What are ERC-20 Tokens: Explained

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What are ERC-20 Tokens: Explained

7 mins read / updated on Thu Nov 02 2023

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Let's begin by revisiting ethereum, the foundational platform for ERC-20 token development. Post-Bitcoin, Ethereum has emerged as a leading player in the digital asset space. ERC tokens derive their architecture from the ethereum blockchain platform. This decentralized, peer-to-peer platform has gained significant traction among crypto enthusiasts.

The ERC-20 Ethereum token model is a guideline for creating exchangeable tokens that are harmonious with the extensive Ethereum ecosystem. Ethereum is a prominent digital asset that enables the inception of diverse applications, including tokens. These applications function autonomously, without the need for intermediaries.

Also Read: Ethereum Staking Rewards

The ripple effect of the ERC-20 standard can be witnessed throughout the digital asset domain. Numerous renowned tokens, including the stablecoin tether and the pioneering oracle service Chainlink, utilize the ERC-20 token system at their core.

The inherent functionality of ERC-20 standardizes all the tokens developed under this protocol. Thus, they can seamlessly integrate with other tokens and ERC-20-friendly services like MyEtherWallet and MetaMask.

To fathom its utility, let’s address the challenges faced by token creators:

Crafting Smart Contracts: These contracts are pivotal in deciding the token's overall supply, circulation, issuance timetable, and more. They also oversee crucial operations like assessing holder balances and enabling token transfers. Constructing these contracts demands expertise and is labor-intensive. Faulty contract development can lead to catastrophic consequences.

Compatibility with Wallets and Exchanges: Crafting tokens outside of the integrated ERC-20 framework entails added efforts to ensure their compatibility with third-party offerings, including wallets and exchange platforms.

Also Read: Best Ethereum Wallet

What is ERC 20?

ERC-20 stands as the benchmark for exchangeable tokens formulated using the Ethereum blockchain. In contrast to the distinguished non-fungible tokens (NFTs) which are unique, ERC-20 tokens are exchangeable.  

ERC-20 facilitates developers to craft tokens ingrained with smart contracts, adaptable with varied offerings. These tokens signify assets, entitlements, permissions, digital assets, and other transferable entities.


Also Read: What are Defi Tokens

What are the properties of ERC-20 tokens?

The Ethereum network predominantly features ERC-20 tokens. Conceived as utility tokens, they cater to functions and can be used to procure products and services. Characteristic features of these tokens include:

Uniformity - Every token shares an identical code, though individual transaction histories might differ.

Movability - Enables transmission from one destination to another.

Restricted Quantity - An established quantity of tokens ensures developers cannot inflate their numbers.

Also Read: Soulbound Tokens

History of ERC-20

In 2015, the popularity of smart contracts was on the rise, but they were plagued by challenges. The lack of a uniform token system led to a chaotic ecosystem where every application demanded its unique token, leading users to juggle between multiple tokens for varied applications.

The Origin of the Standard

In 2015, developer Fabian Vogelsteller proposed the ERC-20 to instate a uniform standard for smart contracts on the Ethereum blockchain. Vogelsteller introduced this via the project's Github page as an Ethereum Request for Comment (ERC), securing the 20th spot, thus named ERC-20.

The Ethereum developer community embraced this suggestion, which evolved into the Ethereum Improvement Proposal 20 (EIP-20) in 2017. Yet, the moniker ERC-20 stuck, as it was its original identity. Post its validation, tokens on the Ethereum blockchain adhering to this standard became interchangeable.

Also Read: Cross-Chain Bridges

How are ERC-20 tokens created?

The creation of ERC-20 tokens stems from executing smart contracts. Through the magic of these smart contracts, unique applications are brought to life, especially in token generation. Picture a contract designed to accept a limit of 1000 ETH. For every ETH deposited, the contract instantly produces 100 ABC tokens which are sent back to the contributor.

Such a mechanism would generate 100,000 ABC tokens, distributing them among the contributors who provided ETH. This method is reminiscent of a company's initial stock offering, where company shares are allocated and sold to contributors.

Furthermore, specific terms can be integrated into the contract. Let’s say, for instance, that 10% of the received ETH is instantly transferred to Bob's Ethereum wallet. In this scenario, Bob could be the leader of the ABC token initiative. Thus, contributors offering ETH are essentially compensating Bob for his efforts on the ABC token, hoping that the token’s value will soar due to Bob's contributions.

The world of ERC-20 tokens is vast and diverse. Some tokens, like the one illustrated above, symbolize digital assets analogous to company shares. It's essential to acknowledge that such tokens could be perceived as securities by regulatory bodies, potentially placing the creators under legal obligations, varying by region.

Moreover, ERC-20 tokens can symbolize rewards or reputation markers. Consider a digital travel agency bestowing points upon users for every booking made. These tokens could be used for future reservations or exchanged among users, enriching them with value beyond their initial ecosystem.

Lastly, ERC-20 can symbolize tangible items like precious metals or properties. Nevertheless, linking digital tokens to real-world assets can pose challenges.

How does ERC-20 work?

Contrary to misconceptions, ERC20 is a guiding protocol rather than a software or program. The role of the ERC20 protocol is to oversee token genesis, ensuring that the tokens adhere to the necessary technical prerequisites. Tokens that don’t match the ERC20 technical criteria won't qualify as ERC20 tokens and hence won’t be introduced on Ethereum.

Visualize ERC20 being analogous to the HTTP protocol for websites. Just as HTTP dictates the structure and conveyance of internet messages and server-browser interactions, ERC20 lays out the fundamental characteristics and operations of Ethereum-based tokens. Non-compliant tokens face rejection and exclusion from trading platforms.

The ERC20 Standard

For smart contracts to incorporate ERC20 tokens, they must abide by the relevant ERC stipulations. Presently, there are nine directives, six being compulsory and the remaining three being discretionary. These encompass:

Compulsory Directives: Allowance, approve, TransferFrom, Transfer, BalanceOf, and Total Supply.

Discretionary Directives: Token Name, Decimal [Maximum:18], and Symbol.

Here’s a concise explanation of how the mandatory directives influence token genesis:

TotalSupply: Dictates the aggregate of tokens to be generated.

Approve: Aims to nullify the chance of spurious tokens by mandating smart contract function approvals.

BalanceOf: Enables users to scrutinize their token count by displaying the total tokens an address possesses.

TransferFrom: Facilitates automated token transfers when necessary.

Transfer: Permits token migration from one address to another, akin to other blockchain transactions.

Allowance: Should a smart contract wish to finalize a transaction, it must ascertain the wallet balance of the transacting user. The allowance directive authorizes the contract to proceed or abort based on the user's balance.

For a token to qualify as ERC20, it must encode these six directives. Absence or ambiguity in these directives can disrupt the token’s interaction with smart contracts, potentially leading to multiple complications.

Difference Between ETH and ERC-20?

While Ether (ETH) serves as the intrinsic digital asset of the Ethereum blockchain, utilized for transaction validations, ERC-20 defines the blueprint for creating interoperable tokens within the Ethereum realm.

What Is an ERC-20 Wallet?

It's a digital pouch designed to accommodate and manage tokens that adhere to the ERC-20 protocol.

The Significance and Implications of ERC20

Thanks to the ERC20 framework, an influx of initial token offerings (ICOs) have been realized. This set standard simplifies the task for developers to spawn decentralized apps (dApps) over Ethereum. Put simply, it offers a guideline for spawning new tokens, ensuring ease of integration with dApps. The tokens adhering to this standard promise high fluidity, and when crafted meticulously, the smart contract operations carry minimal risk.

How to acquire and safeguard ERC-20 tokens?

A plethora of ERC-20 tokens can be traded on digital asset platforms like Coinbase and Binance.

To safeguard these tokens, one requires an ERC20-specific wallet. It's pivotal to select a wallet that's compatible with such tokens. Some of the known wallets tailored for ETH and ERC20 tokens include:

•   MetaMask

•   MyEtherWallet

•   Trust Wallet

•   Mist Wallet

•   Atomic Wallet

Such wallets can also be employed to engage with other blockchain-centric applications, spanning from DeFi platforms to NFT hubs. But always remember to securely backup your confidential keys and seed phrase. Handing them over to someone can jeopardize your entire digital asset collection.

Which digital assets adhere to the ERC-20 protocol?

Post the inception of the ERC-20 protocol, over half a million compliant tokens have been minted. A few prominent ones include:

Uniswap (UNI) - An autonomous exchange allowing users direct token swapping.

Decentraland (MANA) - Underlying the Decentraland virtual realm, MANA is expended to acquire unique LAND tokens.

ApeCoin (APE) - Core token of the Bored Ape Yacht Club cosmos.

Aave (AAVE) - Fundamental digital asset for the Aave lending dApp.

Wrapped Bitcoin (WBTC) - An ERC-20 token equivalent to Bitcoin, enhancing fluidity in DeFi operations.

Advantages of ERC-20 Tokens

The allure of ERC20 tokens stems from their inherent features, including:

  • Quick and global transactions.
  • Ease of creation.
  • Simplified token interactions.
  • Diminished contract risks.
  • Augmented token fluidity.
  • High returns owing to broad acceptance.

Drawbacks of ERC-20 tokens

  • Bottlenecks - High demand can congest the Ethereum chain, as witnessed with CryptoKitties.
  • Delays - It takes around 14 seconds per block, making transactions stretch up to a minute.
  • Dual costs - ERC-20 transactions require another digital asset for fees, causing fragmentation.

What lies ahead for the Ethereum token protocol?

While ERC-20 brings a slew of advantages to the table, it's not devoid of challenges. Issues have led to losses upwards of US$3 million. During peak periods, transaction delays are inevitable. The community constantly refines the code to tackle ERC-20's limitations. Alternatives like ERC223 and ERC777 are under exploration, but ERC-20 remains the dominant standard.

Also Read: ETHx Vs Solo-staking

Frequently Asked Questions [FAQs]

Q: How does an ERC-20 token differ from a regular cryptocurrency?

A: An ERC-20 token operates within the Ethereum ecosystem, following a set standard, while regular cryptocurrencies can function independently on their own blockchains.

Q: What are the benefits of using ERC-20 tokens?

A: They offer rapid global transactions, are easy to create, simplify token interactions, and provide high fluidity.

Q: How do I create my own ERC-20 token?

A: By using the Ethereum platform, following the ERC-20 protocol guidelines, and deploying a smart contract.

Q: What is the maximum supply limit for ERC-20 tokens?

A: There isn't a set maximum limit; it depends on the token's specific smart contract.

Q: How do I transfer ERC-20 tokens between wallets?

A: Using your wallet interface, input the receiver's address, select the token amount, and initiate the transfer.

Q: Can ERC-20 tokens be used to pay for goods and services?

A: Yes, if the recipient accepts ERC-20 tokens as a form of payment.

Q: How do I check the balance of my ERC-20 tokens?

A: Through your ERC-20 compliant wallet or by using platforms like Etherscan.

Q: What is the difference between ERC-20 and ERC-721 tokens?

A: While ERC-20 tokens are fungible and interchangeable, ERC-721 tokens are unique and non-fungible.

Q: Can ERC-20 tokens be listed on cryptocurrency exchanges?

A: Yes, many exchanges support the trading of ERC-20 tokens.

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By:

Zainab Saberi

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