Once upon a time, every new cryptocurrency had to have its own blockchain.

There are thousands of projects and assets, and only a few of them comply with the ERC20 token standard. Ethereum was the first project that began to act as a platform for the development of decentralized applications (dApps), smart contracts, as well as new tokens. Soon enough, several different token models emerged, the most popular and dominant of which was to create ERC20 tokens.

ERC20 is a protocol that developers can use to propose improvements to the Ethereum network. As Ethereum technology attracts huge attention from developers, many projects and initiatives have emerged in the ecosystem. Most projects launched on Ethereum — be it DApps, decentralized finance or other concepts — will come with a native token. They mainly use the created ERC20 token standard to extract benefits that expand Ethereum. Now let’s talk about this standard in more detail.

What is the ERC-20 standard about?

The “ERC” part in the name of this standard stands for Ethereum Request for Comments. At its core, each request is a set of technical documents that define programming standards in the Ethereum blockchain. These are not the same as EIPs — Ethereum Improvement Proposals — as they propose improvements to the Ethereum protocol itself. ERC standards are autonomous implementations and serve to optimize the interaction of smart contracts and applications on the blockchain.

The ERC20 token standard was originally created by Vitalik Buterin and Fabian Vogelsteller in 2015. Many people don’t realize that this token standard is almost as old as the Ethereum network itself. The purpose of this standard is to facilitate the creation of Ethereum-based tokens. Choosing this approach ensures that developers do not need to learn any unnecessary programming skills since they can build on the already existing Ethereum foundation.

ERC20 tokens are created whenever they become immediately compatible with software and services that support this standard. Initial support was a little weak, but now the situation has improved significantly. Currently, many software and hardware wallets, exchanges and other solutions provide support.

What you need to know about Ethereum tokens

Unlike Ether, the native currency of the Ethereum network, ERC20 tokens are not stored in accounts in the traditional sense. Instead, they exist within a contract but can be transferred to any wallet address on the Ethereum blockchain. The reason for storing ERC-20 tokens in a contract is to ensure that they adhere to certain rules, including their naming and divisibility, as well as maintaining a list of matching user balances with corresponding Ethereum addresses.

To move ERC20 tokens across the Ethereum network, users need to submit a transaction to a contract so that balances are distributed elsewhere. The function inside the contract will take care of the allocation process and handle the transfer accordingly.

Although the call to initiate a token transfer is similar to regular Ethereum transactions, there is a fee involved. The actual “call” is included in an additional transaction field that may not be visible to those who don’t know what to look for.

Additionally, although calling a token does not involve sending Ether, there is a transaction fee to be paid. Without such a fee, the transaction will not be included in any future network blocks. As such, these calls will require some amount of ETH to complete as it is not possible to perform any transactions on the network without an ETH balance.

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What are ERC20 tokens used for?

The big question on everyone’s mind is how ERC-20 tokens can be used these days. While these tokens primarily serve as a speculative tool for most users, they are all part of their individual ecosystems. It is often difficult to appreciate how versatile these ecosystems are.

Bringing more use cases for ERC-20 tokens to market is also not that difficult. Developers and service providers can implement these tokens with relative ease, allowing for significant flexibility. Currently, most ERC-20 tokens are supported by multiple exchanges, wallets, etc.

Stablecoins

One exciting use case for the ERC20 token development standard is the introduction of stablecoins. Because these currencies are pegged to a fixed currency value that will never change, they are widely considered a low-risk investment. Stablecoins are often used for the ERC-20 token standard since Ethereum provides a secondary blockchain for issuing these assets.

Stablecoin works very simply. For each fiat-backed asset, the issuer holds reserves in the corresponding fiat currency — euros, dollars or other currencies. For every unit in their bank or reserve, they can mint one unit of ERC20 stablecoin. In theory, the number of units can never be greater than the issuer’s assets. However, the issuer can also use other assets as collateral to create additional assets, including other cryptocurrencies.

However, the issuer may have a fluctuating fund balance to contend with. Maintaining the supply of a stablecoin can be difficult as it may require a larger number of tokens in circulation. Developers can specify all these aspects using smart contract functions to adjust the proposal if necessary.

While many people perceive stablecoins simply as digital assets for trading with other currencies, their use cases are more varied. The stablecoin can be used to participate in DeFi, purchase goods and services, or explore decentralized applications.

Security Tokens

Another type of smart contract-based ERC20 token is a security token. While they have some similarities to stablecoins, there are significant differences in how they function. Security tokens are not based on fiat currencies, but on securities. Companies and issuers can tokenize stocks, bonds, or physical assets using this token standard.

Most often, security tokens are issued to make investments in a company or project more accessible. In exchange for investment, token holders will receive a stake in the business or receive dividends from the company’s earnings. This is a more modern approach to traditional securities. However, at this stage the business model remains somewhat of a niche market.

Ancillary tokens

The third main category of ERC20 tokens are utility tokens. This is a very common type of digital asset that is not backed by anything digital or tangible. Instead, they are viewed as “rewards” that can provide benefits to users without having any extrinsic value. However, utility tokens can serve speculative purposes if they are listed on exchanges.

Benefits of ERC-20

The most important issue that ERC20 addresses is standardization. In the early days of the Ethereum blockchain, developers worked on their own tokens with different functions and rules, which led to compatibility issues. Without addressing this issue, running smart contracts would require complex mathematical equations and cause scalability issues.

ERC-20 greatly simplifies the creation of decentralized applications on the blockchain, listing tokens on cryptocurrency exchanges, and storing tokens in hardware wallets. This also makes them much safer. Additionally, since ERC20 token development company provides a standardized list of rules, it is much easier for developers to follow them rather than starting from scratch.

Standardization helps maintain the overall health of the ecosystem. The lower the costs and barriers to entry, the more vibrant the ecosystem. This is one of the reasons why the price of ether has recently reached all-time highs.

Disadvantages to Consider

The ERC20 token will only be viable depending on the development of the technology. This Ethereum-based token standard is universal, but the network itself suffers from high fees and transaction congestion. Lack of scalability has repeatedly proven to be an issue, although the upgrade to Ethereum 2.0 is intended to address some of the issues in the coming months. Moreover, this problem is not specific to Ethereum, as other blockchains with similar token standards suffer from scalability issues much more severely.

The second drawback is to find out if the ERC20 token is legit. Anyone in the world can create a smart contract to create new assets. Since they can provide liquidity to popular decentralized exchanges such as Uniswap, it is relatively easy to bring a fraudulent token to a wider audience. This is a common problem among new tokens listed on decentralized exchanges, but there is no easy way to prevent it.