WEB3 TOKENS=> The atomic units of web3
Web3 Tokens #
Tokens are the atomic unit of the Web3 and are collectively managed by a distributed ledger. They can be issued with just a few lines of code with a smart contract. Token contracts are rights management tools that can represent anything from a store of value to a set of permissions in the physical, digital, and legal world. They might affect the financial world similar to how the Internet affected the postal system.
A token contract is a special type of smart contract that defines a bundle of conditional rights assigned to the token holder. They are rights management tools that can represent any existing digital or physical asset, or access rights to assets someone else owns. Tokens can represent anything from a store of value to a set of permissions in the physical, digital, and legal world. They facilitate collaboration across markets and jurisdictions and allow more transparent, efficient, and fair interactions between market participants, at low costs. Tokens can also incentivize an autonomous group of people to individually contribute to a collective goal.
The ability to deploy tokens at a low cost relatively effortlessly on a public infrastructure is a game changer, because it makes it economically feasible to represent many types of assets and access rights in a digital way that might not have been feasible before. Examples could be fractional ownership of art or real estate. Such fractional tokenization might improve the liquidity and transparency of existing asset markets. Increasing tokenization of existing assets and access rights could fundamentally impact global economic dynamics, much more than might meet the eye at such an early stage of the Web3
Whereas state-of-the-art digital assets are controlled by centralized entities, they can now be issued with a few lines of code, and managed by a public and verifiable infrastructure like a blockchain network. They can be easily issued and securely traded on a public infrastructure without an intermediary or escrow service. Tokens can provide (i) more transparency along marketplaces than existing financial systems currently offer. This could significantly reduce fraud or corruption along the supply chain of goods, services, and financial transactions. Tokens also have the potential of (ii) reducing the transaction costs of developing, managing, and trading cryptographic assets along distributed ledgers, as opposed to managing assets along state-of-the-art systems. As a result, (iii) increased liquidity, lower costs of price discovery, and less fragmented markets could reduce market friction, enabling more efficient marketplaces for certain assets like art or real estate. Tokenization of the economy could also enable (iv) completely new use cases, business models, and asset types that were not economically feasible before, and potentially enable completely new value-creation models.
Properties of Tokens #
While it is technically possible to represent any asset of the existing economy as a cryptographic token, we still lack adequate taxonomy, and adequate legal framework that understands the full scope and potential of this new substrate with which we can issue any type of asset and access right, including completely new asset classes. However, establishing a consistent and reliable taxonomy for token properties, as well as classification models, is the basis from which developers, policy makers, and investors can make more sense of how to design, apply, or regulate tokens.
Identifying different properties of a token can be used as a first step to fine-tune a future classification framework and also for designing the properties of a token. This identification of properties is a result of a process called “morphological analysis.” It is a framework for structuring the relevant questions as a first approach in a heuristic way, especially useful for exploring all the possible solutions to a multi-dimensional, non-quantified complex problem. Here we introduce the most important perspectives from which we can derive the properties of a token: (i) Technical perspective; (ii) Rights perspective; (iii) Fungibility perspective; (iv) Transferability perspective; (v) Durability perspective; (vi) Regulatory perspective; (vii) Incentive perspective; (viii) Supply perspective; and (ix) Token flow perspective.
From a technical perspective, tokens can be implemented on different layers of the technology, either as (i) protocol tokens, (ii) second-layer tokens, like application tokens or tokens created on a sidechain,[^2] or as (iii) multi-asset ledger tokens. Protocol tokens, also referred to as intrinsic, native, or built-in tokens, have a very clear role in a public network: to keep the network safe from attack by acting as block validation incentives (miner rewards), and for transaction spam prevention. Native protocol tokens might furthermore be needed to pay for transaction fees in the network and can be regarded as the “currency” of the distributed Internet. Application tokens, on the other hand, can have any function or property. They can represent anything from a physical good, a digital good, or a right to perform an action in a network or in the real world. The Ethereum network has one protocol token (ETH) and a whole economy of application tokens running on top of the network (ERC-20 and other Ethereum token standards allow the creation of application tokens with a smart contract).
Fungibility refers to the interchangeability of a unit of an asset with other units of the same asset. Examples thereof could be any durable goods, such as precious metals or currencies. Fungible assets have two key properties: (i) Only quantity matters, which means that units of fungible assets of the same kind are indistinguishable. (ii) Any amount can be merged or divided into a larger or smaller amount of it, making it indistinguishable from the rest. If you were to lend 10 EUR to someone, for example, it would not matter if that person returns the exact same 10 EUR bill or another one, or various bills and coins that amount to the value of 10 EUR. The same applies to one barrel of crude oil. Flour is another example of a fungible asset, and is also one of the reasons why it was used as a commodity currency in the past. Fungibility is an important property of any currency or commodity to serve as a store of value, medium of exchange, and a unit of account.
Equally, fungible cryptographic tokens can represent any physical or digital assets that are identical to each other and can therefore be easily replaced. They are not unique and are therefore exchangeable with other tokens of the same type. If two parties have the same amount, they can swap them without losing or gaining anything. Unique tokens, on the other hand, are non-fungible. Examples thereof are ID cards, or a token that represents the ownership of a house, a car, a piece of art, or a gym membership. Non-fungible tokens can be transferable or not, depending on the use case.
As opposed to common belief, the Bitcoin network does not provide full anonymity, hence privacy, but rather pseudonymity. This means that one can use the power of big data to correlate other data points, which might be publicly available or accessible to certain national security agencies, against the metadata connected to a certain BTC transaction and address. If someone behind a Bitcoin address becomes a person of interest, and the provenance of their tokens’ history becomes tainted or blacklisted, this person might have problems trading their tokens. In such cases, authorities could correlate your Bitcoin address against other, more traditional data points that are subject to know-your-customer regulations (KYC), like banks and exchanges, or even e-commerce platforms like Amazon. If you were to pay for your purchase on Amazon with Bitcoin, for example, and your tokens have a history that is tainted, Amazon might decide not to accept it. The privacy, and as a result also the fungibility of Bitcoin and similar tokens, may therefore be up for debate. If a tokens’ history can be tracked and that token is linked to illicit activity that would make the token “tainted,” limiting its role as a medium of exchange. Newer blockchain networks like “Zcash” and “Monero” are working with alternative cryptographic tools that could make their tokens more private and thus more fungible
Tokens can be transferable or non-transferable, or have restricted transferability. Unique (non-fungible) tokens can be transferable or non-transferable depending on the use case. A plane ticket might be transferable or non-transferable depending on the type of ticket you bought. A piece of art or the registration paper of your car, for example, are unique but transferable. Identity-bound tokens like certificates or licenses are usually non-transferable. A token that allows you to pick up your kids from kindergarten is unique, but could have some limited or temporary transferability to allow you to arrange for someone else to pick up your kids by temporarily granting that person pickup rights. While fungible tokens tend to be transferable in most cases, there are also exceptions to the rule.
In economics, durability refers to the ability of a currency to withstand repeated use. This means that the substrate of that currency should not easily vanish, decay, or rot. Metals or durable foods like wheat have high durability, and were therefore often used as commodity money. The Bitcoin token and similar protocol tokens have so far proven to withstand time, being resilient against any type of censorship or network attack. A resilient network is expected to contribute to a “relatively” stable long-term value of the token. If one can correlate network resilience to the value of the network token, the token can be expected to be durable, as it will not cease to exist. As long as the network is robust and used, new tokens will be minted and demand for tokens will increase. Token prices might decrease due to price fluctuations, but the token as such will not vanish as long as the network is intact. A network with a weak consensus protocol, on the other hand, might be attacked and manipulated, in which case token holders could lose their tokens if the ledger is tampered with.
Regulation is a complex topic that could cover a book on its own, especially taking into account all 200+ jurisdictions in the world. To simplify matters, at this point, it is sufficient to say that regulators need a clear taxonomy of the different types of tokens to understand what they are potentially regulating. Regulatory authorities all over the world are catching up to understand the full potential and implications of the Web3 and it’s tokenized applications. While some tokens might represent completely new asset classes, like native protocol tokens that very often have hybrid functions and are not easy to classify, other token types might represent assets of the existing economy that are understood and regulated. An example for assets that are easy to classify or regulate are tokenized securities and other assets. In more complex cases, entrepreneurs will be confronted with uncertainties of how the regulator might retroactively classify the token. To provide regulatory certainty to entrepreneurs, some jurisdictions have started to offer governmental sandboxes to guarantee innovation while allowing for a process of regulatory learning.
As opposed to tokens that represent existing assets or access rights to an asset or services someone else owns, tokens can also be programmed to incentivize a new form of collective value creation. They can be used to incentivize individual behavior or contributions to a collective goal of a group of people, if and when one provides proof of contributing to a collective goal. Bitcoin and other protocol tokens are a good example for such purpose-driven tokens. Rewards programs or loyalty programs are another example for tokens that are designed to reward behavior. While incentivizing behavior is not a new concept, cryptographic tokens have spurred a lot of innovation around purpose-driven tokens that incentivize behaviors, like CO2 tokens, time bank tokens, social media tokens, attention tokens, etc.
Protocol tokens vary in their token supply strategies. Bitcoin’s token supply is regulated in the protocol and limited to 21 million. The Ethereum network, on the other hand, did not predefine the token supply in the same way. For tokens that represent an access right, the number of tokens is usually limited to the maximum capacity and frequency of the access provider. The only limit is the capacity of a system, such as the capacity of a bus in a public transport network, which can always be extended if necessary, most often including a time lag. Many of the tokens listed on “Coinmarketcap,” especially those that were used for early token sales to raise funds, have a limited token supply. This is especially true for tokens that represent equity in a network. Asset tokens are naturally limited by the amount of assets available to back them with. Any token with a limited supply could potentially serve as a de-facto store of value and medium of exchange, depending on the expected durability, short-term volatility, and fungibility.
Short-term stability of value is one of the most important functions of a medium of exchange, so that it can serve as a unit of account and is fundamental for economic planning. While Bitcoin introduced a groundbreaking consensus algorithm, it comes with a rudimentary monetary policy that simply regulates and limits the amount of tokens minted over time. The protocol does not provide an economic algorithm that guarantees price stability. Depending on the type of token designed, price stability might be desirable, especially in the case of payment tokens that are intended as a day to day medium of exchange. If price stability is needed, according mechanisms need to be built into the mechanism of the token.
Another dimension revolves around the question of the token flow. Tokens might be created for a single purpose and destroyed when the purpose has been fulfilled to complete the cycle. In this case, they flow in a straight line from source to sink. Examples thereof are casino chips that can be used within the realm of the casino and are issued against fiat currency. Once players leave the casino, they can convert the chips back to the local currency. Transportation tickets that pay for access to a system and expire after one-time use, or after a period of time, are another example. They are destroyed upon consumption or after a certain expiry date. Their supply is unlimited, or it is limited to the infrastructural capacities. On the other hand, tokens that can be exchanged back and forth indefinitely, without an artificial expiration condition, can be said to have a circular flow. Most asset tokens that are transferable and have no expiry date, like any currency or commodity token or tokenized art, have circular token flows. Tokens with a circular token flow will only sink when you lose your private keys, or if the physical underlying asset is accidentally destroyed.
Another question when designing a token is whether the token has an expiration date. Any fungible token might be programmed in a way that it expires after a certain date, to prevent hoarding of the tokens. Practically speaking, the token would expire; technically speaking, the token would change state. Bonus points of loyalty programs usually come with an expiry date. In the past, some regional currencies, like the “Wörgl Schwundgeld” (Austria) in the 1930s, experimented with an inbuilt deflation of their currency to prevent hoarding and inflation. The currency was introduced as a parallel currency that could only be spent in the region of Wörgl. By losing 1 percent of its value each month, individual spending was encouraged while saving was disincentivized. This measure was introduced to combat a country-wide deflationary policy and helped with both unemployment numbers and infrastructure investment.
- The following text it’s a ‘simplification’ of the original by Shermin Voshgmir in the Token Economics Book
More about Token Economy, Design and Engineering #
- Catalini, C., Gans, Joshua S.: “Some Simple Economics of the Blockchain”, NBER Working Paper No. 22952, 2016
- Chen, Y., “Blockchain Tokens and the Potential Democratization of Entrepreneurship and Innovation”. Business Horizons, Forthcoming; Stevens Institute of Technology School of Business Research Paper, 2017.