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• These tokens are issued on a blockchain network
• An asset backs them.
• They are not tied to a specific cryptocurrency.

IOU is borrowed from a traditional financial term, “I Owe You.” It means that the party has a certain amount of debt from another. IOU is a particular type of contract because it is in the form of a token that is a digital asset. Assets back these tokens. They make the contract between both parties brilliant, and the token has a specific value. 

Understanding with an Example

Let us say you lend $100 to your friend, Sarah, and want proof or acknowledgment of this transaction. In this situation, IOU tokens can be handy. Sarah can create an IOU token on a blockchain network, and this token will represent the debt she owes you. The IOU token is backed by the $100 she borrowed from you. She can then send this IOU token to your digital wallet on the identical blockchain.

The IOU token is a digital contract between you and Sarah, indicating that she owes you $100. It is like a virtual promissory note. The beauty of using a blockchain is that the transaction is recorded in a decentralized and immutable way, providing a transparent and tamper-proof debt record.

Later, when you want your money back, you can refer to the IOU token as proof of the debt. You can show the token on the blockchain and request the $100 from Sarah, reminding her of the amount she borrowed.

The Working of IOU tokens

1. Creation

The lender or the borrower creates IOU tokens on any blockchain. These tokens have all the details of the agreement between the two parties. 

2. Sending

After the creation of the token, this step is followed by sending the token to another person. The token is sent to the crypto wallet of that person. The token acts as a representation of the loan agreement.

3. Completion

After the borrower sends the remaining money to the lender, including the interest rate, the loan agreement is completed, and the token is considered fulfilled.

Advantages of Creating an IOU Token

Using IOU tokens creates a promise that cannot be denied; that is why these tokens are used to create a contract between the two parties. Since IOU tokens are non-destructible, they can neither be changed nor deleted, making them more secure.

Another advantage of these tokens is that they are not tied to a specific cryptocurrency, providing better freedom to be backed by any asset of their choice. IOU tokens can be traded on any exchange, such as Poloniex and Uniswap. These tokens can be used as collateral assets on lending platforms that support them, such as Poolin.

Risks Associated with IOU Tokens

Trustability is the central issue that IOU token holders often face because the crypto market is uncertain.  As any authority does not regulate the crypto space, it is prone to scams. Hence you should ensure that the borrower with whom you are lending money will be able to return it.

Users should also trust the platform on which they created the token so that the platform will not freeze or suspend it. IOU tokens do not have any legal use. It means that if any borrower refuses to return the lender’s money. The lender cannot go to court and file a case.

Disclaimer

The views and opinions stated by the author, or any people named in this article, are for informational purposes only and do not establish financial, investment, or other advice. Investing in cryptocurrencies and NFTs comes with a risk of financial loss.