Blog Crypto What is ERC-20? A Guide to Ethereum’s Crucial System

What is ERC-20? A Guide to Ethereum’s Crucial System

date August 9, 2022 time 5 min read 445 views

It’s 2022, and anyone who uses the internet from time to time has probably heard of Ethereum. But when it comes to ERC-20 and ERC20 tokens, there’s a shroud of mystery (and a big dose of confusion) surrounding what the number-letter combination is all about. Let’s break it down into plain English.

If you have even a passing interest in Ethereum and other related projects, you may have come across the term ERC-20—most likely in relation to ERC-20 tokens. But what’s it all about? The ERC-20 is a common list of rules that tokens operating within the larger Ethereum ecosystem must follow, such as how to transfer tokens between addresses. Without it, it wouldn’t be possible for developers to predict interactions between tokens and create new tokens for Ethereum in a relatively pain-free way.

Confused? Don’t worry—we’ll run through the system in greater detail, explain the role of ERC-20 tokens, and compare the system with similar protocols for other blockchain ecosystems. All while keeping things as simple as possible.

What is ERC-20?

Short for Ethereum Request for Comment 20, you can think of ERC-20 as a kind of regulatory standard for all tokens in the Ethereum blockchain. Having this mechanism in place ensures all tokens remain interchangeable and follow the same rules, creating a better experience for developers and crypto users alike. 

ERC-20 helps to open up Ethereum for everyone.
ERC-20 helps to open up Ethereum for everyone. (Source: Unsplash)

As for the name, it dates back to the idea’s birth. Ethereum’s Github page had an option to make an Ethereum Request for Comment, and the post suggesting what is now ERC-20 was comment number twenty. It was first proposed in 2015, but the implementation didn’t come into full swing until 2017.

To understand what ERC-20, it helps to rewind for a second to review what Ethereum is all about. 

ERC-20 and smart contracts

Although Ethereum’s native token ETH gets the bulk of the attention, the Ethereum blockchain was designed to offer much more than a speculative cryptocurrency. Above all, Ethereum provides an ecosystem where various developers can launch various projects, with the vision of creating a single place for all kinds of decentralized applications—from finance and gaming.

This is made possible by smart contracts, which make Ethereum a suitable place for building a much wider range of applications (something that blockchains like Bitcoin can’t support). For example, a developer could create a lending protocol and use a smart contract to ensure that the lender gets a borrower’s collateral if the borrower stops paying.

These smart contracts also explain the introduction of ERC-20, which governs the many tokens that rely on them. To make it possible for so many diverse tokens to co-exist on Ethereum and for everyone to move between them seamlessly, they must be interchangeable—and ERC-20 makes that possible. 

Before ERC-20, developers created all kinds of tokens that floated around as separate entities. This might not sound so bad, but it wasn’t exactly convenient for people to constantly convert between the tokens of each app.

Now, ERC-20 defines information like:

  • How to tokens between accounts
  • The total supply of tokens on a network
  • How withdrawals and transactions are approved
  • How events are logged
  • The balance of a tokenholder’s account

ERC-20 tokens

If you’re still struggling to get your head around ERC-20, let’s look at some examples of the tokens that rely on it. There are more than 1,000 tokens in total, including many famous projects. 

Ethereum is about more than just its native token ETH.
Ethereum is about more than just its native token ETH. (Source: Unsplash)

It’s worth noting that the term “token” isn’t interchangeable with cryptocurrency. A cryptocurrency is a specific type of token that’s used for payments, but tokens can also be used to represent ownership of an asset or other applications. Each project on Ethereum has its own token.

Being part of the ERC-20 means developers can take advantage of Ethereum’s smart contract system rather than creating their own, and it means that a wide range of wallets and exchanges will automatically support their own token (since it’s part of ERC-20).

This is also great for crypto traders, because they can open one wallet and know it’s suitable for all ERC-20 tokens, or move their tokens between different games and applications.

ERC-20 supports leading stablecoins

Prominent stablecoins USDT and USDC are both ERC-20 tokens—considering they’re both in the top 10 coins by market cap, this shows just how important the system is in the crypto world. Both projects are stablecoins that allow you to use crypto for future trades and transactions while knowing its value will remain backed by the US dollar and therefore be prone to fewer fluctuations. 

Another ERC-20 token is LINK of Chainlink, which is a network focused on providing data and information through smart contracts that uses LINK as an incentive within the system. This shows just how far-reaching the use of ERC-tokens can be.

Comparison with other ecosystems

ERC-20 might be the best-known system of its kind, but it’s not the only one around. For instance, Binance operates BEP-2, which is all about the Ethereum fork Binance Chain (a protocol based on Ethereum but with some amendments). Binance also created its own Binance Smart Chain, which is compatible with ERC-20 tokens (as well as the Binance Chain) and uses another system called BEP-20.

Binance’s BEP-20 could be competition for ERC-20.
Binance’s BEP-20 could be competition for ERC-20. (Source: Unplash)

BEP-2 cannot support smart contracts, but BEP-20 is serving as some more serious competition for ERC-20. The two frameworks are similar, but BEP-20 has some additional functions (such as the need to specify a token owner’s address and the number of decimals for token units). It also has lower fees for its transaction due to an alternative consensus mechanism called proof of staked authority (PoSA).

For now, ERC-20 is largely considered the market leader due to the high number of applications it supports. The transition to Ethereum 2.0 could also strengthen ERC-20’s position as it will speed up transaction times, although BEP-20 is currently faster.

Having said this, Ethereum does recognize the limitations of ERC-20 and is trying to improve them. This is why it’s working on further Ethereum standards, such as ERC-223 and ERC-777. So far, ERC-20, it has remained the most popular since it’s accessible for developers and so widely used.

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