Daily Archives: December 12, 2022

Presently, there are thousands of cryptocurrencies out there, with many more being started daily. While they all rely on the same premise of a consensus-based, decentralized, and immutable ledger in order to transfer value digitally between trustless parties, there are subtle and not-so-subtle differences between them.

This article will make sense of the landscape and look to help categorize cryptocurrencies into four broad types:

The first major type of cryptocurrency is payment cryptocurrency. Bitcoin, perhaps the most famous cryptocurrency, was the first successful example of a digital payment cryptocurrency. The purpose of a payment cryptocurrency, as the name implies, is not only as a medium of exchange but also as a purely peer-to-peer electronic cash to facilitate transactions.

Broadly speaking, since this type of cryptocurrency is meant to be a general-purpose currency, it has a dedicated blockchain that only supports that purpose. It means that smart contracts and decentralized applications (Dapps) cannot be run on these blockchains.

These payment cryptocurrencies also tend to have a limited number of digital coins that can ever be created, which makes them naturally deflationary. With less and less of these digital coins can be mined, the value of the digital currency is expected to rise.

Examples of payment cryptocurrencies include Bitcoin, Litecoin, Monero, Dogecoin, and Bitcoin Cash.

The second major type of cryptocurrency is the Utility Token. Tokens are any cryptographic asset that runs on top of another blockchain. Ethereum network was the first to incorporate the concept of allowing other crypto assets to piggyback on its blockchain.

As a matter of fact, Vitalik Buterin, the founder of Ethereum, envisioned his cryptocurrency as an open-sourced programmable money that could allow smart contracts and decentralized apps to disintermediate legacy financial and legal entities.

Another key difference between tokens and payment cryptocurrency is that tokens, like Ether on the Ethereum network, are not capped. These cryptocurrencies are, therefore, inflationary meaning that since more and more of these tokens are created, the value of this digital asset should be expected to fall, like a fiat currency in a country that is constantly running its cash printing press.

A Utility Token serves a specific purpose or function on the blockchain, called a use case.

Ethers use case, as an example, is for paying transaction fees to write something to the Ethereum blockchain or building and purchasing Dapps on the platform. In fact, the Ethereum network was changed in 2021 to expend, or burn off, some of the Ether used in each transaction to align the use case. You will hear these sorts of tokens referred to as Infrastructure Tokens.

Some cryptocurrency projects issue Service Tokens that grant the holder access to or allow them to perform something on a network. One such type of this service token is Storj, an alternative to Google Drive, Dropbox, or Microsoft Onedrive. The platform rents unused hard drive space to those looking to store data in the Cloud.

These users would pay for the service in Storjs native utility token. To earn these tokens, those who are storing the data must pass random file verification cryptographically every hour to ensure that the data is still in their possession.

Another example of a token is Binances Binance Coin (BNB), which was created to give the holder discounted trading fees. As this type of token grants access to a cryptocurrency exchange, you will sometimes hear it referred to as an Exchange Token.

Tokens are most commonly sold by Initial Coin Offerings (ICO), which connects early-stage cryptocurrency projects to investors. The ones that represent ownership or other rights to another security or asset are called Security Tokens, a type of fractional ownership. More broadly speaking, exchange and security tokens belong to a larger class of Financial Tokens related to financial transactions, such as borrowing, lending, trading, crowdfunding, and betting.

Another interesting use of tokens is for governance purposes. These tokens give its holders a right to vote on certain things within a cryptocurrency network. Generally, these tend to bigger and more significant changes or decisions and is necessary to maintain the decentralized nature of the network. This allows the community, through their votes, to decide on proposals, rather than focus the decision-making power in a small group.

An example would be a DAO (Decentralized Autonomous Organizations), which are a type of virtual cooperatives. The most famous of these is the Genesis DAO. More currently, the MakerDAO has a separate governance token, called the MKR. Holders of MKR get to vote on decisions pertaining to MakerDAOs stablecoin, called Dai.

Lastly, there are also Media and Entertainment Tokens, which are used for content, games, and online gambling. An example is Basic Attention Token (BAT), which awards tokens to users who opt-in to view advertisements, which then can be used to top content creators.

You might wonder why another commonly heard token hasnt been mentioned. Non-Fungible Tokens (NFTs) are certainly one of the hottest topics in the Decentralized Finance (DeFI) space. However, NFTs are not a cryptocurrency as cryptocurrencies are fungible meaning one unit of a particular cryptocurrency is identical to the next.

A holder of one BTC should be completely indifferent if another person offers them another unit of BTC. Same for any cryptocurrency. However, for NFTs, each one is unique and non-fungible, so we dont include them as a cryptocurrency.

Given the volatility experienced in many digital assets, stablecoins are designed to provide a store of value. They maintain their value because while they are built on a blockchain, this type of cryptocurrency can be exchanged for one or more fiat currencies. So stablecoins are actually pegged to a physical currency, most commonly the U.S. dollar or the Euro.

The company that manages the peg is expected to maintain reserves in order to guarantee the cryptocurrencys value. This stability, in turn, is attractive to investors who might use stablecoins as a savings vehicle or as a medium of exchange that allows for regular transfers of value free from price swings.

The highest profile stablecoin is Tethers USDT, which is the third-largest cryptocurrency by market capitalization behind Bitcoin and Ether. The USDT is pegged to the US dollar, meaning its value is supposed to remain stable at 1 USD each. It achieves this by backing every USDT with one US dollar worth of reserve assets in cash or cash equivalents.

Holders can deposit their fiat currency for USDT or redeem their USDT directly with Tether Limited at the redemption price of $1, less fees that Tether charges. Tether also lends out cash to companies to make money.

However, stablecoins arent subject to any government regulation or oversight. In May 2022, another high-profile stablecoin, TerraUSD, and its sibling coin, Luna, collapsed. TerraUSD went from $1 to just 11 cents.

The problem with TerraUSD was that instead of investing reserves into cash or other safe assets, it was backed by its own currency, Luna. During its crash in May, Luna went from over $80 to a fraction of a cent. As holders of TerraUSD clamored to redeem their stablecoins, TerraUSD lost its peg to the dollar.

The lesson here again is to do your due diligence before even buying stablecoins by looking at the whitepaper and understanding how the stablecoin maintains its reserves.

Central Bank Digital Currency is a form of cryptocurrency issued by the central banks of various countries. CBDCs are issued by central banks in token form or with an electronic record associated with the currency and pegged to the domestic currency of the issuing country or region.

Since this digital currency is issued by central banks, the central banks maintain full authority and regulation over the CBDC. The implementation of a CBDC into the financial system and monetary policy is still in the early stages for many countries; however, over time it may become more widely adopted.

Like cryptocurrencies, CBDCs are built upon blockchain technology that should increase payment efficiency and potentially lower transaction costs. While the use of CBDCs is still in the early stages of development for many central banks across the world, several CBDCs are based upon the same principles and technology as cryptocurrencies, such as Bitcoin.

The characteristic of the currency being issued in token form or with electronic records to prove ownership makes it similar to other established cryptocurrencies. However, as CBDCs are effectively monitored and controlled by the issuing government, holders of this cryptocurrency give up the advantage of decentralization, pseudonymity, and lack of censorship.

CBDCs maintain a paper trail of transactions for the government, which can lead to taxation and other economic rents to be levied by governments. On the plus side, in a stable political and inflationary environment, CBDCs can be reasonably expected to maintain their value over time or at least track the pegged physical currency.

In addition to having the full faith and credit of the issuing country, buyers of CDBCs would also not have to worry about fraud and abuse that has plagued many other cryptocurrencies.

Thank you for reading CFIs guide to the Different Types of Cryptocurrency. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

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Types of Cryptocurrency - Overview, Examples - Corporate Finance Institute

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