What is ERC-20: Understanding the Token Standard That Powers DeFi
If you’ve ever dabbled in cryptocurrencies, you’ve almost certainly heard of the ERC-20 standard. You might not even realize that many of your favorite tokens, from stablecoins to gaming assets, are built right on its foundation. But what is ERC-20 really, and why is it so crucial for Ethereum and the entire crypto world?
In this article, we’ll break down all aspects of this key standard, explain how it works, look at the most popular tokens, discuss the challenges it faces, and explore what the future holds for it.
What Does ERC-20 Mean in Crypto?
Let’s start with the basics: what is ERC? Imagine it’s a universal “building material” for tokens on the Ethereum blockchain. “ERC” stands for “Ethereum Request for Comments,” and, in the context of the standard we’re discussing, “20” is the unique proposal number for creating this “building material.”
This standard defines a set of rules that any token created on Ethereum must follow. Why is this necessary? To ensure all tokens are “fungible” (or interchangeable). This means one UNI token is exactly like another, just as one dime is identical to any other dime. Thanks to this, tokens can easily “talk” to wallets, exchanges, and decentralized applications (dApps), almost like speaking a universal language.
Before ERC-20, creating tokens was more complicated, with each project inventing its own rules. Imagine the chaos! ERC-20 brought order to this by giving developers a simple, clear template: follow the rules, and your token will work anywhere Ethereum is supported. This was a real breakthrough that simplified the launch of crypto projects and, essentially, laid the foundation for the ICO (Initial Coin Offering) boom and the rapid growth of decentralized finance (DeFi).It’s precisely thanks to this standard that today we can easily understand what is ERC-20 and why it’s so important for the entire crypto world.
How the ERC-20 Standard Operates in Practice
Alright, we’ve figured out what is ERC-20. Now, let’s look at how it works “under the hood.” The Standard defines six mandatory and several optional functions that every token must support.
These functions are implemented via smart contracts – automated programs on the Ethereum blockchain that automatically execute predefined conditions. The token’s smart contract is what enforces all the rules.
ERC-20 meaning implies that all tokens of this format have a mandatory set of common functions:
- Total Supply. Shows how many tokens exist in total. Think of it like checking a book’s total print run.
- Balance by Address. With this function, you can find out how many tokens are held at a specific address (wallet). Essentially, it’s your balance.
- Token Transfer. The most common function! It allows you to send a specific amount of tokens from your address to another. It’s like sending money to a friend.
- Spending Approval. This function grants another address (like a decentralized exchange’s smart contract) permission to spend a certain amount of your tokens on your behalf. You’re basically saying, “Okay, this application can take 100 tokens from me when I ask it to.”
- Transfer by Permission. This function is used in conjunction with “Spending Approval.” It allows the “spender” address to actually move tokens from the owner to another address, but only within the pre-approved amount.
- Permission Check. This function lets you verify how many tokens you’ve allowed another address to spend. You can always see how many “permissions” have been granted.
All these functions interact with your crypto wallet that supports ERC-20 tokens (whether it’s MetaMask, Trust Wallet, or any other). So, what is ERC-20 wallet? It’s simply a tool that lets you manage tokens created under this standard: send, receive, and interact with them via dApps. Your wallet just calls the necessary functions in the token’s smart contract.
Thus, ERC-20 meaning in practice boils down to all tokens operating under consistent, predictable rules. This ensures the security and reliability of operations, guaranteeing compatibility with any platform that supports the ERC-20 standard.
ERC-20 Tokens: Key Projects and Their Uses
Thanks to the ERC-20 standard, the Ethereum ecosystem simply exploded! Thousands of projects emerged, using an ERC-20 token for a wide variety of purposes. Let’s look at some of the most prominent examples and understand how they’re used in the real world.
Here are a few types of ERC20 tokens and their applications:
- Stablecoins. These are tokens pegged to the value of fiat currencies (like the US dollar) to avoid crypto market volatility. The most famous examples are USDT (Tether), USDC (USD Coin), and DAI. It’s important to understand that while these stablecoins are widely used as ERC-20 tokens on the Ethereum blockchain, they can also exist in other formats on other blockchains, such as TRC-20 on Tron or BEP-20 on BNB Smart Chain. They play a huge role in DeFi, allowing traders and investors to maintain asset stability without exiting crypto. It’s like a digital version of the dollar that can be quickly transferred and used in decentralized applications.
- Decentralized Finance (DeFi) Tokens. ERC-20 became their foundation. For example, UNI is the governance token for the decentralized exchange Uniswap. UNI holders can vote on important protocol changes. LINK is the token for Chainlink, an oracle network that feeds real-world data to the blockchain. AAVE is the token for the Aave lending protocol, where users can borrow and lend cryptocurrencies against collateral.
- Utility Tokens. These tokens grant access to specific functions or services. For instance, BAT (Basic Attention Token) is used in the Brave browser to reward users for viewing ads and to pay for content. This shows how an ERC-20 token can be integrated into everyday applications.
- Meme Tokens. Of course, we can’t forget them! SHIB (Shiba Inu) is a prime example of how an ERC-20 token can become a cultural phenomenon and attract millions of users, even if its primary value lies in building a strong community and generating online hype. While their practical use might be limited, they demonstrate how easy it is to create and distribute a token on Ethereum.
Overall, an ERC-20 token has become a universal tool for tokenizing almost anything: from company shares and real estate to event tickets and even votes in decentralized organizations. Its simplicity and compatibility have allowed it to become the foundation for a vast number of projects across various fields – from finance and gaming to art and logistics. It’s truly a “Swiss Army knife” for creating digital assets on Ethereum.
What Are the Downsides of ERC-20?
Despite all its advantages, the ERC-20 standard isn’t without its drawbacks. And, as often happens in the tech world, the main issues are related to scalability. Since all ERC-20 tokens live on the Ethereum blockchain, they directly depend on its performance. Imagine Ethereum as a highway: too many cars (transactions) cause traffic jams.
This leads to two main problems:
- High Gas Fees. During periods of high network congestion, transaction fees (that “gas” we talked about) can skyrocket. Sending $10 might cost $50 in gas, which, let’s face it, isn’t very appealing to users. This makes small transactions uneconomical and deters many people.
- Slow Transaction Speeds. Due to Ethereum’s limited throughput, transactions can process slowly, especially when the network is overloaded. Waiting 10-15 minutes, or even longer, for a confirmation isn’t the most inspiring user experience.
- Compatibility Issues. ERC-20 tokens are inherently “tailored” for Ethereum and cannot directly interact with other blockchains (like Binance Smart Chain or Solana). For cross-chain operations (moving tokens between different networks), you need to use special “bridges,” which add complexity and potential security risks.
Another nuance: the lack of a native “burn” function. While developers can add this function to a token’s smart contract, the ERC-20 standard doesn’t include it by default. This sometimes complicates token supply management if tokens need to be continuously removed from circulation.
This is a direct dependency on the ERC-20 network (meaning Ethereum itself). Any problems or congestion in the main Ethereum network directly affect all ERC-20 tokens, making their use less convenient.
And, of course, while the ERC-20 standard itself is robust, errors in smart contract implementation can lead to vulnerabilities. For example, if a developer incorrectly configures the “spending approval” function, it could allow an attacker to “approve” too many tokens and steal them.
Therefore, it’s always important to trust only verified projects and ensure smart contracts undergo audits.
Future Prospects of the ERC-20 Standard
So, we’ve discussed what is ERC-20 and its complexities. But does that mean its time is running out? Not at all! Despite the emergence of new standards (like ERC-721 for non-fungible tokens, or NFTs, and ERC-1155 for hybrid tokens), ERC-20 remains a fundamental and the most widely used standard for fungible tokens. It’s not going anywhere.
To understand what is ERC, you also need to remember that this standard is constantly evolving and adapting to the changing blockchain landscape. Here’s what its future holds:
- Most importantly, the development of Ethereum itself. Upgrades like Sharding (dividing the blockchain into smaller parts to increase throughput) and Danksharding (an even more advanced form of sharding) will directly improve the performance and scalability of all ERC-20 tokens. As Ethereum becomes faster and cheaper, using this token standard will become even more convenient.
- The growth and development of Layer 2 (L2) solutions, such as Arbitrum, Optimism, and Polygon, are already significantly reducing fees and speeding up transactions for ERC-20 tokens. This makes them much more convenient for everyday use and mass adoption.
- The development of bridges and cross-chain protocols will allow ERC-20 tokens to move more freely between different blockchains. This will expand their ecosystem and open up new possibilities for interaction.
ERC-20 will remain the backbone for most DeFi protocols, ensuring liquidity and interoperability. It will play a key role in the development of Web3 applications, from decentralized social networks to metaverses.
We will also see new applications of ERC-20 tokens across various sectors of the economy and digital space. For example, in the tokenization of real-world assets, the creation of decentralized loyalty systems, community governance, and much more.
In other words, the ERC-20 Standard is a reliable foundation for the future of the tokenized economy.
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