What Is Tokenization? An Overview on Payment

What Is Tokenization? An Overview on Payment

Tokenization refers to the process of encrypting sensitive information by replacing the details with random strings of characters. These random character strings are generated by algorithms and are referred to as tokens.

Tokens can be used as a more secure method of data transfer, such as a customer’s credit card or bank account information. Rather than the raw data being exposed, the same information in tokenized format can be passed through a payment gateway instead.

Keep in mind we’re not talking about a crypto token or cryptocurrency here.

What is tokenization and what purpose does it serve? Some security methods, like the computer chips in credit cards, are designed to stop hackers from replicating banking details onto another card. The main goal of safeguarding data through tokenization, however, is to prevent online data breaches.

How Does Tokenization Work?

With regard to payment processing, tokenization requires a credit card or account number to be substituted with a token. The token itself isn’t connected to any person or account.

The 16-digit primary account number (PAN) of a customer gets replaced with a custom-made string of random numbers, letters, and special characters. This process eliminates any connection between customer data and a transaction.

Payment tokenization safely stores bank account numbers or credit card numbers in a virtual vault. This allows for the safe transmission of data through wireless networks. Organizations need a payment gateway to effectively make use of tokenization.

Payment gateways are services offered by e-commerce applications that double as tokenization service providers. They allow for direct payments or the processing of credit card payments. This kind of gateway can store credit card numbers in a safe manner and generate the random tokens needed for payment tokenization.

Tokenization vs Encryption

How is tokenization different from encryption? Both methods involve protecting information from prying eyes, but how they go about doing this is quite different.

While encryption uses a “key” to protect data, tokenization uses a “token.” One method makes data opaque, with the intention of revealing it later through use of a special decryption key. The other method uses random data to represent real data.

Encryption

Encryption can be reversed. Data that has been encrypted is intended to be decrypted at some point and restored to its initial state. How strong the encryption will be depends on the complexity of the algorithm used to encrypt the data.

All encryption can theoretically be broken. The stronger the encryption algorithm, the more difficult it will be to break. But given sufficient computing power, an attacker can overcome just about anything. Encryption serves to obfuscate data but doesn’t protect it completely. When something is encrypted, it becomes more difficult to access — but not impossible.

Tokenization

Tokenized data can’t be reversed. Tokenization involves substituting sensitive data with random data, so there’s nothing to decrypt. A token simply holds the place of other data and has no real value.

The real data can remain in a different location such as an offsite platform. The original data doesn’t have to be kept inside an online computer network at all. If the tokens are compromised, an attacker has gained nothing. Tokens are useless to criminals.

Benefits

Tokenization

Encryption

Reversible X
Refunds, chargebacks, subscriptions X
Low-cost per transaction X
Centrally controlled X
Established security X
PAN data displayed X

What Are Some Examples of Tokenization?

When a credit card transaction is processed, the primary account number (PAN) gets substituted with a token. For example, 1234-2323-3434-5454 might be replaced with 6^fjk8Nm$zqGa.

A merchant can then use this token ID to retain customer records, like connecting the 6^fjk8Nm$zqGa token to Bob Smith. The token then gets sent to the payment processor who de-tokenizes the identification and confirms the transaction. 6^fjk8Nm$zqGa turns into 1234-2323-3434-5454 again.

Only the payment processor can read the token, making it useless for outside parties. The token can only be used with one merchant.

Here are some more specific examples of using tokenization payment.

Apple and Android Pay

With payment apps like Apple Pay or Android Pay, you first take a picture of your credit card and upload it to your phone. Then the payment processor (either Apple for Apple Pay or Google for Android Pay) sends the details to the bank who issued the credit card, which then tokenizes the card’s details. The token is then sent to Apple or Google before being programmed into the phone. This way, the number stored in the payment app can’t be of any use to attackers.

Tokenization Within Apps

Some apps allow for direct in-app purchases on a mobile device. If the phone has a token, such apps won’t have access to any raw credit card information. Not only does this kind of tokenization of payment prevent data from being useful to criminals, but it also makes payments easier. A tokenized account can be linked to your stored payment and shipping information, making the process quicker the next time around.

Tokenization in eCommerce

Tokenization helps protect consumers when they shop online, too. For example, when someone buys a product from a retail website, the retailer tokenizes the card information and keeps it on file. The data is safe even if it were to be hacked. If an attacker gains access to the system, all they will be able to see is random strings of characters.

Tokenization ensures these types of transactions can happen in a way that most benefits customers in terms of both safety and speed.

Benefits of Tokenization

Merchants and their customers benefit from tokenization in many ways, notably additional security, reduced costs, and a better user experience.

Additional Security

Today, cybersecurity often functions from a perspective of assuming that breaches are likely to occur. Because of how tokenization works, even if hackers access tokenized data, they probably still won’t be able to use it. The data would have to be decrypted first to be of any use. In this way, tokenization minimizes the risk of a data breach being harmful to a merchant or its customers.

Reduced Costs

Merchants can save on some of the costs that come with payment card industry (PCI) regulatory compliance by working with the right tokenized service providers. Protecting a company’s reputation by securing customer data can also prevent losses down the road, should something go wrong.

Better User Experience

Tokenization allows customers to store their credit cards in mobile wallets or at checkout for online payments. Cards can then be charged again without having to expose the original information. Merchants can provide a smoother customer experience this way because tokens can be used as payment for recurring subscriptions and one-click payments.

The Takeaway

Tokenization works by replacing real information with random characters called tokens. The tokens can then be used to process payments. There are a number of advantages to tokenization, especially over encryption — notably, while encryptions are made to be deciphered, tokenization is not.

There’s a lot to know when it comes to securing your transactions, finances, and investments. With a SoFi Invest® brokerage account, you can build your portfolio by securely trading your choice of stocks, exchange-traded funds (ETFs), and Initial Public Offerings (IPOs).

Find out how to get started with SoFi Invest.

Photo credit: iStock/paulaphoto


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.


Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.


Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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What Is a Utility Token?

What Is a Utility Token?

While the word “cryptocurrency” is often used as an umbrella term to describe all digital assets, there are actually several specific types of cryptos. Most of them fall into two main categories: coins and tokens.

Coins, or currencies, have one function: to transfer monetary value. Bitcoin (BTC) and Litecoin (LTC) are good examples of currencies.

Tokens, on the other hand, are a different class of cryptos entirely. Security tokens and utility tokens are the most common types.

Definition of Utility Token

A utility token is a crypto token that serves some use case within a specific ecosystem. These tokens allow users to perform some action on a certain network.

A utility token is unique to its ecosystem. Brave’s Basic Attention Token (BAT), for example, can only be used to tip content creators through the Brave browser or through other applications that have integrated BAT wallets, like Twitter. BAT has no other use beyond speculating on its value. The same can be said of any utility token.

Utility tokens are not mineable cryptocurrencies. They are usually pre-mined, being created all at once and distributed in a manner chosen by the team behind the project.

Utility Token vs Security Token

The main difference between a utility token and a security token is that security tokens give rights of ownership to a company. Think of them sort of like digital, decentralized shares of stock. Security tokens are also classified as securities by financial regulators like the Securities and Exchange Commission (SEC), making them subject to all the same rules as stocks, bonds, ETFs, and other securities.

While utility tokens are not currently classified as securities, there has been some speculation that one day, they could be. Even though these tokens are not intended to represent an investment the way that security tokens are, that’s not what matters most to regulators. The SEC uses something called the Howey Test to determine whether or not an investment is a security.

The criteria of this test are:

•   A monetary investment

•   People invest because they expect to make money

•   The investment is a “common enterprise,” meaning investors will only make money based on what the issuers of the investment do

•   Profits are dependent on the work of a third party

If the investment in question checks the above boxes, the SEC considers it a security. It’s not difficult to argue that they can apply to most tokens and cryptocurrencies.

What Are Utility Tokens Used For?

A utility token can serve just about any purpose a developer wants it to. In general, utility tokens provide access to a specific service or product with a blockchain ecosystem. In other words, you might need a certain utility token to be able to perform actions on an altcoin’s network.

While cryptocurrencies are a form of digital money, utility tokens might be better described as pieces of software. They can be used to transfer value, but that’s generally not their main purpose.

To swap tokens on a decentralized exchange (DEX), or do any number of decentralized finance (DeFi) activities, users may need a specific DEX token. Alternatively, such a token could be used to reward users of the platform or to pay out interest to those who deposit funds that the platform then lends out to borrowers.

Non-fungible tokens (NFTs) serve as a type of unique utility token, too. An NFT token is a one-of-a-kind digital piece of art, although NFTs can also be applied to things like music.

Utility tokens that have been used in Initial Coin Offerings (ICOs) could even be used for malicious or fraudulent reasons. For example, during the ICO craze of 2017-18, some new blockchain projects offered utility tokens to investors with promises of great returns. In reality, the projects were fake, and there wasn’t even any new software application being built. Investors who decided to buy ICO tokens like these often had no recourse and lost everything.

Get up to $1,000 in stock when you fund a new Active Invest account.*

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*Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

Examples of Utility Tokens

There are countless crypto projects that have made use of a utility token. Here are a few popular utility token examples. Most of these tokens run on the Ethereum network.

Basic Attention Token (BAT)

BAT token works with the Brave browser, which is designed to be secure and private. The Basic Attention Token allows for a new advertising revenue model that does away with the need for constant tracking of user’s behavior. Brave users can earn BAT by opting-in to view advertisements. BAT can then be used to tip content creators on their websites or on Twitter.

Chainlink (LINK)

Chainlink (LINK) is what’s known as an “oracle.” Oracles input data from an external source and upload that data to the blockchain. This can be useful for smart contract applications that need real-time price data.

0x (ZRX)

0x hopes to create a secure and fast crypto trading platform that incorporates elements of both centralized and decentralized exchanges.

Binance Coin (BNB)

Binance Coin (BNB) falls under the category of “exchange tokens,” or a token that is native to a specific crypto exchange’s ecosystem. In Binance’s case, users who hold BNB on the platform enjoy a 25% discount on trading fees. Instead of the fees being taken in the form of fiat or the crypto being traded, fees are deducted from the trader’s BNB balance instead.

Zilliqa (ZIL)

Zilliqa is a platform for creating decentralized applications. The goal is to make these apps more affordable and secure for developers. ZIL tokens also have uses in gaming and facilitating digital advertising.

Aurora (AOA)

Aurora is a decentralized banking platform for crypto. The system runs on smart contracts. The AOA token is a stablecoin that is backed by endorsements, debt, and reserves of cryptocurrency. There’s also a decentralized exchange.

What Are the Challenges of Using Utility Tokens?

Aside from regulatory challenges, there are technological and market challenges associated with the use of utility tokens.

One technical challenge involves transaction fees. Because many utility tokens are ERC-20 tokens running atop the Ethereum blockchain, Ether gas fees can sometimes get very high. As more people vie for space in the next block, they bid up gas prices, making it more expensive for everyone to make any transaction on the Ethereum network.

Like most altcoins, utility tokens can be used as vehicles for financial speculation. Depending on the purpose of the token, this could raise issues. If a certain dollar amount of tokens is required for users to do something on a network, and the dollar value of the token fluctuates wildly, users may struggle to anticipate how many tokens they need.

This is part of the reason why some utility tokens are stablecoins, or coins that are designed to maintain a 1:1 ratio with another asset, most commonly a fiat currency like the U.S. dollar.

The Takeaway

A utility token is a type of token that has a specific use case. Most of these tokens are created on an existing blockchain like Ethereum — the applications that these tokens are used for are created using Ethereum smart contracts, and the token then runs atop the Ethereum blockchain.

Some other platforms that developers might use for similar purposes include Tron (TRX or Tron token) or the Binance Smart Chain.

Photo credit: iStock/PeopleImages


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

2Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade Amount Bonus Payout
Low High
$50 $99.99 $10
$100 $499.99 $15
$500 $4,999.99 $50
$5,000+ $100

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Guide to Options Spreads: Definition & Types

Guide to Options Spreads: Definition & Types

Options spreads are multi-legged trading strategies used to limit risk while also capturing the potential for profits. Traders using an option spread simultaneously buy multiple options with the same underlying asset with different strike prices, different expiration dates, or both.

Understanding options spreads can help you decide whether these strategies will work for your portfolio, and which one to use in a given situation.

Credit and Debit Spreads

The difference between credit spread options and debit spreads is that an options trader sells one (credit), and buys the other (debit). When a trader sells an option, they receive a premium (a credit) to their account. Conversely, when they buy an option, they pay a premium to open the position, resulting in a debit to their account.

Recommended: What Investors Should Know About Spread

3 Common Option Spread Strategies

In options spread strategies, the trader buys and sells multiple options pegged to the same underlying asset or security. The type of options that the trader buys and sells are all of the same type (i.e., they’re all call options or put options), and they either have different strike prices or expiration dates.

Recommended: Popular Options Trading Terminology to Know

There are several different types of option spreads. Here’s a look at a few common ones:

1. Vertical Spread Options

A vertical spread is an options strategy in which the options have the same expiration date but different strike prices. There are four types of vertical spread options that investors use depending on whether they are bullish or bearish and whether the spread is a debit or credit.

Bull Call Spreads

A bull call spread strategy involves buying a call option, and then also selling another call at a higher strike price. The call spread options have the same underlying asset and expiration date.

Investors using this bull spread options strategy anticipate an increase in the value of the underlying asset. With this strategy, a trader caps their potential losses to the net premium they paid for the options (essentially hedging their risk). Their maximum gain is capped at the differences in strike prices, minus the net premium paid.

For example, a trader buys a call option on Stock X at a strike price of $10, for a premium of $2. They also sell a call option with an identical expiration date at a strike price of $12, receiving a premium of $1. This is referred to as a “debit” spread, as the trader pays a net premium (of $1 in this case) to buy into their position.

Bear Call Spreads

The opposite of a bull call spread, a bear call spread benefits when the underlying asset’s value decreases. If we stick with Stock X from our previous example, a trader using a bear call spread would anticipate that Stock X’s value is going to decrease.

As such, the trader sets up the spread by selling a call option, and buying another call option at a higher strike price—the inverse of the bull call spread method. This is a “credit” spread,, so the trader can not gain more than the net premium the trader received for the position. Their potential loss is capped at the differences in strike prices.

Example: A trader sells a call option on Stock X at a strike price of $10, and buys another call at a strike price of $12.

Bull Put Spreads

A bull put spread is similar to a bull call spread, but it involves puts rather than calls. Using a bull put spread, a trader anticipates an increase in the underlying asset’s value. In our example, the trader would sell a put option at a strike price of $10, and simultaneously buy another at a lower strike price, say, $8.

The trader can not lose more than the difference between the strike prices or gain more than the premium received.

Bear Put Spreads

A bear put spread is the inverse of a bull put spread. In our example, the trader would buy one put option at a $10 strike price, and simultaneously sell another put at a lower strike price, like $8.

The trader can not lose more than the net premium the trader paid to take the position (again, because this is a “debit” spread) or gain more than the difference in strike prices.

2. Horizontal Spreads

Horizontal spreads (also called “calendar spread options”) involve options with the same underlying asset, the same strike prices, but different expiration dates. The main goal of this strategy is to generate income from the time decay effects, or volatility of the two options.

There are also two main types of horizontal spreads.

Call Horizontal Spreads

A call horizontal spread is a strategy which a trader would employ if they believe that the underlying asset’s price would hold steady. In this case, the trader would buy a call with an expiration date on January 15th, for example, and sell another call with a different expiration date, like January 30th.

The trader can also reverse these positions, by selling a call option that expires on January 15th, and selling another that expires on January 30th. The two positions with differing expiration dates act as buffers, reigning in potential losses (the premium paid) and gains.

Put Horizontal Spreads

Put horizontal spreads similar to call horizontal spreads, except that traders utilize puts instead of calls.

3. Diagonal Spreads

Finally, we have diagonal spreads, which incorporate elements from both vertical and horizontal spread strategies. That is, diagonal spreads involve the same option types and underlying asset (the same as before), but with differing strike prices and differing expiration dates.

Diagonal spreads—with different strike prices and expiration dates—allow for numerous combinations of options, making them a fairly advanced strategy. They can be bearish, and bullish for example, while also using calls or puts, with different time horizons (long or short).

Other Options Spreads

While we’ve covered the main types of options spread strategies, there are a few more you may run into.

Butterfly Spread Options

A butterfly spread incorporates multiple strike prices, and can utilize either calls or puts. It also combines a bull and bear spread across four different options.

An example would be a trader buying a call at a certain strike price, selling two more calls at a higher strike price, and then buying another call at yet an even higher strike price—of equal “distance,” or value, from the two central calls. This results in a cap on losses and gains, with the trader realizing gains depending on volatility levels of the underlying asset.

Box Spread Options

A box spread option strategy involves a bear put and a bull call with identical strike prices and expiration dates. Under very specific circumstances, traders can use the strategy to create profitable arbitrage opportunities.

The Takeaway


There are several different options spreads strategies that traders use to limit their losses and achieve potential gains based on their projections about the price of a specific asset. Options strategies can get complicated, but you don’t need to invest in derivatives in order to build a portfolio.

Whether you’d rather start slow or dive into derivatives, a user-friendly options trading platform like SoFi can help in your investing journey. SoFi’s platform offers an intuitive design and access to educational resources about options. You’ll have the ability to trade from either the mobile app or web platform.

Trade options with low fees through SoFi.


Photo credit: iStock/damircudic

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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American Option vs European Options: Key Differences

American Option vs European Option: What is the Difference?

Two of the most popular types of options are American and European. American and European options have a lot in common, but there are some key differences that are important for investors to understand.

Options Basics

One of the reasons investors like options trading is that it provides the right, but not the obligation to the buyer, to buy (call) or sell (put) an asset. Making the choice to buy (call) or sell (put) is known as exercising the option.

Recommended: Call vs Put Option: The Differences

Like all derivatives, the value of options reflects the value of an underlying asset. The value of an option changes as its expiration approaches and according to the price of the underlying asset. Investors using a naked option trading strategy may not have the cash or assets set aside in their portfolio to meet the obligations of the contract.

If the value of the contract or the underlying asset doesn’t increase, the investor would choose to let it expire and they lose only the premium they paid to enter into the contract. Both put and call options contracts include a predetermined price to which the buyer and seller agree, and the contract is valid for a specified period of time.

After the contract ends on the expiration date, so does the option holder’s ability to buy or sell. There are many different options trading strategies that investors can use.

Recommended: What Is a Straddle in Options Trading?

What Are American Options?

America options are the most popular, with both retail investors and institutional investors using them. One of the reasons for their popularity is their flexibility. Traders can exercise their right to buy or sell the asset on any trading day during the term of the agreement.

Most often, American stock options contracts have an expiration period between three and twelve months.

American Option Example

Say an investor purchases an American call in March with a one-year expiry date. The contract states that the investor has the option to purchase stock in Company X for $25 per share. In options terminology, $25 would be known as the option’s strike price. As the price of the underlying stock asset changes, the value of the option also changes.

After the investor purchases the American call options, the value of the stock increases. Within a few months the price was $50. The investor decides to exercise their option to buy, purchasing 100 shares of the stock at the agreed upon strike price of $25/share, paying a total of $2,500. The investor then sells the shares at the current market price of $50/share, making a profit of $2,500 because their value had doubled, not including the premium paid.

Investors can also buy put options, which give them the right to sell instead of the right to buy. With put options the scenario is reversed in that the investor would exercise their right to sell if the asset decreased in value.

What Are European Options?

European options are similar to American options, but holders can only exercise them on the expiration date (not before), making them less flexible.

European Options Example

Let’s say an investor purchases a European call option for 100 shares of Company X with a strike price of $25 and an expiration date six months from the time of purchase. Three months after the contract starts, the price of the stock increases to $50/share. The investor can’t exercise the right to buy because the contract hasn’t reached the expiration date.

When the option holder is able to exercise three months later, the stock is down to $30/share. So the investor can still exercise the option and make a profit by purchasing 100 shares at $25 and selling them for $30. The investor would also need to subtract the upfront premium they made, so this scenario wouldn’t be nearly as profitable as the American option scenario.

This is why European options are not as valuable or popular as American options. Options pricing reflects this difference. The premium, or price to enter into a European option contract is lower. However, traders can sell their European options at any point during the contract period, so in the example above the trader could have sold the option for a profit when the stock price went up to $50/share.

American Style Options vs European Style

American and European options are similar in that they have a set strike price and expiration date. But there are several key differences between American and European options. These include:

Trading

One main difference between American and European options is traders typically buy and sell European options over-the-counter (OTC) and American options on exchanges.

Recommended: What is the Eurex Exchange?

Premiums

American options typically have higher premiums than European options since they offer more flexibility. If the investor doesn’t exercise their right to buy or sell before the contract expires, they lose the premium.

Settlement

European options tend to relate to indices, so they settle in cash. American options, on the other hand, typically relate to individual stocks or exchange-traded funds and can settle in stock or cash.

Settlement Prices

With American options, the settlement price is the last closing trade price, while with European options the settlement price is the opening price of index components.

Volume

American options typically have a much higher trading volume than European options.

Exercising Options

Traders can only exercise European options at the expiration date, while they can exercise American options at any point during the contract period. Traders can sell either type of option before its expiration date.

Pricing Models

A popular pricing model for options is called the Black-Scholes Model. The model is less accurate for American options because it can’t consider all possible trading dates prior to the expiration date.

Recommended: Black-Scholes Model Explained

Underlying Assets

The underlying assets of most American options are related to equities, European options are typically pegged to indices.

Risks of Americans and European Options

American options are riskier to an options seller because the holder can choose to exercise them at any time.

For buyers, it’s easier to create a hedging strategy with European options since the holder knows when they can exercise their right to buy or sell. Day traders and others who invest in options realize that there are risks involved with all investing strategies, along with potential reward.

The Takeaway

Options are one commonly traded type of investment, and many traders use them to execute a trading strategy. However, it’s possible to build a portfolio without trading options as well.

If you’re interested in options trading, one great way to get started is by checking out SoFi’s options trading platform. With an intuitive design, this platform is made to be user-friendly. Investors can trade options from the mobile app or web platform, and they can find more information about options through the educational resources offered.

Trade options with low fees through SoFi.


Photo credit: iStock/AleksandarNakic

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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What Are Blockchain Consensus Algorithms?

Blockchain Consensus Algorithms: Different Types and How They Work

What Are Blockchain Consensus Algorithms?

A crypto consensus mechanism forms the foundation of any blockchain. In 2009, Satoshi Nakamoto invented Bitcoin’s proof-of-work consensus algorithm to secure the Bitcoin network. Since then, several alternative consensus algorithms have been proposed.

The basic idea of achieving consensus on a blockchain is to create a way that everyone can agree that certain transactions are valid. That way, no one can cheat the system by creating fake transactions with money they don’t have, and the same funds can’t be sent twice.

Part of the reason Bitcoin was such a transformative technological innovation is that the proof-of-work method of achieving crypto consensus was the first-ever practical solution to the “double spend problem.”

With previous versions of electronic currency, one of the biggest hurdles programmers struggled to overcome was how to create a scarce digital asset that people couldn’t replicate and that couldn’t be spent more than once without everyone knowing.

Thanks in no small part to consensus algorithms, cryptocurrencies and the blockchain technology that powers them have overcome this problem.

Recommended: Crypto 101: What is Cryptocurrency?

What Is a Consensus Mechanism?

In a system run by one central authority (say, a bank), preventing double spending is simple. One entity manages the ledger of transactions, making sure everything runs smoothly. If Alice wants to give a dollar to Bob, the central manager subtracts a dollar from Alice’s account and adds that dollar to Bob’s account. Payment rails like banks and PayPal use this type of consensus mechanism.

With cryptocurrencies, however, there is no single entity in charge of the system, because it is a decentralized network by design. That makes keeping a record of the ledger of transactions — or, establishing a consensus mechanism — more difficult.

Recommended: What Is Distributed Ledger Technology (DLT)?

Consider Bitcoin, as an example. Instead of a single central server, many thousands of people around the globe run the Bitcoin software. The servers they run are called “nodes.” The nodes must somehow come to the same conclusion regarding what transactions have occurred on the network, or to “achieve consensus.” All the nodes need to be on the same page for the network to function.

How Does a Consensus Algorithm Work?

The way a crypto consensus mechanism works varies depending on the algorithm. But all have the same end goal: to achieve consensus on the network. This requires all nodes to agree on which transactions are valid and which are not. Consensus must be maintained from block to block in an orderly and secure fashion if things are to continue running smoothly.

Many of the potential cyberattacks that target blockchains involve disrupting the process of new block generation in some way. For this reason, it’s important that crypto consensus be achieved in a way that makes it difficult for bad actors to intervene.

Types of Consensus Algorithms

There have been many attempts to improve upon proof-of-work (PoW) algorithms. Proof of stake (PoS) might be the most popular of these, as many of the top cryptocurrencies by market cap today are PoS coins. Other crypto consensus methods like proof of burn or proof of capacity are less well-known and haven’t been tried as much.

Proof of Work

While there are now many different consensus algorithms, proof of work is still the most commonly used. To date, this method has shown itself to be reliable and secure.

Miners are the people who run computers that maintain the network by solving complex mathematical problems. The miner that first solves the problem gets to add the next block of transactions to the blockchain and also earns the new coins minted along with that block (the block reward). This is the process by which a verifiable history of transactions on the blockchain gets created.

PoW has shown to be a strong and secure method of achieving consensus. It would require so much computational power to overtake a large PoW network that any would-be hackers would be incentivized to become honest participants in the network instead. In other words, it’s easier and more rewarding to just mine for coins than it is to make any attempts at attacking the network.

Some of the downsides of PoW are that the process takes a lot of energy, it may not scale well, and it can trend toward centralization due to the high costs of new equipment — not everyone will be able to afford to mine. The main benefit of PoW is that it has the longest track record and has proven to be the most secure consensus algorithm. To date, there has never been a successful attempt at disrupting Bitcoin’s block production.

Proof of Stake

Proof of stake is a popular consensus mechanism that can be used by blockchains to verify their transaction history. While miners in PoW networks perform energy-intensive work to mine blocks, validators in PoS commit stakes of tokens to validate blocks.

With PoS, validators take the place of miners. They verify transactions by staking crypto on the network, which involves locking up a certain amount of coins for a set period of time, during which the coins will be unusable. Validators have a chance at being randomly selected to find the next block.

Other validators then “attest” that they also believe the block to be valid. Once enough validators have attested to a block’s validity, the block is then added to the chain. All validators involved in the process receive part of the block reward.

One of the big differences between PoS and PoW is that PoW requires miners to expend energy in the form of electricity to find blocks. PoS requires validators to stake their crypto, or in other words, to deposit money. For this reason, proof of stake is praised for being a less energy-intensive consensus mechanism than proof of work.

On the other hand, a disadvantage of PoS is that it favors the wealthiest token holders (who can stake more tokens) and trends toward centralization.

Proof of Burn

Proof-of-burn (PoB) algorithms employ the process of “burning” tokens to achieve crypto consensus. Burning coins involves sending them to an address from which they can never be recovered. Once sent to a burn address, coins are lost forever.

On a PoB network, people mine crypto by burning coins. The more coins burnt, the greater the reward.

An advantage of PoB is that it takes very little energy. A disadvantage is the question of how supply and demand will play out on such a blockchain. Burning existing coins to receive a reward of new coins seems counterintuitive. A delicate balance would have to be maintained for the system to work long-term.

What is the Bitcoin Consensus?

Bitcoin uses the proof-of-work consensus mechanism. Miners must contribute computing power and electricity to mine what remains of the 21 million bitcoins. Bitcoin mining involves processing transactions for the network, work for which miners are compensated with newly minted coins (the block reward). As of December 2021, each block rewards miners with a total of 6.25 BTC.

What is the Ethereum Consensus?

The Ethereum network also uses proof of work, although developers have been planning a move to proof of stake for some time. This change seems to be delayed each time it approaches, so there’s no telling when exactly it might happen.

The Takeaway

Consensus needs to be reached for a crypto network to know which transactions are valid. Otherwise, anyone could spend the same funds twice or make fake transactions using funds they don’t own.

While there are a number of other ways of achieving consensus, proof of work and proof of stake are the most well-known and widely used for now.

Photo credit: iStock/Eoneren


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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