ERC20 Tokens : Innovative Digital assets transforming Ethereum Ecosystem

Ethereum serves a role far beyond that of a simple cryptocurrency. It has emerged as a platform capable of building decentralized applications (dApps) through its smart contract functionality, driving innovation in blockchain technology. If Bitcoin is defined as digital gold, then Ethereum can be seen as digital oil, laying the foundation for the widespread use of blockchain technology across various ecosystems. At the heart of this ecosystem is the ERC20 standard. ERC20 tokens are digital assets used in various projects and applications on the Ethereum blockchain, playing a crucial role in today’s cryptocurrency market. As a blockchain project that aims for decentralization, tokens issued based on Ethereum smart contracts which we explained at previous article can be created by anyone. These tokens include stablecoins, utility tokens, security tokens, and community governance tokens, each serving a different purpose.

In this article, we will explore what ERC20 tokens are, how they work, and their impact on the Ethereum ecosystem.

The Origin and Purpose of ERC20

ERC20 stands for "Ethereum Request for Comment 20," a technical standard used for generating and managing tokens on the Ethereum blockchain. It clearly defines the characteristics of a token, including its name, symbol, and total supply. While it is possible to use a custom format when issuing tokens, doing so could lead to compatibility issues with other tokens or integration problems with wallets. For example, suppose Alice wants to send 10 ABC tokens to Bob using the ABC token contract. Alice would submit a transaction signed with her private key to the blockchain, and if she has 10 ABC tokens, the token contract would execute the transaction, transferring 10 ABC tokens to Bob. If this function is labeled as "transfer" in the contract, it ensures consistency. However, if other tokens like DEF or GHI use different terms like "send" or "transmit" instead of "transfer," it could complicate token exchanges and wallet integrations. ERC20 was proposed as a standard interface to prevent such situations.

Through the standardization of ERC20, different tokens can be distinguished and traded in a standardized manner, providing trust and stability for investors and users. Additionally, the ERC20 token standard allows for the automation of token issuance and management through smart contracts. By adhering to this standard, tokens can be easily supported by various cryptocurrency exchanges, enabling users to securely transfer and store tokens on the Ethereum network. Finally, Ethereum operates on the principles of distributed computing, allowing applications to run and tokens to be issued without centralized servers. Compared to traditional centralized systems, this enables more transparent and reliable transactions while supporting the tokenized economy of the Ethereum ecosystem, fostering the development of a blockchain-based economic ecosystem through the issuance and trading of various tokens.

Notable ERC20 Tokens and its Role

The Ethereum blockchain hosts numerous ERC20 tokens, some of which play crucial roles in the market:

💡 Tether (USDT): Tether is a stablecoin that is pegged to the value of the US dollar, providing a stable means of transaction in the highly volatile cryptocurrency market. Widely used by many, Tether offers significant liquidity across various cryptocurrency exchanges and facilitates trading activities.

💡 Chainlink (LINK): Chainlink is a decentralized oracle service that connects smart contracts with real-world data. It ensures the reliability of data uploaded to the blockchain, enabling smart contracts to interact with external data feeds, events, and payment methods, thereby expanding the applicability of blockchain technology beyond its usual confines.

💡 Binance Coin (BNB): Initially launched on the Ethereum network, BNB is used within the Binance exchange ecosystem to pay for transactions and fees at discounted rates. It demonstrates its utility in reducing transaction costs and promoting efficient token economy management.

💡 USD Coin (USDC): USDC is another stablecoin pegged with US Dollar that offers transparency and reliability. Like USDT, it is widely used for trading and transactions, offering an economic stability mechanism in Ethereum network.

💡 Wrapped Bitcoin (WBTC): WBTC brings Bitcoin's liquidity into the Ethereum ecosystem, allowing Bitcoin to be directly used in Ethereum-based DeFi applications. It bridges the Bitcoin and Ethereum blockchains, enhancing liquidity and creating new opportunities for cross-chain interactions.

💡 Uniswap (UNI): UNI is the governance token for the Uniswap decentralized exchange, providing holders with voting rights on platform development and changes. As Uniswap leads the decentralized exchange sector, UNI plays a critical role in the autonomous governance of this DeFi platform.

💡 DAI: DAI is a stablecoin pegged to the US dollar but fully decentralized and backed by cryptocurrency collateral. It provides a stable financial element in the DeFi sector, enabling predictable transactions without centralized control.

💡 Maker (MKR): MKR tokens are used in the governance of MakerDAO, which manages the DAI stablecoin. MKR holders help maintain DAI's integrity and stability through governance, influencing key components of the DeFi ecosystem.

💡 Compound (COMP): COMP tokens grant holders the ability to participate in the governance of the Compound protocol, a platform for lending and borrowing cryptocurrencies. This strengthens decentralized financial governance and supports autonomous management of financial operations on the blockchain.

💡 Aave (AAVE): AAVE tokens are used for governance and safety modules within the Aave lending system, one of the foremost lending platforms in DeFi. The token facilitates interest rate reductions and serves as a risk mitigation tool, crucial for maintaining system stability and user confidence.

The ERC20 tokens listed above are not just popular due to their market capitalization. Based on interoperability and standardization, these tokens fundamentally enrich the Ethereum ecosystem through their contributions to various applications and blockchain technology. These tokens represent a blend of financial innovation, user empowerment, and systemic improvements, continuing to drive the evolution of the blockchain sector. For stakeholders in the blockchain and cryptocurrency space, understanding the functionalities, roles, potential impacts, and technical specifications of these ERC20 tokens is essential to leveraging the opportunities they present in the expansive digital economy.

However, there are some limitations to ERC20 tokens. First, there is the issue of network congestion and high gas fees. To process transactions on the Ethereum network, users must pay gas fees in Ether, and these fees can spike during times of network congestion. This not only hampers the efficiency of small transactions but also negatively impacts user experience. To address this, networks with improved processing speeds, lower gas fees, and account abstraction technologies that can subsidize transaction costs have been introduced. Secondly, the ERC20 standard does not clearly handle transaction failures, which can also negatively affect user experience.

Use case of ERC20

Let us explain in more detail the application of ERC20 tokens across various industries and sectors:

• 1. Decentralized Finance (DeFi)
• Decentralized Finance, or DeFi, aims to decentralize traditional financial services by utilizing blockchain technology. This allows financial transactions to be conducted directly without intermediaries such as banks or financial institutions. ERC20 tokens play a central role in the DeFi ecosystem and support several functions:
• • Lending and Borrowing: On DeFi platforms like Aave and Compound, users can use ERC20 tokens as collateral to borrow or lend to other users. By depositing their tokens on the platform, users can earn interest and use the collateral to borrow other assets.
  • Liquidity Provision: On decentralized exchanges like Uniswap, users can deposit ERC20 tokens into liquidity pools, thereby supplying liquidity to the exchange and earning fees in return. This process is similar to market making on traditional exchanges but is managed automatically through smart contracts.
  • Stablecoins: Stablecoins such as USDT and DAI adhere to the ERC20 token standard and play a crucial role in maintaining stable value in the volatile cryptocurrency market. Particularly, DAI is a decentralized stablecoin issued against cryptocurrency collateral and is used in various financial activities within DeFi platforms.
• 2. Gaming Industry
• In the gaming industry, ERC20 tokens are essential for guaranteeing ownership of digital assets and ensuring transparency in in-game economies.
• • Tokenization of In-Game Assets: In blockchain-based games, players can own and trade in-game assets through ERC20 tokens. For example, gold or items in the game can be issued as ERC20 tokens, allowing players to freely buy and sell assets. Unlike traditional game economies, this allows players to own assets with real value and potentially cash them out.
  • Transparency of Game Economy: By using ERC20 tokens, all economic activities within the game are recorded on the blockchain, making them transparently accessible. Every transaction is verifiable, which helps prevent fraud and contributes to creating a fair environment within the game.
• 3. Integration with NFTs
• NFTs (Non-Fungible Tokens, ERC-721) represent the ownership of unique digital assets and are primarily used for digital artworks, collectibles, and in-game items. ERC20 tokens can be combined with these NFTs to create more complex and diverse ecosystems.
• • Digital Art and Collectibles: Artists can mint their digital works as NFTs and combine them with ERC20 tokens for sale. For instance, ownership of a specific artwork can be divided and sold as ERC20 tokens, while the original NFT holder retains rights to the artwork. This structure allows artists and owners to protect and trade the value of their works securely on the blockchain.
  • Community Governance and Management: In NFT projects, ERC20 tokens can be used to manage the governance of the community. Token holders can vote on the project's direction or make decisions on specific matters, enabling decentralized project management and promoting community participation.

In this way, ERC20 tokens play a crucial role across various fields, including DeFi, the gaming industry, and integration with NFTs, driving the development and innovation of the blockchain ecosystem.

Security and Governance of ERC20

Security is a crucial consideration for all blockchain assets, including ERC20 tokens. There have been instances where vulnerabilities in smart contracts were exploited by hackers, leading to the loss of user assets. Therefore, it is essential to thoroughly review the smart contract code and conduct security testing. Since general users are often unable to verify the code of a smart contract themselves, it is recommended to check whether the project has had any security incidents and if the smart contract has been audited by a reputable third party. Additionally, it is important for users to securely store their ERC20 tokens offline. As a result, an increasing number of users are storing their private keys, which prove ownership of ERC20 tokens, in hardware wallets like D'CENT and others.

Economic Impact of ERC20 Tokens

ERC20 tokens play a significant role in the cryptocurrency economy. Numerous projects have raised funds based on this standard and provided new services to users. This has offered an alternative to the global financial system and significantly increased the liquidity of digital assets. In particular, ERC20 tokens are crucial in providing financial services to people who may not have access to traditional financial institutions. This promotes financial inclusion and contributes to building a more equitable global economic system.

Tips for Transferring ERC20 Tokens

While ERC20 represents the standard interface for Ethereum, each blockchain network has its own standard for issuing tokens. For non-developers, it's not necessary to fully understand ERC20, but one common mistake users make is sending ERC20 tokens to an address on a different network. For example, ERC20 tokens are compatible with wallets that support the Ethereum network, but if ERC20 tokens are sent to another network (e.g., Binance Smart Chain BEP-20 or TRON TRC-20), and the receiving wallet does not support BEP-20 or TRC-20, the tokens could be lost. Therefore, it is crucial to confirm which network your assets are on before sending them to another address to avoid losing them.

As mentioned earlier, sending ERC20 tokens requires a fee (in Ether), and miners prioritize transactions based on the fees set. If a transaction is set with a low fee, it may take longer to process, especially when the network is congested. One of the issues with ERC20 is that it does not clearly handle transaction failures. By blockchain design, until a transaction is completed, no new transactions can be made from the same address. In such cases, if a transaction is pending, you can overwrite it by sending a new transaction with a higher fee to the same address. This allows miners to prioritize and process the new transaction. D'CENT wallet, for instance, helps users by categorizing fees into low, medium, and high, enhancing user convenience.

Future Outlook of ERC20

The success of ERC20 tokens is closely tied to the success of the Ethereum blockchain. Ethereum is a leading blockchain platform that provides smart contract functionality, and a variety of decentralized applications (dApps) are being built on it, with ERC20 tokens at the center. Understanding the future prospects of ERC20 tokens requires an understanding of Ethereum's development direction, technological advancements, and the overall trends in the blockchain industry.

• Ethereum 2.0 Upgrade and ERC20 Tokens: The Ethereum 2.0 upgrade aims to significantly improve the performance and scalability of the Ethereum network. Previously, the Ethereum network used the Proof of Work (PoW) consensus algorithm, but it is transitioning to Proof of Stake (PoS). This upgrade is expected to increase transaction processing speed, reduce gas fees, and greatly enhance the network's energy efficiency. These upgrades will directly impact the usability of ERC20 tokens, making transactions smoother and alleviating the high fee issues. This will improve user experience and promote the broader adoption of ERC20 tokens.
• Introduction of Layer 2 Solutions: Alongside Ethereum 2.0, the introduction of Layer 2 solutions will also play an important role in the future of ERC20 tokens. Layer 2 solutions are scalability solutions designed to reduce the load on the Ethereum mainnet by processing transactions off-chain and then recording them on the mainnet. Examples of such solutions include Optimistic Rollups and Zero-Knowledge Rollups (ZK-Rollups).

These solutions are expected to significantly increase transaction processing speed, reduce gas fees, and further enhance the usability of ERC20 tokens. This will be particularly important for DeFi applications, which generate a large volume of transactions, as Layer 2 solutions will help increase the overall efficiency of ERC20 tokens across the DeFi ecosystem.

Conclusion

ERC20 tokens are continuously evolving alongside advancements in blockchain technology and will remain a crucial component of the digital asset ecosystem in the future. The Ethereum 2.0 upgrade, the adoption of Layer 2 solutions, and the expansion of new standards are all factors that brighten the future of ERC20 tokens. These changes and developments will allow ERC20 tokens to become more efficient and scalable digital assets, playing an important role across various industries and sectors.