Crypto Basics Crypto Knowledge

What Are ERC-20 Tokens?

Overview

Bitcoin (BTC) and Ethereum (ETH) are often mentioned in the same sentence as they have been the top two cryptocurrencies in market cap for some time. Whilst both the Bitcoin and Ethereum networks have the underlying principle of a distributed ledger; both differ heavily from a technical standpoint. 

To have a good understanding of ERC-20 tokens, it is first essential to understand the Ethereum network and why they are needed. ETH (Ether) is the currency used to fuel transactions on the Ethereum network, and ERC-20 tokens live on the Ethereum blockchain.

When the Ethereum blockchain grew in popularity, people started creating their own smart contracts. However, to use smart contracts and Dapps (decentralized applications) to their fullest potential, users quickly highlighted a problem of interoperability as each token contract would be uniquely individual.

To put this into perspective, if an exchange wanted to list a token, they would need to write a custom code to interact with each contract individually. The same dilemma also applied to wallet providers if they wanted to support a new token. Therefore, adding hundreds of different tokens would be extraordinarily complex and highly inefficient. 

What Is an ERC-20 Token?

An ERC-20 token is a token on the Ethereum blockchain that has been created in line with the ERC-20 standard. This standard is essentially a guideline or set of rules that the token or smart contract must follow to be implemented. 

It may be easier to think of the ERC-20 standard as specs for a token in the Ethereum ecosystem to adhere to. 

What Are The Rules?

The standard defines six mandatory functions the smart contract should implement and three optional functions. 

The optional functions are token name and symbol (i.e. Ethereum/ETH) and how many decimal points your token can be divided by. The six mandatory parameters are slightly more complex. 

  1. The first is ‘total supply. This means there should be a method in place that defines the total number of tokens. The smart contract will refuse to create new tokens once this limit is reached. 
  2. The second is the ‘balanceOf’ method; this must specify how many tokens each address holds. Etherscan is a tool that helps you do precisely this; by searching the Ethereum address, you can find transactions to and from as well as the total balance.
  3. The following two are ‘transfer’ methods. One is to take an amount from the total supply of tokens and transfer it directly to a user’s address. 
  4. The next is a ‘transferfrom’ method. This is a transfer of ownership between users from one address to another. 
  5. The last two are also very similar, the first of which is the ‘approve method’. This verifies that the contract can transfer a specific amount of tokens whilst keeping in mind the total supply. 
  6. And finally, the ‘allowance method’. This checks that the user has enough tokens or ‘balance’ for a transfer to another address to be authorized. 

These guidelines make for multiple use cases for crypto traders and investors. ERC-20 tokens are commonly bought through large exchanges such as Binance and Coinbase.

They are also prevalent in the world of Defi. Platforms such as Uniswap specialize in swapping erc20 tokens in a decentralized manner. To do this, you’ll need a non-custodial wallet such as MetaMask, if you want to swap tokens or buy and sell into ERC-20 stablecoins such as USDT (Tether). 

Who Created The ERC-20 Token?

The ERC20 token standard began as an idea from the Ethereum community and was brought to life by the Ethereum developers in 2015. However, a standard of this type must be submitted through an EIP (Ethereum Improvement Proposal) to be officially recognized.

The proposal must disclose the new functionalities and the specific set of rules for the new standard. The EIP is then passed to a committee that reviews, amends and finalizes the details. Once completed, it becomes an ERC (Ethereum Request for Comment). 

It wasn’t until 2017 that the ERC-20 token standard was officially recognized. They were extremely popular during the ICO (Initial Coin Offering) boom of 2017, where they dominated the majority of funds raised for investment. 

What Are They Used For?

Smart contracts are undoubtedly a critical use case for ERC-20 tokens. They can be used to create smart property or tokenized digital assets for people to invest in. 

App builders also utilize ERC20 tokens when adding utility or new functions to a project. This is advantageous when the native token (ETH) may not be suitable, as they can create a new token with the necessary functionality.

What Cryptos Are ERC-20 Tokens?

A substantial number of top-tier crypto projects and digital currencies were built using the ERC-20 framework. Projects such as USDT (Tether), USDC (USD Coin), LINK (Chainlink), WBTC (Wrapped Bitcoin), BAT (Basic Attention Token) and DAI. 

What Are The Drawbacks?

Despite the numerous perks of the ERC-20 token standard, it does have a couple of drawbacks. An estimated $3 million has been lost by users sending tokens as payment for a smart contract instead of using the native currency Ether. 

This in itself could be argued as a downside. Ether is needed as a second crypto in the form of payment when any transactions are made involving ERC-20 tokens. Not only does this add an extra element of hassle, but also time and cost. 

The average block time is around 14 seconds, so transactions can often take up to a minute to process, which some users find inadequate. 

Users can also struggle with low throughput. If the Ethereum network gets clogged in a time of high demand, the network can be considerably slower and much more expensive.

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