Although it is not certain how the challenge coin came to be, one story dates back to WW l.   When a wealthy officer had bronze medallions struck with the flying squadrons insignia to give his men.  Shortly after, one of his flying aces was shot down over Germany and captured.  The Germans took everything except a small leather pouch , he had around his neck that contained the medallion .  The pilot escaped and made his way to France, but the French believed he was a spy and sentenced him to death.  In an effort to prove his identity the pilot produced the medallion.  The French soldier recognized the insignia and his execution was delayed.  The French confirmed his identity and sent him home to his unit unharmed.
 
In Germany after WW ll Americans stationed there, took up a local tradition of conducting “pfenning checks”. The pfenning was the lowest denomination  of coin in Germany, and if you did not have one when checked you were stuck in buying the beers in the local pub. This evolved from pfenning to the units medallion. A member would “challenge” each other by slamming a coin down on the bar.  If any member present did not have a medallion, he had to buy a drink for the challenger and anyone else without a coin.  If all of the other members had the medallions, the challenger had to buy the drinks.  
 
They are used in modern day as a way of honoring the military by exchanging the coins of your organization.