Recently, one of the most common methods of raising funds for the launch and development of projects in the cryptocurrency industry has become the so-called initial coin offerings (ICO). Most ICOs use the Ethereum network as a platform, or more precisely, the smart contracts of this network. When conducting fundraising campaigns, ICO organizers usually accept ETH or BTC as payment, charging investors in return tokens. Most often these are ERC-20 tokens.
What does the abbreviation ERC-20 stand for?
ERC (Ethereum Request for Comments) is the official protocol for making proposals for improving the Ethereum network; 20 — unique identification number of the offer. The technical specifications for tokens issued on the Ethereum blockchain were published in 2015. Tokens meeting these specifications are known as ERC-20 tokens and are effectively smart contracts on the Ethereum blockchain. Despite the fact that ERC-20 tokens operate within the framework established by the Ethereum team, this framework is wide enough to provide developers with a lot of flexibility when creating them.
The ERC-20 standard defines a set of rules that must be followed in order for a token to be accepted and to be able to interact with other tokens on the network. The tokens themselves are blockchain assets that can have value and can also be sent and received like any other cryptocurrency.
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What caused the need to create an ERC-20 standard?
Before the advent of the ERC-20 standard, there were many compatibility issues between the various forms of Ethereum tokens, each with a completely unique smart contract. In other words, in order for an exchange or wallet to support a token, its creators had to write a completely new code each time. Thus, maintaining the growing number of tokens became more and more problematic, taking too long. To solve this problem, a standard protocol was created for all tokens.
How are ERC-20 tokens different from traditional cryptocurrencies?
The difference between ERC-20 tokens and other well-known cryptocurrencies, for example, bitcoin or Litecoin, is that they are tied to the Ethereum network, use the address format accepted within this network, and are sent using Ethereum transactions. Accordingly, transactions involving ERC-20 tokens can be tracked in the block explorer.
At first glance, such a transaction may look empty, since the ‘Value’ field is zero, but the number of tokens sent (in this case, OmiseGo) can be seen in a separate field.
It is important to understand that ERC-20 tokens are not completely independent — as mentioned above, they are based on the Ethereum blockchain, on the distributed computing power of which they rely in their work.
What are ERC-20 tokens for?
The scenarios for using ERC-20 tokens are very different. For example, they can act as project shares, certificates confirming the ownership of assets, points in loyalty programs, or as a cryptocurrency. There are also options in which ERC-20 tokens simultaneously perform several such roles.
Among the most famous ERC-20 tokens are: 0x, Aragon, Augur, Aeternity, Aion, Binance Coin, BAT, Bancor, Civic, Decentraland, Dentacoin, DigixDAO, Dragon, District0x, EOS, FirstBlood, Gnosis, Golem, Iconomi, Kin, KuCoin, Kyber, Melonport, Matchpool, Numeraire, OmiseGo, Po.et, Raiden, RChain, Ripio, SingularDTV, Status, Storj, TAAS, TenX, TTron, VeChain, Veritaseum, Viberate, WeTrust, Wings and iExec RLC.
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What are the main characteristics of the ERC-20 protocol?
The ERC-20 standard provides six mandatory and three optional (but recommended) parameters for any smart contract.
Mandatory parameters include the «totalSupply» function, which is responsible for the total emission of tokens, ensuring that new tokens cannot be created after the maximum number is reached.
The «balance0f» function determines the initial number of tokens assigned to a specific address. Usually, this is the address belonging to the ICO organizers.
The standard also describes two methods for moving tokens required for their distribution among users and the ability to make transactions. So, the «transfer» function ensures the transfer of tokens to the user who invested in the project during the ICO; function «transferFrom» is required to complete transactions between users.
In addition, two more functions are needed to verify the two previous methods for moving tokens. The «approve» function is used to check that the smart contract, based on the total issue, can distribute tokens, while the «allowance» function is needed to check that the address has sufficient balance to send tokens to another address.
Among the optional parameters is the definition of the maximum number of fractional digits after the decimal point (for comparison, bitcoin has eight such digits — 1.00000000 BTC), the name of the token and its symbol.
A set of these parameters allows exchanges and wallet providers to create a single codebase that interacts with any ERC-20 smart contract.
Are there risks when using ERC-20 tokens?
Since ERC-20 tokens are actually smart contracts, they, despite all their effectiveness, have certain risks. For example, a smart contract cannot be changed after it has been initiated by the ICO organizers; it may also contain bugs and vulnerabilities that can lead to loss of funds.
The history of Ethereum knows many such incidents — one of the most famous examples was The DAO hack in 2016. To eliminate its consequences and return funds on the network, a hard fork was carried out, as a result of which the new chain continued to exist under the name Ethereum, and the opponents of such a decision kept the old chain, announcing the creation of Ethereum Classic.
What other problems can arise with ERC-20 tokens?
It should be noted that the ERC-20 protocol is not always sufficient for the purposes that are pursued when creating tokens, and in itself does not guarantee that a token will be useful, valuable or functional.
In addition, one of the drawbacks of the ERC-20 standard can be considered that it makes the possibility of creating tokens quite trivial at the technical level. This allows many projects to simply launch ICOs, which is confirmed by the total number of tokens — as of May 1, 2018, there were already about 80 thousand of them. This leads to an abundance of similar tokens, making it much more difficult for investors to choose them.
Another problem is that tokens can be mistakenly sent to another ICO’s smart contract.
In this case, if the smart contract does not provide for such an opportunity, the tokens will be lost. As of the end of 2017, more than $ 3 million was lost in this way! The ERC-223 proposal, which describes a situation in which a non-ERC-20-compliant transaction is rejected, is intended to address this issue. It can also be expected that the ERC-20 protocol itself will undergo certain changes in the future.
