What are ERC-20 Tokens on ETH Network & How does ERC-20 Coins Work?

What are ERC-20 Tokens: Benefits & Working of ERC-20 Tokens

ERC-20 tokens are a type of token that is built on the Ethereum Blockchain. They are known as ERC-20 tokens because they conform to the ERC-20 standard. Continue reading to know more about ERC-20 tokens in detail.

24 MAY 2023, 3 min read

Understanding the intricacies of different token standards can be challenging in the ever-evolving landscape of blockchain.

This article aims to simplify one of the most prevalent token standards - the ERC-20. By the end of this article, you will understand what ERC-20 tokens are, how they function, their pros and cons, and their relationship to other token standards, specifically ERC-721.

What are ERC-20 Tokens?

ERC-20 is a protocol specification used to create tokens on Ethereum's blockchain. It's important to understand that ERC-20 isn't a crypto in and of itself; instead, it's a standard that outlines specific guidelines for token issuance on Ethereum's platform.

"ERC" signifies Ethereum Request for Comments, with "20" denoting the specific proposal ID. ERC-20 tokens represent blockchain-generated assets that carry value and can be transferred or received, akin to cryptocurrencies such as Bitcoin, Ethereum, or Litecoin.

The key distinction is that ERC-20 tokens are created on the Ethereum network, adhering to a standardized set of regulations. This uniformity allows them to effectively interact with other ERC-20 tokens and applications developed on Ethereum. Notable examples of ERC-20 tokens comprise Chainlink (LINK), Tether (USDT), and Shiba Inu (SHIB).

How Do ERC-20 Tokens Work?

Understanding how ERC-20 tokens work requires a basic knowledge of smart contracts - self-executing contracts with the agreement directly written into code.

The ERC-20 standard prescribes a collection of operations a smart contract on the Ethereum network can perform. These operations include the methodologies for transferring tokens, approving transactions, allowing users to retrieve token-related information, and defining the overall token supply.

For example, a person or an organization can create a fixed amount of a specific token and decide how these tokens can be transferred or utilized. Once the smart contract is deployed on the Ethereum blockchain, the rules defined within the contract cannot be changed. The standardization that ERC-20 offers ensures that all tokens on the Ethereum network can be universally accepted and interact with each other.

Advantages of ERC-20 Tokens

ERC-20 tokens hold numerous advantages.

Primarily, they help to standardize the Ethereum network's token operations and make it easier for developers to create new tokens. This encourages a richer ecosystem within the Ethereum network.
Further, ERC-20 tokens are widely adopted and accepted. As they follow a standardized protocol, most wallets, and exchanges already support ERC-20 tokens. This makes them highly accessible to investors and users alike.
Since the ERC-20 standard is used by the majority of Initial Coin Offerings (ICOs), these tokens often represent a project's utility or value. This can lead to potential opportunities for investors and foster innovation in the blockchain space.

Limitations of ERC-20 Tokens

While ERC-20 tokens have undoubtedly significantly expanded the blockchain ecosystem, they aren't without drawbacks.

One of the more serious concerns is security. As ERC-20 tokens are constructed on the Ethereum network, they are prone to the same security vulnerabilities within that system. This interdependency means that any breaches or flaws in the Ethereum blockchain could adversely impact the associated ERC-20 tokens.
Moreover, the cost of operations involving ERC-20 tokens can be a considerable burden for investors due to Ethereum's gas fees. 'Gas' in the Ethereum network refers to the computational effort required to execute operations. Every transaction involving ERC-20 tokens incurs these gas fees, which fluctuate based on network congestion. During periods of high demand, these fees can become prohibitively expensive, impacting the usability and attractiveness of ERC-20 tokens for some users.

ERC-20 Tokens V/S ERC-721 Tokens

Now that you better understand ERC-20 tokens, discussing another popular token standard - ERC-721 is important. While ERC-20 tokens are fungible, meaning each unit is identical to every other unit, ERC-721 tokens are non-fungible, meaning each is unique.

A good real-world comparison would be dollars versus concert tickets. All dollars are the same, but each concert ticket is unique regarding a specific seat at a specific event.

ERC-721 tokens' uniqueness paved the way for their use in representing ownership of unique items, leading to their popularity in digital art and collectibles. A notable example is CryptoKitties, a game where each digital cat is an ERC-721 token with distinct characteristics.

Conclusion

ERC-20 has become a foundational element in the Ethereum ecosystem and beyond, driving a new wave of blockchain applications. While it has its limitations, its impact on the industry is undeniable. Whether you're a developer or an investor, understanding ERC-20 tokens and their operations is crucial in the rapidly evolving crypto world.

Frequently Asked Questions

What is the ERC-20 token standard?

The ERC-20 token standard is a protocol used to develop Ethereum tokens. It ensures that all tokens on the Ethereum network can interact uniformly with one another and other Ethereum protocols.