The Ethereum blockchain's blueprint: What are ERC-20 tokens?

Ethereum (ETH) is home to some of cryptocurrency's most diverse decentralized projects – GameFi, DeFi, and SocialFi are just a few themes that have gained popularity through decentralized apps (dApps) in the Ethereum ecosystem. One reason for this growth is Ethereum’s clear guidelines for third-party developers, which provide a structured framework for building and scaling blockchain applications. With established standards in its codebase, Ethereum gives programmers the tools to bring their blockchain ideas to life.

One of the most important standards developers encounter on Ethereum is Ethereum Request for Comment 20 (ERC-20). Without it, many widely used web3 projects and tokens wouldn’t exist. Below, we’ll explain how ERC-20 shapes blockchain development and why it’s a cornerstone of Ethereum’s ecosystem. 

What is ERC-20 in crypto?

ERC-20 is the standard for creating fungible tokens on the Ethereum blockchain. Unlike non-fungible tokens (NFTs), fungible tokens are interchangeable at a 1:1 market price between wallets and on exchanges. Developer Fabian Vogelsteller first proposed ERC-20 in the Ethereum Improvement Proposal (EIP-20) in 2015 to establish a universal standard for tokens within the Ethereum ecosystem.

With ERC-20, fungible tokens follow the same coding standards across Ethereum wallets, crypto exchanges, and dApps, ensuring safe and consistent transfers on the blockchain. ERC-20 remains the dominant framework for fungible tokens in cryptocurrency and has influenced the development of other token standards. Developers launching a fungible token on Ethereum must adhere to the functions outlined in ERC-20.

How does the ERC-20 standard work? 

At the core of the ERC-20 standard are smart contracts – blockchain-based agreements that define a token’s essential features and enable transactions without intermediaries. Developers create ERC-20 tokens by importing code libraries with predefined functions into smart contracts, ensuring compatibility with all Ethereum-based wallets, exchanges, and dApps.

Key features of the ERC-20 protocol

While smart contracts form the foundation of ERC-20 tokens, developers must define specific functions to govern how these tokens operate. Each function sets parameters for a fungible Ethereum token, ensuring smooth transfers and interoperability across platforms.

• Transfer: The most fundamental function in ERC-20 tokens, Transfer enables users to send tokens between wallet addresses. This function is essential for all crypto transactions.
• TransferFrom: Similar to Transfer, this function allows approved users to send tokens on behalf of another address, provided they have the necessary authorization. It’s commonly used in decentralized exchanges (DEXs) and dApps, where smart contracts facilitate transactions.
• TotalSupply: This function specifies the total number of tokens created and in circulation. Since it defines a cryptocurrency’s tokenomics, TotalSupply is crucial for ensuring transparency and trust within the crypto community.
• Allowance: When activated, Allowance returns the number of tokens a spender is authorized to withdraw from an owner’s account. It’s often used alongside Approve and TransferFrom to manage token permissions in dApps.
• Approve: This function grants permission for a spender to withdraw a specified number of tokens from an owner’s account. It works in conjunction with TransferFrom and is a core feature in DeFi protocols.

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Benefits of ERC-20 in blockchain

ERC-20 broadened the potential of blockchain technology while maintaining core principles like security and decentralization. By providing a standardized framework for token creation, ERC-20 enables anyone to generate value and contribute to various web3 applications.

Standardization 

The most significant advantage of ERC-20 is the uniformity it introduced for developers. This standardized set of rules ensures that all fungible tokens on Ethereum share the same core properties, making them easily recognizable by wallets, exchanges, and dApps. The consistency provided by ERC-20 simplifies token creation while ensuring widespread compatibility across the Ethereum ecosystem.

Interoperability

Although ERC-20 was designed for Ethereum, it extends across the broader Ethereum Virtual Machine (EVM). EVM-compatible blockchains – including Polygon (MATIC), Avalanche (AVAX), and Optimism (OP) – recognize Ethereum’s token standards, allowing ERC-20 tokens to move seamlessly between networks. This interoperability gives crypto traders access to lower transaction fees and opportunities like yield farming.

Liquidity

Another major benefit of ERC-20’s interoperability is the increased liquidity it brings to the crypto ecosystem. Because ERC-20 is widely accepted, developers who use this standard gain instant access to an active web3 community. The ability to transfer ERC-20 tokens between wallets and exchanges facilitates easy swaps between digital assets and fiat, as well as participation in DeFi liquidity pools for passive income. This high liquidity improves market efficiency, reduces slippage, and provides investors with greater flexibility when entering or exiting positions.

Security

Ethereum consistently ranks as the second-largest cryptocurrency by market cap and has one of the most active developer communities. This scale and reputation enhance the security of ERC-20 as a token standard. While smart contract exploits remain a risk, ERC-20’s well-defined rules help mitigate vulnerabilities. Additionally, Ethereum’s robust blockchain infrastructure makes unauthorized access highly unlikely, reinforcing ERC-20’s reliability.

Examples of ERC-20 tokens

According to the Ethereum blockchain explorer Etherscan, there are now over 1 million smart contracts for token projects. Among them, a few ERC-20 tokens have emerged as dominant players in the decentralized economy.

• Tether USD (USDT): Tether Limited’s USDT is a stablecoin designed to maintain a value pegged to the US dollar. Originally launched on the Bitcoin (BTC) blockchain, it quickly gained traction as an ERC-20 token due to its low volatility and widespread adoption in DeFi applications. USDT remains the most liquid stablecoin – especially within the Ethereum ecosystem – and frequently surpasses both Bitcoin and Ethereum in trading volume.
• Shiba Inu (SHIB): Created by the pseudonymous developer "Ryoshi," Shiba Inu is an ERC-20 memecoin inspired by Dogecoin (DOGE). While both feature the same dog-themed branding, SHIB distinguished itself with an active development community and an expanding ecosystem. In addition to the SHIB token, the project introduced ShibaSwap (a DEX) and Shibarium (a layer-2 blockchain) to add utility and long-term value to its web3 presence.
• Wrapped BTC (wBTC): Similar to USDT, which is pegged 1:1 with the U.S. dollar, wBTC is backed 1:1 with Bitcoin. The goal of wBTC is to bring Bitcoin liquidity to Ethereum dApps, allowing BTC to be used in the ERC-20 ecosystem. Custodian BitGo holds BTC reserves to back every wBTC issued and burns tokens when users redeem them for actual Bitcoin.
• Uniswap (UNI): Uniswap is a pioneering DEX on Ethereum that introduced the Automated Market Maker (AMM) model for decentralized token swaps. A few years after launching, the Uniswap team issued the UNI token as an ERC-20 asset to reward early users and liquidity providers. In addition to its role as an incentive, each UNI token carries governance rights, allowing holders to vote on protocol proposals.

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If you've been using ERC-20 tokens on exchanges and DeFi platforms, remember to report all of these activities to the IRS before the tax deadline. CoinTracker simplifies this task thanks to our integrations with hundreds of crypto exchanges, wallets, and DeFi smart contracts. After linking all of your accounts to our Portfolio Tracker, you'll get an instant read on your crypto transaction history, as well as IRS-compliant tax forms ready for your crypto CPA or a solution like TurboTax and H&R Block. 

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.