Cryptocurrencies and tokens are integral to decentralized finance (DeFi) and the Web3 revolution. However, despite their superficial similarities, they serve different purposes within the blockchain ecosystem. Understanding these differences is critical for creators, collectors, investors, and other crypto enthusiasts.
In this article, we'll demystify the differences between cryptocurrencies and tokens, explore their unique roles, and provide a comprehensive understanding of their tax and regulatory implications.
What is a Cryptocurrency?
Cryptocurrencies are the "native" digital asset of a blockchain network. They incentivize people to run nodes, validate transactions, and keep blockchains operational and efficient.
Most blockchains charge transaction fees – denominated in their "native" cryptocurrency – to interact with the network. For example, Ethereum charges a "gas" fee in ETH for each transaction. The network routes these fees to the nodes and validators as compensation.
The inner workings of "consensus mechanisms" vary depending on the blockchain. For example, Bitcoin uses a proof-of-work consensus mechanism whereby validators compete to solve a mathematical puzzle, add a new block to the blockchain, and earn BTC rewards.
Some of the most popular cryptocurrencies include:
- Bitcoin – Bitcoin is the first and most well-known cryptocurrency, primarily used as a store of value and hedge against inflation.
- Ethereum – Ethereum is a blockchain platform supporting the creation and execution of smart contracts and the creation of dApps.
- Dogecoin – Dogecoin is a meme-coin with a passionate community and is often used for small transactions or speculation.
- Binance Coin – Binance Coin is the native cryptocurrency of the Binance ecosystem and is used to pay trading fees.
Cryptocurrencies serve many purposes, but most aim to become a medium of exchange. While Bitcoin, Dogecoin, and others seek to replace fiat currencies, Ethereum, Binance Coin, and others maintain marketplaces serving other purposes.
What is a Token?
Tokens are units of value built atop a blockchain network. But unlike cryptocurrencies, they're not associated with any consensus mechanism and merely use the blockchain to record transactions.
Most blockchains create, transfer, and destroy tokens using smart contracts. Generally, these smart contracts adhere to "token standards" like Ethereum's ERC-20 for fungible tokens (e.g., altcoins) or Binance Coin's BEP-721 for non-fungible tokens (NFTs).
Some popular tokens include:
- Stablecoins – Stablecoins aim to maintain a peg to a fiat currency or other physical asset. Examples: Tether (USDT), USD Coin (USDC), Binance USD (BUSD)
- Non-Fungible Tokens – Non-fungible tokens, or NFTs, have unique identifiers that serve as a record of ownership. Examples: CryptoPunks, Bored Apes
- Utility Tokens – Utility tokens serve as a medium of exchange for a business. Examples: Basic Attention Token (BAT), Uniswap (UNI), Cardano (ADA)
- Governance Tokens – Governance tokens allow holders to participate in decisions. Examples: MakerDAO (MKR), Aave (AAVE)
Many crypto projects launch tokens on other blockchain networks rather than building a blockchain. That way, they can capitalize on the efficiency of large blockchain networks while unlocking the business benefits of holding and exchanging value based on smart contracts.
Ethereum is the most popular blockchain for minting crypto tokens using smart contracts. However, a growing number of competitors aim to address specific niche use cases or offer lower costs, faster transactions, or a combination of these attributes.
Similarities & Differences
Cryptocurrencies and crypto tokens serve different purposes. As we’ve discussed, cryptocurrencies facilitate network activity and secure a blockchain, while tokens leverage smart contracts to support a range of use cases, such as collectible NFTs or governance.
But there are also some similarities:
- Blockchain – Both cryptocurrencies and tokens exist and trade on blockchain networks. They use cryptography to ensure security and transparency while decentralizing control.
- Value/Purpose – Cryptocurrencies and tokens can hold a value that fluctuates depending on supply and demand. You can store them in wallets or trade them on exchanges. And they have a well-defined purpose.
Tax & Regulatory Implications
The IRS treats all "virtual currencies" as property for tax purposes. In short, anyone receiving a cryptocurrency or token must pay tax on the income and capital gains tax on any profits upon sale. And usually, that means reporting any capital gains or losses on Form 8949 and carrying over the appropriate amount to Form 1040 Schedule D.
Fiat-to-crypto-to-fiat trades are relatively easy, but the situation becomes a little more complex with crypto-to-crypto trades. The IRS requires you to determine the cost basis of each transaction in U.S. dollars, which creates a lot of legwork unless you use crypto tax software.
ZenLedger connects to your exchanges and wallets, aggregates transactions, and computes capital gain or loss. Then, the platform generates the tax forms you must file each year, including Form 8949, Form 1040 Schedule D, and others.
While the IRS stance is pretty straightforward, cryptocurrencies and tokens also come under the purview of other regulatory bodies, such as the Securities & Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC). And depending on the cryptocurrency or token's characteristics and purpose, it could fall under numerous regulations.
Some tokens are eerily similar to securities (e.g., stocks). For example, initial coin offerings (ICO) involve selling crypto tokens to raise money for a project. Not surprisingly, the SEC believes many of these tokens act as securities and are subject to registration requirements.
Finally, the CFTC treats all cryptocurrencies and tokens as commodities. As the regulatory authority over the interstate trading of commodities, the agency develops and enforces regulations for crypto exchanges to ensure they comply with regulatory requirements.
The Bottom Line
Cryptocurrencies and crypto tokens may appear similar but serve very different purposes in the blockchain ecosystem. Cryptocurrencies incentivize people to run nodes and validate transactions, while tokens harness the power of smart contracts to unlock the potential of Web3 and DeFi. Both come under the purview of multiple regulators.
If you trade cryptocurrencies or tokens, ZenLedger can help you keep everything organized for tax time. Get started for free today!