ERC-20

#web3-eli5

Ethereum modeled ERC-20 tokens after Bitcoin. ERC-20s are the most basic tool used by modern blockchains to create value and utility. And from the beginning of Web3, it was assumed that people and projects would create and trade their own ERC-20s. These tokens might function a lot like Bitcoin, but they can be used on a massive network full applications and communities.

ERC-20s are:

  • Fully fungible
  • Can be divided into (and moved in) almost infinite fractions
  • Can be used to represent anything that needs to be counted on-chain
  • No Royalties

How can they be used?

Store of value

Since the creation of Bitcoin, digital currencies have gained popularity as the ultimate self sovereign store of wealth. Some tokens, like Bitcoin, have a total circulation that is capped and an issuance schedule built into their code. Others plan for a small amount of inflation to provide for the security of the network (see below). Either way, the code may be completely  immutable or changeable only by a community vote. This level of stability has attracted many investors fleeing faster inflation or debasement of their national currencies.

Though ERC-20 tokens came several years after Bitcoin, their programmability and fungibility have led crypto investors to treat some of them as a store of value as well.

Trade

Before Bitcoin became a store of value, it was meant to be a currency. And in May 22, 2010 Laszlo Hanyecz made the first peer to peer token transaction when he paid 10,000 for a pair of pizzas. A meal that cost him about 40 bucks at the time would be worth about $285 million today. The purchase is so infamous, May 22nd is now known as Bitcoin Pizza Day.

In Web3, ERC-20 tokens can be used for any number of transactions. They can represent points in a game or measure of your contributions inside a community. Tokens that can be used within a community to purchase goods or services are often referred to as utility tokens.

Gas

Most blockchains have a native ERC-20 token that is used to pay the operators for processing transactions. This token is the fuel that keeps the system running.

These network operators  are in continual competition to receive newly minted tokens and gas payments to add the next block in the chain. As one is awarded a block, the others are paid to check the work and ensure that the data stored on the chain is valid.

Gas prices rise and fall with traffic on the network. This adds to the concept of these tokens being used as a store of value. As a network is more widely adopted and use goes up, the gas token becomes more valuable.

Initial Funding

Some projects choose to raise funds through the sale of tokens. Much like an IPO on the stock market, Initial Coin Offerings (ICOs) are a public sale of tokens to the investors and the general public. ICOs were quite common until they reached their peak in 2017.

There was no regulation in place to protect investors and the market was full of retail investors hoping to get rich quick. Scam projects were everywhere. After several public rug-pulls and increased scrutiny from regulators, ICOs quickly fell out of favor.

As the ICOs slowed down, venture capitol moved into the space. And the VCs were happy to take up the slack.

When an investor is ready sell their position in a successful project, tokens provide a level of liquidity that is hard to match.

Rewards

Many projects use some type of token as a reward for using their product or service. It has become an expectation by early adopters of Web3 projects to receive rewards in the form of air-dropped coins. The term "airdrop" refers to the fact that projects drop coins into the users wallet. Since the project is the one initiating the transaction, they cover the cost. As gas prices have risen, many projects have opted for a claim method that requires the user to pay the gas to receive their tokens. Most users are willing to pay the cost. Especially if they think the coin has or will have value in the future.

Another reward method involves making regular payments to users for holding on to their tokens. This inflates the coin supply. But, by holding the tokens, they are making them more scarce. This drives the cost of the coins and the valuation of the project up.

An interesting side effect happens when you combine the openness of blockchain with people's desire to get something for nothing. Vampire Attacks occur when the competitor of a more successful or established project uses free tokens to draw in new customers. This tactic has been shown to produce mixed results for the projects. But it always seems to benefit the customers. They end up with free tokens and, occasionally, a better product or service to use.

Ownership

In the US, the SEC has made it crystal clear that projects cannot sell tokens as a share of ownership to "unqualified" investors. But project tokens that were either earned or given to users can be purchased on any number of decentralized exchanges. When someone who isn't a pure speculator holds a token from a project, they begin to feel a sense of ownership. And as they begin to feel like an owner, they begin to act like one. The goals of the holder become aligned with the goals of the project in a way that rarely happens with users of web2 products.

Governance

Many of the projects being built in Web3 are owned and operated by the community members who own the tokens. Most of these communities require that you own some amount of tokens in order to vote. The requirements and the voting power of your tokens will vary from project to project.

  • You might only own a fraction, but most projects require that you hold at least one whole token to vote.
  • Weighted voting gives large investors more voting power. One token = one vote.
  • Some projects are more egalitarian. One owner = One vote, regardless of your level of ownership. This protects the community from a hostile takeover.

Access

Many projects require you to hold tokens as a means gain access to their community or exclusive content. This is also known as Token Gating. Some token gating requirements are as simple as holding a single token. Others offer multiple tiers based on how many, or the total value, of their tokens you hold.

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