What is ERC-20?

You have likely heard the term ERC-20 thrown around in meetings about blockchain or read it in whitepapers while researching the cryptocurrency space. It is one of those technical acronyms that sits right at the intersection of code and commerce.

For a founder navigating the Web3 landscape, understanding this term is not optional. It is the plumbing that makes a vast majority of the digital asset ecosystem function.

At its core, ERC-20 is a technical standard used for smart contracts on the Ethereum blockchain for implementing tokens. ERC stands for Ethereum Request for Comments, and 20 is the unique proposal ID number assigned to this request.

It is a set of rules. Nothing more, nothing less.

When a developer creates a token on Ethereum, they have to decide how that token behaves. Before this standard existed, every token was unique. This meant that exchanges and wallets had to write custom code to support every single new token that launched. It was a bottleneck that stifled innovation.

ERC-20 solved this by creating a common language. It ensures that all tokens created using this standard adhere to a specific list of rules so that they can be shared, exchanged for other tokens, or transferred to a crypto wallet.

To understand why ERC-20 is the dominant standard, you have to understand fungibility.

In economics, fungibility is the property of a good or a commodity whose individual units are essentially interchangeable. Currency is the prime example.

If you lend someone a ten dollar bill, it does not matter if they pay you back with the exact same ten dollar bill or a different one. The value is identical. They are mutually interchangeable.

ERC-20 is a standard specifically for fungible tokens.

This is distinct from unique assets. In the physical world, a house or a piece of art is not fungible. In the digital world, we handle those unique assets differently.

For a startup looking to build a currency, a loyalty point system, or a governance voting share, you need fungibility. You need every single unit of your token to be treated exactly the same as every other unit.

When you deploy an ERC-20 contract, you are essentially telling the Ethereum network that you are creating a supply of identical digital items. The standard dictates how those items are created and how they move from one address to another.

It defines the logic that allows a decentralized exchange to trade your token against another without needing to know anything specific about your project. It just looks at the code, sees it follows the ERC-20 rules, and executes the trade.

The ERC-20 standard is rigorous. For a smart contract to be considered ERC-20 compliant, it must implement six specific functions and two events.

This might sound technical, but for a business owner, these functions represent the fundamental operations of your digital asset economy.

Here are the core concepts these functions cover:

• Total Supply: The contract must report the total number of tokens that will ever exist or that currently exist. This provides scarcity and market cap transparency.
• Balance Of: The contract must be able to report the account balance of another owner’s account. This is how a wallet knows how many tokens a user holds.
• Transfer: This function allows the transfer of a specific number of tokens from the total supply to a user account.
• Transfer From: This is crucial for automation. It allows a smart contract to move tokens on a user’s behalf if they have given permission.
• Approve: This checks against the total supply to ensure the user has the required number of tokens to perform a transaction. It prevents counterfeiting or double spending.
• Allowance: This checks if one user has a remaining balance approved to spend from another account.

If your developer misses one of these or implements them incorrectly, the token is not ERC-20 compliant. It will not work with the thousands of tools, exchanges, and wallets that expect this standard.

These rules create a predictable environment. When you build a business on top of this standard, you are leveraging years of infrastructure development that relies on these specific six functions.

It is common for founders to confuse ERC-20 with other standards, specifically ERC-721.

This comparison is vital because it determines the nature of the product you are building.

As mentioned, ERC-20 is for fungible tokens. Every token is the same.

ERC-721 is the standard for Non-Fungible Tokens, or NFTs. In an ERC-721 contract, every token is unique and has a distinct ID. One ERC-721 token is not equal to another, even if they are from the same smart contract.

Think of the difference between a stack of dollar bills and a deck of collectible trading cards.

If your startup is building a payment layer, a stablecoin, or a platform specifically for voting rights where every vote carries equal weight, you use ERC-20.

If you are tokenizing real estate deeds, selling unique digital artwork, or creating distinct avatars for a video game, you would look toward ERC-721 or the hybrid ERC-1155.

Knowing the difference prevents you from architecting a system that fails to meet the user’s need for either uniformity or uniqueness.

While ERC-20 is the industry standard, it is not without flaws. A founder must be aware of the operational risks involved in deploying these contracts.

Once a smart contract is deployed to the Ethereum blockchain, it is immutable. You cannot easily patch it like you would a SaaS platform or a mobile app.

If there is a bug in the code of your ERC-20 token, it is there forever. This has led to the loss of millions of dollars in the past. Security audits are not a luxury in this space. They are a requirement.

There is also the issue of lost tokens. The standard has a known quirk where if users accidentally send tokens to a smart contract address that is not designed to handle them, those tokens can be frozen effectively forever.

Additionally, operating on Ethereum involves gas fees. Every time a user transfers your ERC-20 token, they must pay a fee to the network in ETH.

This impacts your business model. If you are creating a loyalty program where the value of the reward is five dollars, but the gas fee to transfer the token is ten dollars, your unit economics are broken.

Founders need to calculate the velocity of the token and the cost of transactions. You may need to look at Layer 2 scaling solutions which still use the ERC-20 standard but process transactions off the main Ethereum chain to save costs.

Despite the risks, the value of aligning with ERC-20 is interoperability.

By using this standard, your startup’s asset creates immediate liquidity potential. It can be integrated into lending protocols, yield farming pools, and decentralized exchanges on day one.

You do not have to build the marketplace. The marketplace already exists and is waiting for compliant assets.

This allows you to focus on the utility of your project rather than the infrastructure of the ledger.

For a founder, the ERC-20 standard represents a tradeoff. You accept the constraints of the six mandatory functions and the risks of the Ethereum network in exchange for access to the largest decentralized economy in the world.

It is a tool. Like any tool in business, its effectiveness depends entirely on the skill and strategy of the hand wielding it.