also enables the proliferation of fraudulent schemes. Investors should be cautious and conduct thorough research to avoid falling for pyramid and Ponzi schemes disguised as legitimate blockchain projects.

Differentiating Between Different Token Standards

While ERC-20 is the original and most widely used Ethereum token standard, several others have been developed to address its limitations or serve different purposes.

• ERC-20 remains the most popular standard, primarily used for creating fungible tokens. However, the need for unique tokens with distinct attributes led to the development of other standards, particularly for non-fungible tokens (NFTs).
• ERC-721 is specifically designed for NFTs, where each token is unique. This standard was famously utilized by the CryptoKitties DApp, enabling users to mint and manage tokens that represent individual assets, such as digital art or in-game items, with unique metadata.
• ERC-1155 aims to combine the functionalities of ERC-20 and ERC-721 by supporting both fungible and non-fungible tokens within a single contract, offering greater flexibility and efficiency.
• ERC-223 and ERC-621 focus on enhancing usability. ERC-223 includes safeguards to prevent accidental token transfers to incorrect addresses, while ERC-621 allows for adjustments in the token supply by adding functions to increase or decrease it.

Conclusion

The ERC-20 standard has long been a cornerstone in the crypto asset space, offering a straightforward way to deploy versatile contracts for various applications, such as utility tokens and stablecoins. Despite its widespread use, ERC-20 lacks certain features found in newer standards. Time will tell if these emerging standards will eventually surpass ERC-20 in popularity and functionality.