What Are ERC-20 Tokens? An Explanation for Beginners

Ethereum project is known as a front-line player of the cryptocurrency world. As you know, Ethereum is a decentralized computer network that has two main functions: blockchain to record transactions and virtual mechanism to produce smart contracts. Due to these functions, Ethereum allows users to create decentralized applications. Users have an opportunity to build their apps on the basis of the Ethereum blockchain, while providing their computing powers in turn. These powers support proper functioning of the entire network.

Applications create ERC20 tokens, which function as a digital currency, points in various loyalty programs, and proofs of ownership. Also, ERC-20 tokens can be exchanged for digital coins/other tokens or stored into a personal wallet.

Vending machine and ERC-20 functioning

How does ERC-20 work?

When a smart contract creates token, the ERC-20 enters the stage. Tokens can be used for trading, transferring or buying goods, while ERC-20 is a protocol or a so-called token language, used particularly within the Ethereum network.

For instance, let’s say we have decided to create an online casino that uses cryptocurrency. When playing casino, users must have chips to make the game simple and clear. If a player wants to take part in game, he changes fiat money for tokens, which replace chips.

With this casino analogy, it becomes clear that Ethereum tokens represent value of something else. They might represent physical or real-life objects like goods/services, fiat money, as well as financial instruments such as stocks. Tokens’ functions and properties are variable and depend on tasks assigned to them. Some developers use them as decentralized governance over the network or a payment access to a resource, but tokens support many other possibilities.

In the cryptocurrency community, tokens are widely used as an asset to be changed for BTC, ETH or any other coin. In most cases, they have a fixed supply, rate of inflation and all traits other currencies have.

ERC-20 tokens have the same parameters as the Ethereum tokens and guarantee interoperability between them. To comply with ERC-20, developers are expected to incorporate the concrete set of features into a smart contract to be able to fulfill the following functions:

  • Transfer tokens
  • Get the total supply
  • Obtain the account balance
  • Approve spending

ERC-20 allows interaction with other contracts and apps within the Ethereum blockchain.

How do ERC-20 tokens differ from cryptocurrency?

Unlike traditional cryptocurrencies, ERC-20 tokens are tied to the Ethereum network and are transferred by means of the Ethereum transactions. These transactions can be traced within the Ethereum blockchain. It means that ERC-20 tokens are not completely independent and rely on the computing powers distributed by the Ethereum blockchain.

Main ERC-20 characteristics

ERC-20 offers 6 basic and 3 optional parameters for smart contracts. The most important functions that explain ERC-20’s functionality are the following:

  • TotalSupply function regulates the general release of tokens;
  • Balance0f function determines an initial amount of tokens assigned to a specific address;
  • TransferFrom function ensures proper transactions of tokens;
  • Approve function verifies whether a smart contract can distribute tokens in accordance with total emission;
  • Allowance function verifies whether a certain address have a sufficient balance to send tokens to another address.

These parameters allow exchange services and wallet providers to create a single code base, which interacts with any ERC-20 smart contract.

Problems connected with ERC-20 tokens

ERC-20 is just a protocol and a basis for Ethereum tokens, which is not fully sufficient for all purposes. Due to this fact, there are no guarantees that tokens created on the ERC-20 basis are always useful or valuable. Tokens can be supplemented, while maintaining compatibility with the ERC-20 standard. The main problem with ERC-20 is that it makes tokens trivial on the technical level. As a result, a huge number of similar tokens appear. Therefore, users find it difficult to choose a perspective investment option.

Also, there are projects that implement the basic ERC-20 principles in a strange way, which creates additional complexities and confusions among those who want to operate these tokens. Some smart contracts don’t support specific ERC-20 functions and these tokens simply disappear. By the end of 2017, about $3 million were lost this way.

To sum up, ERC-20 made the token development simple, which accelerated interest and growth in the cryptocurrency space and far beyond it. Thus, ERC-20 improved the cooperation between exchanges, wallets and other cryptocurrency-related projects. We believe that ERC-20 will be improved and expanded in the nearest future.

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