If you have spent time exploring cryptocurrencies and blockchain projects, chances are you have come across the term “ERC-20.” These tokens dominate much of the digital asset ecosystem, powering everything from decentralised finance (DeFi) platforms to stablecoins and gaming applications. But what exactly are ERC-20 tokens, why are they so important, and how do they fit into the broader Ethereum landscape?
Fintech Review explains what ERC-20 tokens are, how they work, their advantages and limitations, and why they remain central to Web3 innovation.
The Basics of ERC-20
ERC-20 is a technical standard used for creating and managing tokens on the Ethereum blockchain. The “ERC” stands for Ethereum Request for Comment, and “20” refers to the unique proposal number assigned when the standard was introduced in 2015.
In simple terms, ERC-20 is like a common set of rules that developers must follow when creating tokens on Ethereum. These rules ensure that tokens created by different projects can interact seamlessly with wallets, exchanges, and applications. Without such a standard, each new token would require custom integration, slowing adoption and creating friction across the ecosystem.
Why Standards Matter
To understand the importance of ERC-20, think of it like the standardisation of internet protocols. Just as the HTTP standard allows browsers and websites to communicate with each other, the ERC-20 standard ensures tokens can be transferred, stored, and used consistently across Ethereum-based platforms.
Before, tokens on Ethereum were created using ad hoc methods, often incompatible with one another. But the introduction of a shared standard provided:
- Interoperability: Any ERC-20 token can be used in wallets and applications that support the standard.
- Efficiency: Developers do not need to reinvent token logic for every project.
- Adoption: Users and investors can easily transfer and trade tokens knowing they follow a reliable format.
Therefore this simple set of rules paved the way for an explosion of token-based projects on Ethereum.
How ERC-20 Tokens Work
ERC-20 tokens are implemented through smart contracts on the Ethereum blockchain. These smart contracts define the rules for issuing, transferring, and managing the token. The ERC-20 standard specifies a list of functions that every token contract must include.
totalSupply read
Returns the total number of tokens in existence.
function totalSupply() external view returns (uint256)
balanceOf read
Returns the balance of a specific address.
function balanceOf(address account) external view returns (uint256)
transfer write
Moves tokens from the sender to a recipient. Does not use allowance.
function transfer(address to, uint256 amount) external returns (bool)
approve write
Sets the spender’s allowance over the caller’s tokens.
function approve(address spender, uint256 amount) external returns (bool)
allowance read
Returns the remaining amount the spender can use from the owner’s balance.
function allowance(address owner, address spender) external view returns (uint256)
transferFrom write
Moves tokens from the owner to a recipient using the spender’s allowance, and reduces the allowance accordingly.
function transferFrom(address owner, address to, uint256 amount) external returns (bool)
By following these functions, ERC-20 tokens behave consistently across applications.
Examples of ERC-20 Tokens
ERC-20 tokens have become the backbone of the Ethereum ecosystem. Some of the most well-known cryptocurrencies and stablecoins are ERC-20 tokens, including:
- USDT (Tether) and USDC (USD Coin), two of the most widely used stablecoins.
- DAI, a decentralised stablecoin issued by the MakerDAO protocol.
- UNI, the governance token of the Uniswap decentralised exchange.
- LINK, used by the Chainlink oracle network.
- SHIBA INU, SHIB, a meme coin that gained global attention.
In fact, thousands of tokens have been launched using ERC-20, ranging from serious financial instruments to experimental community projects.
ERC-20 Transfer & Allowance Simulator
- approve sets or updates the allowance for the spender.
- transferFrom moves tokens from the holder using that allowance.
- Direct transfer ignores allowance.
Advantages of ERC-20 Tokens
The popularity of ERC-20 tokens comes from several advantages.
- Ease of creation: Developers can launch a new token relatively quickly using standard templates.
- Compatibility: Tokens can be instantly used across Ethereum wallets, exchanges, and dApps.
- Liquidity: Standardisation has encouraged exchange listings, increasing liquidity for ERC-20 tokens.
- Community trust: Investors know what to expect from ERC-20 tokens because they follow a well-tested set of rules.
- Programmability: As smart contracts, ERC-20 tokens can be integrated into complex applications like lending, trading, and governance.
Together, these advantages have made ERC-20 the dominant token standard in crypto.
Limitations
Despite their success, ERC-20 tokens are not perfect. For instance, some of the main limitations include:
- Gas fees: Transactions on Ethereum can be expensive, especially during times of network congestion. Sending or swapping ERC-20 tokens may cost more than the value of the transaction itself.
- Scalability issues: Ethereum’s limited throughput means ERC-20 tokens are subject to delays during periods of heavy activity.
- Smart contract risk: Bugs in token contracts can lead to vulnerabilities, as seen in past hacks and exploits.
- Approval mechanism flaws: Early implementations of ERC-20 had design issues where tokens could be lost if the approval and transfer functions were not used correctly.
These challenges have led to the creation of newer token standards, but ERC-20 remains dominant due to its widespread adoption.
ERC-20 in DeFi
Decentralised finance relies heavily on ERC-20 tokens. Almost every major DeFi application on Ethereum, from lending protocols like Aave to decentralised exchanges like Uniswap, uses ERC-20 tokens as the primary building blocks.
In DeFi, ERC-20 tokens serve multiple purposes:
- Collateral: Users deposit ERC-20 tokens into lending protocols to borrow other assets.
- Liquidity: Pairs of ERC-20 tokens are used to create liquidity pools on decentralised exchanges.
- Governance: Many DeFi projects issue ERC-20 governance tokens, allowing users to vote on protocol decisions.
- Rewards: Yield farming often distributes ERC-20 tokens as incentives for providing liquidity or staking.
Without ERC-20 tokens, the DeFi ecosystem would look very different.
The Evolution Beyond ERC-20
While ERC-20 was revolutionary, Ethereum has since introduced other token standards to address new use cases.
ERC-721: Non-fungible tokens, NFTs, that represent unique assets such as digital art or collectibles.
ERC-1155: A multi-token standard that allows both fungible and non-fungible tokens to be managed within one contract.
Layer 2 solutions: Scaling technologies like Optimism and Arbitrum reduce gas costs and increase transaction speeds for ERC-20 tokens.
These innovations build on the foundation laid by ERC-20, but they do not replace its role as the primary standard for fungible tokens on Ethereum.
The Role of ERC-20 in Tokenisation
ERC-20 tokens are not limited to cryptocurrencies. They are also used for tokenising real-world assets such as real estate, commodities, and equities. By representing ownership on the blockchain, these tokens can make assets more liquid, divisible, and accessible.
This process of tokenisation could transform how capital markets function. Investors may one day trade tokenised shares or bonds with the same ease as transferring ERC-20 tokens today.
Risks and Considerations for Investors
For investors, ERC-20 tokens offer both opportunities and risks.
Opportunities: Access to a wide range of assets, participation in DeFi, and potential upside from emerging projects.
Risks: High volatility, potential for scams, and the complexity of managing wallets and private keys.
Regulation is another factor to watch. As governments refine their approach to crypto, ERC-20 tokens may face stricter compliance requirements.
Investors should approach ERC-20 tokens with caution, focusing on projects with strong fundamentals, reputable teams, and transparent governance.
The Future of ERC-20 Tokens
Looking ahead, ERC-20 tokens are likely to remain central to the Ethereum ecosystem for years to come. Even as new standards emerge, the sheer scale of adoption ensures ERC-20’s relevance. Stablecoins, governance tokens, and utility tokens continue to rely on ERC-20 for simplicity and compatibility.
As Ethereum scales through upgrades and layer 2 solutions, the usability of ERC-20 tokens will improve. Lower fees and faster settlement will make them even more practical for everyday transactions and financial applications.
Conclusion
ERC-20 tokens represent one of the most important innovations in the history of blockchain. By establishing a simple, reliable, and interoperable standard, ERC-20 made it possible for thousands of projects to build on Ethereum and for millions of users to access digital assets.
They are not without challenges, from scalability issues to security risks, but their advantages far outweigh their limitations. ERC-20 tokens underpin much of DeFi, stablecoins, and tokenisation efforts, making them essential to the Web3 landscape.
For anyone exploring cryptocurrencies, understanding ERC-20 tokens is foundational. They are not just another technical standard, they are a cornerstone of how the digital economy works today.
