Token Standards Explained From ERC20 to Advanced DeFi Protocols

When you step into a crypto trader’s room or sit at a table with a friend who just discovered a new wallet, the first word that pops up is always the same: “token.” The name feels like a label, like those plastic stickers you put on your pantry items. But unlike a kitchen item, a token is a living unit of value that exists on a blockchain, and its character is defined by the rules it follows—its standard.

Let me walk you through the evolution, from the simple ERC‑20 to the sophisticated systems that power DeFi today. We’ll keep it practical, grounding each standard with real examples and a touch of the market’s pulse.

Ethereum and the Birth of ERC‑20

When Ethereum launched, the community faced a blank slate: how should people swap, sell, or hold assets on a network that could also host any logic? The answer was, in a way, the most straightforward token imaginable—an analogue of USD, but digital. It came in the shape of the ERC‑20 standard.

ERC‑20 is a set of rules that tell the Ethereum Virtual Machine (EVM) how a token should behave. Think of it as a set of ingredients for a recipe that anyone can follow. The key functions are:

• totalSupply(): How many coins exist?
• balanceOf(address): Who owns how many?
• transfer(to, amount): Move tokens from one address to another.
• approve(spender, amount) and transferFrom(...): Allow third parties to move tokens on your behalf.

No surprises, no hidden fees, just a neat, predictable interface. Because anyone could look at the code and see the same functions, trading bots, exchanges, and wallets could all speak the same language.

The first token under ERC‑20 was Basic Attention Token (BAT), born from the idea of monetising attention in a digital world. If you’re a reader, you might have seen BAT pop up on a browser extension. A simple token, but it was the catalyst that proved the model was usable at scale. The market responded, and ERC‑20 tokens flooded the space.

The Need for Variance: ERC‑721 and Non‑Fungible Tokens

A big part of our emotional attachment to money is the desire for uniqueness. We cherish that original blue‑print, that limited edition. In the crypto world, this is non‑fungibility. ERC‑721 addressed that.

Each ERC‑721 token is distinct; it couldn’t be swapped on a one‑to‑one basis with another token. They’re perfect for collectibles, game items, or digital art. A simple example is CryptoKitties—a game where each cat is unique, identifiable, and has a value attached to its attributes.

The main interface changes:

• ownerOf(tokenId): Which address owns this unique piece?
• safeTransferFrom(from, to, tokenId): Move ownership safely, preventing accidental loss.

Because it’s non‑fungible, the contract can store metadata—images, rarity codes, or any data you want. This opened the door for a new economy of digital ownership, where scarcity and provenance become programmable.

Evolving Into ERC‑1155: The “Multitype” Token

While ERC‑20 and ERC‑721 were revolutionary, each had their niche. The need for a protocol that could hold both fungible and non‑fungible items under one roof hit developers hard. ERC‑1155 answered, offering a single smart contract that can batch manage up to 10^10 distinct token types.

There are a few reasons this matters:

• Efficiency: One contract means lower gas, simpler wallets, fewer security vetting iterations.
• Batch transfers: Send many items in a single transaction, ideal for gaming.
• Shared functionality: The same interface applies whether you’re moving a fungible token or a unique item.

For users, it feels like a more natural way to shop online where you can buy a bundle of items: a set of in‑game currencies, a unique avatar piece, maybe even a rare weapon, all together.

Stability in the Storm: ERC‑223 and ERC‑777

During the first wave of tokens, people ran into a common pitfall: sending a token to a contract that didn’t expect it. The default transfer() would silently lose the tokens because the receiving contract would not emit the right event or handle the transfer. This led to accidental losses.

ERC‑223 tried to fix that by requiring the receiving contract to have a tokenFallback function, but its adoption stayed low. ERC‑777 pushed the idea further, adding features like:

• Sending with data: A transfer can include a message, which the receiving contract can react to.
• Operator model: Delegating permissions to other addresses, making it easier to approve large operations.
• Hooks: beforeTransfer and afterTransfer functions, giving more flexibility for contracts to react to token movements.

In practice, these standards improved safety and allowed developers to build more secure dApps. Few projects still use ERC‑223, but ERC‑777 has found a home in a handful of exchanges and DeFi protocols looking for enhanced token interactions.

The Rise of Decentralised Finance (DeFi)

By 2019, the DeFi ecosystem was taking shape. DeFi means “finance that runs on a public chain, where no single point of failure exists.” In other words, a permissionless system where anyone can lend, borrow, trade, and earn.

Tokens are the lifeblood of DeFi: They are collateral, they are rewards, they are the currency of the economy. DeFi protocols built on Ethereum needed more than just fungibility or uniqueness. They needed:

• Liquidity (the ability to feed your swaps).
• Stability (safe, predictability of prices).
• Governance (letting token holders decide the protocol’s future).

That brings us to the most advanced token primitives used in DeFi.

Liquidity Pool Tokens

In a typical Automated Market Maker (AMM) like Uniswap, you pool your assets into a reserve that can be skimmed off by anyone. In return, you receive LP tokens that represent your share of the pool, and the amount of liquidity you supplied.

The LP token is ERC‑20, but the value it carries is different: its worth depends on the pool’s total assets, the volatility of the underlying tokens, and impermanent loss. People trade those tokens to share or sell their share of a reserve.

Imagine you and a friend buy a basket of apples and oranges, and you both get a receipt saying you each own 50% of the basket. Later, the basket becomes valuable because an orchard produced an unexpected surplus. Your receipt’s value jumps because you own a part of that surplus.

Governance Tokens

When you own a governance token (like COMP or UNI), you gain the right to vote on the protocol’s future. The math behind governance tokens is fascinating: there are two models—one‑to‑one with liquidity provision, and one that rewards active participants regardless of liquidity.

Governance tokens come with the heavy responsibility of “being wise.” Many people make a mistake by buying them purely for speculation, whereas the real utility lies in using your stake to shape the protocol’s rules—fee structures, risk models, or even charitable funds.

Utility Tokens for DeFi Services

Beyond governance, some tokens act as “gas for the protocol.” For example, a protocol might require you to pay in a specific token to mint synthetic assets. The token’s price moves with overall protocol usage.

For users, this means the token becomes a part of the ecosystem’s health. Think of it as a local currency in a tiny town: the more you spend to get services, the more circulation it encourages, potentially boosting its supply and, in turn, its value.

Flash Loans: One‑Day Loans with No Collateral

Flash loans are a DeFi wizard trick, made possible by the determinism and atomicity of smart contracts. The idea: you borrow a massive sum of tokens and repay it in the same transaction. If not, the entire transaction reverts—nothing leaves the pool.

The standard behind flash loans is mostly a custom interface, but the pattern is universal: a function that takes amount and data. No collateral, no credit check. It allows arbitrageurs to exploit price differences across markets, liquidate undercollateralised positions, or test a protocol’s safety.

Because they rely on the guarantee that the transaction will revert if something fails, they can be more powerful than a mere “borrow” function. The only danger is that the protocol’s security is compromised if a smart contract receives unexpected data.

Cross‑Chain Tokens: Bridges, Wrapped Tokens, and Token Standards like ERC‑677

The world isn’t limited to Ethereum. Binance Smart Chain, Polygon, Solana, and others host their own tokens—and everyone wants them to talk to each other. Bridges are the solutions.

Most bridges simply mint and burn tokens. You send a token from Ethereum, it records the “burn,” and then it creates a wrapped token on the destination chain. Wraps like WETH (Wrapped Ether) do the same but also act as ERC‑20 tokens.

But there’s a standard that’s slightly different—ERC‑677. This is an extension that allows the transferAndCall pattern. It means that when you transfer a token to a contract, you can optionally trigger a function call that receives the data you want. This pattern removes the need for a manual “callback” gas payment, making cross‑chain messaging simpler.

When you look at a DeFi protocol running on multiple chains, you’ll see wrapped tokens as its building blocks, enabling liquidity to thrive in a multi‑world economy.

The Layer‑Two Momentum: Optimistic and ZK Rollups

As blockchains grew in popularity, the pressure to keep gas costs low intensified. Rollups layer transactions on top of the main chain and then settle them together, saving space and time. Tokens in rollups follow the same standards: ERC‑20, ERC‑721, even ERC‑1155.

But the interaction is a bit subtle. Because rollups are still “off‑chain” until they finalize, the token’s state might be in flux. Users interact with local contracts on the rollup, and the rollup’s root chain updates the state afterward. The key is that the token standard itself does not change; only the underlying network does.

For a portfolio analyst like me, the upside is that the liquidity and gas savings allow a larger number of participants. The downside? A longer confirmation window to lock in trades.

DeFi Tokens with Built‑In Yield: Interest‑Bearing Tokens

Protocols such as Compound, Aave, and Yearn Issues a second token to represent deposits. For instance, you deposit DAI into Compound and receive cDAI. cDAI tracks the underlying DAI adjusted for accrued interest. Over time, cDAI’s exchange rate for DAI rises.

The standard here is an ERC‑20 wrapper, but its semantics differ: the balance changes over time, not directly by transfers. This gives the protocol a built‑in way to reward liquidity and measure risk.

Imagine it as a savings account that automatically re‑calculates your balance each month. In crypto, you get it instantly, in a smart contract that’s guaranteed to run the algorithm.

Security, Governance, and the Emotional Landscape

Tokens are not only logic; they are feelings. When you buy a governance token, you invest a piece of yourself into the future of the protocol. That’s a responsibility. Even if the price remains flat, your vote may determine a fee increase that could hurt your own returns.

Similarly, the rise of flash loans and unstable tokens has frightened people. The memory of a protocol’s failure echoes in chat rooms and Twitter threads for weeks. The fear leads to more scrutiny and, hopefully, stronger audits.

When you hold or use a token, remember that beyond the numbers, there’s a network, a community, and a set of rules written in code. You become a participant in a story that’s still unfolding.

A Practical Takeaway: Stay Grounded with Standards

1. Understand the token’s purpose. Is it a simple transfer‑capable unit (ERC‑20) or does it have a unique function (ERC‑721)? Knowing the difference helps you anticipate risks.

2. Watch for upgrades. Tokens may migrate from ERC‑20 to ERC‑777 for safety, or a project may issue a new version. Use official documentation and community channels to confirm.

3. Check the governance mechanism. If you’re planning to get involved, see how voting works. Is it based on lock‑up or liquidity contribution? Align that with your risk appetite.

4. Verify cross‑chain behavior. If you’re using wrapped tokens, test small amounts on testnets before going live. Check the bridge’s audit reports.

5. Consider the emotional lock‑in. If a token’s value relies on community sentiment, a sudden shift (a hack, a regulatory announcement) can send the price into a tail spin. Diversify, and stay informed.

Markets test patience before rewarding it. Each standard brings a layer of certainty and friction. By understanding their mechanics and history, you reduce the blind spots and avoid being swept along by hype or fear.

Closing Thoughts

Tokens are the smallest building blocks of a vast ecosystem. Their standards evolve like the language of a community—a set of guidelines that ensures everyone can write and understand. ERC‑20 gave us the first standard language. ERC‑721 opened the door to uniqueness. ERC‑1155 merged these worlds. DeFi protocols added layers of complexity—liquidity, governance, interoperability—that make the space fascinating and, at times, intimidating.

If you approach these standards with curiosity, patience, and a dash of skepticism, you'll find that they are not abstract codes but tangible tools. Think of each token as a garden: some are common plants that grow fast (ERC‑20), others are singular flowers (ERC‑721), while some are collections of both, each adding different hues to the landscape (ERC‑1155). The ecosystem—DeFi’s protocols, bridges, governance—makes the garden flourish.

Keep your eyes open for new developments. Just as every season brings different fruit, every new protocol may introduce a new standard or reimagine an old one. Embrace the learning curve, stay anchored in the fundamentals, and remember: knowledge is the real reward, not a headline price swing.