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Explained: What Are ERC-20 Tokens and ERC-20 Standard?

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The popularity of cryptocurrencies has grown immensely in recent years, and with Bitcoin reaching its all-time high, it’s not surprising many altcoins aspire to penetrate this competitive industry. Many of these coins are built on the Ethereum blockchain. Thus, making them compliant with the ERC-20 tokens and standard.

The ERC-20 refers to (Ethereum Request For Comments) while the number 20 represents the unique number ID to distinguish the standard from others. ERC-tokens are digital assets designed, issued, and used just like a Bitcoin, except it runs solely on the Ethereum blockchainThese tokens mainly rely on a specific smart contract that keeps track of that token’s transactions.

On the contrary, ERC-20 is a set of rules that help developers simplify and improve the process of creating a standard Ethereum-based token. 

So, when you’re exchanging USDT or DAI, the chances of you being exposed to the concept of ERC or ERC-20 tokens are inevitable. But, what is ERC-20, and how does it work?

Why Do Crypto Users Need to Know the ERC-20 Standard?

Crypto traders and investors may or may not thrive with the technical knowledge of blockchain or smart contracts. But the ERC-20 token standard paved a strategic pathway for creating new tokens that neither of us should ignore. 

When analyzing cryptocurrencies from the blockchain perspective, new tokens have always struggled to interact with each other. Hence, Ethereum set a standard for every new token built on Ethereum to abide by the rules (ERC standard’s protocol.) From there, a new coin is must submit comprehensive information to the Ethereum Improvement Proposal (EIP). These standard ERC-20 parameters include its name, symbol (an abbreviation used when displaying balances), decimals (determines the number of decimal places after the point), and the total supply of issued tokens. 

In the end, an individual or organization that fulfills these protocols can issue its own set of tokens.

Ethereum blockchain

The Difference Between Standard Crypto and ERC-20 Tokens

ERC-20 tokens indeed function as a regular cryptocurrency, but their concepts are different. In fact, the terms cryptocurrency and tokens represent different meanings, and it shouldn’t be used interchangeably.

First of all, cryptocurrency is a form of digital assets where they are encrypted by cryptography. That means these cryptos are running on their distinct blockchains, and the ledgers are distributed on decentralized blockchains.

Tokens, on the other hand, are a utility that exists on top of a blockchain. Ethereum’s ERC-20 tokens and some other alternatives, including the ERC-223, ERC-721 are among the most popular. 

Basically, what sets ERC-20 tokens apart from standard crypto is it relies entirely on the Ethereum blockchain rather than having their unique blockchain. Hence, there’s a gas fee to perform a transaction. And a miner uses these fees to execute transactions on the network. And the gas fee fluctuates depending on the network activities. Ultimately, the more congested the network is, the higher the gas fees.

The Correlation of ERC-20 and Smart Contracts

In 2015, Fabian Vogelsteller, a notable figure in the blockchain industry with a web-development background, proposed ERC-20, the technical standard behind smart contracts implementing the token on the Ethereum blockchain. 

A smart contract is a code that is executed upon a request from an end-user or another program. Smart contracts are also responsible for handling transactions, confirming costs, and keeping track of each token’s holders’ balance.

Typically, these contracts can have a specific name, supply, and behavior. But as long as they implement the basic ERC-20 rules, they are all ERC-20 compliant. 

The Purpose of ERC-20 Tokens

Beyond USDT, top cryptocurrencies like LINK are among the best ERC-tokens rely on the ERC-20 standard. The ERC-20 tokens also referred to as utility tokens, aim to provide an alternative to Bitcoin wherein sending or trading the tokens requires a gas fee.

Since ERC-20 tokens are built on smart contracts, the functions are varied. It can function as a currency, reputation points in an online platform, lottery tickets, a financial asset like a share in a company, or proof of ownership. 

Here are some of the characteristics of the ERC-20 tokens: 

  • Applicable for payment transactions, and it is transferable. ERC-20 tokens function just like any other cryptos. They are transferable from one address to another, as long as it fulfills the requirements. 
  • They are fungible. That means all transaction histories are traceable even though each token’s code is identical. 
  • There must be an identified total supply of ERC-20 tokens created. Some ERC-20 tokens may or may not have a fixed supply of coins. Its purpose of having a total supply is to ensure the ecosystem is aware of the total number of tokens circulating.

Commonly, ERC-20 tokens are bought, sold, exchanged, or traded on cryptocurrency exchanges. They are storable in any Ethereum compatible wallets, like MetaMask and MyEtherWallet, paper wallet, wallet app, or even a hardware wallet like Trezor or Ledger Nano S.

Which Cryptocurrencies Are Based on The ERC-20 Standard?

There are plenty of token standards on the Ethereum blockchain. While ERC-20 tokens are among the most popular. According to Etherscan, more than 200,000 ERC-20-compatible tokens exist on Ethereum’s main network. Among them, plenty of the top digital currencies by market cap serving different purposes.

  • ChainLink Token (LINK), Chainlink is an ERC-677 token that inherits functionality from the ERC-20 token standard. This token runs on a blockchain middleware that acts as a bridge between cryptocurrency smart contracts, data feeds, APIs, and traditional bank account payments. 
  • Maker (MKR) is a utility token based on the Decentralized Autonomous Organization (DAO) that creates DAI stablecoin on the Ethereum blockchain.
  • Tether (USDT), a stablecoin that runs on the ERC-20 protocol. That means the deposit address is an ETH address, while the deposits and withdrawals take place on the ETH network.

When Ethereum switches to the Proof-of-Stake consensus mechanism in the ETH 2.0 Upgrade and implements sharding to overcome scalability issues, we can expect the number of projects based on the ERC-20 standard to grow exponentially. Plus, the ETH 2.0 addresses the transaction issues where users can perform ERC-20 token transfers almost instantaneously at a cheaper rate.  

The Pros of ERC-20 Tokens

ERC-20 are popular for a reason, and here’s are several factors that make them attractive:

  • Convenient. ERC-20 tokens are simple and easy to deploy. That’s because Ethereum smart contracts are written in a Solidity programming language similar to JavaScript. Alternatively, developers can also code smart contracts with Vyper programming language that is similar to Python.
  • Flexible for customization. Depending on the business logic and user interactions, ERC-20 tokens are customizable to enable features like gas auto-refill for future transactions, freezing and unfreezing a token, adding on a central mint to modify the tokens in circulation, and more.
  • A defined roadmap for developers. The ERC-20 standard gives developers a proper blueprint, which allows them to create new tokens in an effortless way instead of building them from scratch. 
  • Token standardization. Ethereum provides the token specification that includes interaction rules between different tokens and token purchase rules. With a universal standard, users can transfer new tokens to a wallet and be put on an exchange all at once.
  • Liquidity. If the projects based on Ethereum are active and interact with each other, that brings more projects and more users to the Ethereum network. There is also a solution like Uniswap converting ERC-20 tokens between each other has become even more straightforward.
  • Widely Accepted. ERC-20, as well as its tokens, are recognizable on most exchanges and wallets. That is mainly because of the universal protocol that is adaptable by broad exchanges. Plus, its fungibility makes it excellent for trading applications.
  • Eradicate counterfeit tokens. All transactions are subject to approval, and the total supply of tokens smoothens the auditing process by ensuring there’s no duplicate of tokens in circulation.

ERC-20 may remain one of the most popular standards utilized by many developers worldwide. However, it’s not perfect. 

The Limitations of ERC-20 Tokens

Despite all the good qualities, ERC-20 tokens have some flaws and problems it fails to address. Among them are the following aspects:

  • Instability. The Ethereum blockchain has recently moved its consensus method from the Proof-of-Work to the Proof-of-Stake system via the ETH 2.0. Though ETH 2.0 aims to address all of the scalability issues, many changes are just undergoing, and it’ll take time, and the project is yet to complete. At this time, there might be system instability. Besides, some tokens might risk being destroyed when used as payment for smart contracts. Hence, the birth of ERC-233 to circumvent the problem.
  • Expensive gas fee. ERC-20 relies on the Ethereum blockchain, and to complete each transaction, there will be a gas fee. While the gas fee is parallel to the blockchain activities, the gas fees increase when there’s heavy traffic in the blockchain. Hence, it’s not sustainable in the long-run.
  • Transfer bugs. In Ethereum, there are two kinds of accounts. One of which is an externally owned account (EOA) controlled by private keys, and another one is a contract account held by the contract code. Sending tokens from one EOA account to another using the transfer function causes no problems but transferring funds to a contract account results in a bug that has already led to the loss of nearly a million dollars.
  • Slow transactions. The withdrawal and transactions are correlated to the Ethereum blockchain. When the network is congested, all of the transfers on ERC-20 will be slowed. Though ‘Sharding’ is expected to resolve this problem, it’s still at its infant phase and yet to be fully-adopted on Ethereum blockchain.
  • Irreversible transactions. There is no way to return funds if users sent ERC-20 tokens to the wrong address, and tokens remain forever trapped in contracts. The same applies to the tokens stolen by hackers, with the ill-famous DAO hack as one of the most vivid examples.
  • A very low entry point. Critics say that it is too easy for people to create their tokens with no apparent purpose or goals. As a result, developers can easily exploit the policies to develop fraudulent ICOs and tokens with non-value adding projects.

Many solutions aim to overcome technical problems of the standard. But most of them remain to be some quick and sneaky hacks that don’t give a full explanation. Thus, investors should take this into considerations when assessing an ERC-20 project.

Alternatives to ERC-20 Tokens

There are a few other ERC token standards beyond ERC-20. While they may possess similar protocols, they indeed serve a different purpose. Let’s take ERC-721 for an example;

ERC-721 tokens are non-fungible. That means each token is unique and rare to protect its distinct values. While the features depict the value, it represents. For example, Ethereum DApp (CryptoKitties) defines its value through the set limits that preserve its scarcity. This type of token helps prevent counterfeits and boosts the confidence of the ownership of an investment.

The ERC-777 is seen as an upgrade for ERC-20. Though it features similar functionalities to the ERC-20, it distinguished itself by offering the choices to mint or burn a token and eventually speeding up the transfer process. It is backward compatible with wallets and proxy contracts without having to be redeployed.

Besides that, ERC-223 is another alternative. It is mainly to counter the scenario of an irreversible transaction to a smart contract on ERC-20 tokens. It notifies users to cancel a transaction whenever it triggers a transfer to smart contracts without an intent. However, the gas fee is inevitable, and only a limited wallet is accepting it. 

How to Send and Receive ERC-20 Tokens?

Users can send and receive ERC-20 tokens using any wallet that supports Ethereum based assets. All ERC-20 transactions require a gas fee to pay the miner. Hence, the amount of Ether you store on your wallet should always be slightly higher than the actual amount you want to send. The best practice is for a user to avoid transferring ERC-20 tokens if the ETH balance is too low.

Note that fees for sending Ethereum assets increase if you send them to a smart contract address, such as that of an initial coin offering (ICO) since the transactions are more complicated and require several interactions.

For example, some wallets (Exodus) pay the network fee for users in ETH while charging the equivalent commission in the ERC-20 token they use.

It is easy to acquire ETH by exchanging any cryptocurrency in your wallet for ETH or receiving it from another wallet.

To receive tokens, you should only provide the public address that starts with “0x”. Make sure that you copy-paste it and never try to type the address manually as there is a good chance to make a mistake and lose the funds with no chance of recovery.

How to Store ERC-20 Tokens? 

To exchange ERC-20 tokens on the Ethereum blockchain is easy. But, it is clear that both the exchange address and ERC-20 token address are unique. Hence, sending the ERC-20 token to a personal wallet’s address and exchange’s Ethereum address is different. 

All you need to clearly identify the wallet or the exchange address you intend to send your tokens to. Otherwise, the tokens in the transactions will not be successful and the ERC-20 token may not be credited by the exchange.

Can I Send ERC-20 Tokens to Ledger Nano and MetaMask?

Yes, you can send ERC-20 tokens on both Ledger Nano and Metamask wallets as they are compatible with the ERC-20 standards.

In case you’re not aware of what’s Ledger Nano S/X, it is, a hardware wallet for storing digital assets and conduct transactions in popular cryptocurrencies like Bitcoin, Ethereum, USDT, and including ERC-20 tokens. With the Nano Ledger, you can secure and manage over 1,500 cryptocurrencies. And the Ledger Live application allows buying coins directly in your ETH account.

Metamask, on the other hand, is a cryptocurrency wallet for storing, sending, receiving Ethereum, and ERC-20 tokens through regular websites. Metamask is available as a browser extension and a mobile application. 

So, if you’re considering storing your tokens in a hardware wallet with the convenience of a hot wallet, these solutions are ideal.

Closing Thoughts

ERC-20 tokens have definitely had a significant influence on the cryptocurrency industry. Not only are they responsible for the billion-dollar ICO industry, but it’s also making digital assets more widespread.

The newly created tokens can be added to exchange platforms when they are released without any communication between the cryptocurrency and exchange developers. But only if abide by the ERC-20 standard. That’ll result in less risk, reduced complexity, more uniformity, and increased liquidity of tokens inspiring more trust among users.

Enthusiasts have already experimented with newer standards like ERC-223 or ERC-777, but ERC-20 remains the preferred one. There is a high probability that the ERC-20 protocol will improve very soon by adding features to address vulnerabilities and existing token problems.

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