The emergence of distributed technologies like blockchain and other DLTs has enabled the rise of digital tokens. These cryptographic tokens are easily issued at low cost, and facilitate collaboration across markets and jurisdictions, promising radically more transparent, efficient and fairer interactions between market participants. They can represent a store of value or a set of permissions in the physical, digital, and legal world. The ability to rapidly deploy tokens at low cost is a game changer. It creates a range of new asset classes, that can enable new business models that were not feasible before while improving the liquidity and transparency of new and existing asset markets. It is possible that the impact of tokenizing existing asset classes – like real estate, commodities, and securities – might by far exceed the impact of the new type of asset classes like native blockchain tokens.
While the existence of tokens in general, and digital tokens in particular, is not in and of itself new, the speed with these new blockchain based tokens are being deployed combined with the scope of value which these tokens represent, is by far unprecedented. Within less than a decade since the emergence of the Bitcoin Whitepaper in 2009, the world has gone from no cryptographic assets to a thriving ecosystem of around 1700 crypto assets listed on Coinmarketcap by the end of 2018. But while more and more people are starting to invest into cryptographic tokens, the understanding of the different token types out there is still limited. Even among professional investors and seasoned members of the blockchain community. To add to the confusion, terms like cryptocurrency, crypto asset, and tokens are very often used as synonyms.
The media mostly tend to refer to these new assets as “cryptocurrencies”. Often they use the term to describe a diverse range of cryptographic assets or “cryptographic tokens” that could represent anything from a physical good, a digital good, a security, a collectible, a royalty, a reward, a ticket to a concert, just to name a few options. I would, therefore, like to argue, that the term cryptocurrency is not ideal since many of these new assets were never issued with the intention to represent money in the first place.
A cryptographic asset would be a more generic term that one could use. However the term token is also generic, and with the rise of ICOs over the last few years, the term token has become somewhat omnipresent, describe a diverse range of cryptographic assets. While the lack of clear agreed upon terminology and definitions is a quite common one in emerging domain, precision in language and terminology is a basis for an informed, nuanced dialogue. This chapter will, therefore, try to give an overview of different types of cryptographic tokens, from a technical, legal and business perspective.
Definition of Tokens
As stated above, Tokens are not a new thing and have existed before the emergence of Blockchain. Traditionally, tokens can represent any form of economic value, like a Jeton as used in casinos, a voucher, a gift card, bonus points in a loyalty program, etc. Tokens are also commonly used in computing, where they can represent a right to perform some operation, or manage access rights, just to name a few examples. Cryptographic tokens on the Blockchain combine both concepts: access right to some kind of economic value or permission to conduct some operation in a network which usually results in some kind of economic value. Tokens can, therefore, represent legal instantiations of a share of an asset, a set of permissions, or a set of claims.
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The advantage of cryptographic assets over traditional tokens is the possibility to build specific, auto enforceable business logic into the governance rules of the token infrastructure via “smart contracts” that run on some kind of distributed ledger at very low cost, with high levels of transparency to all actors involved.
From Native Tokens to App Tokens
Crypto Economics as a backbone of Blockchain is a new discipline, and tokens seem to be the killer app of this emerging techno-legal phenomena. The crypto economics behind blockchain allows for the creation of a new type of global governance tool, reducing the transaction costs of global coordination, steered by cryptographic tokens.
It all started with native tokens of state of the art public & permissionless Blockchains like Bitcoin, Ethereum, and the like. These native tokens (or protocol tokens) are part of the incentive scheme of Blockchain infrastructure. The governance rules tied to these tokens – the so-called consensus mechanism – was a game changer in the evolution of peer-to-peer (P2P) networks. Bitcoin and it’s underlying blockchain technology introduced the concept of economic incentives to make sure that all network actors, who mostly do not know or trust each other, follow the rules. These blockchain based cryptographic tokens enable “distributed Internet tribes” to emerge. As opposed to traditional companies that are structured in a top-down manner with many layers of management and bureaucratic coordination, blockchain disrupt classic top-down governance structures with decentralized autonomous organizations (DAOs), where a group of people bound together not by a legal entity and formal contracts, but instead by cryptographic tokens that act as incentives, and fully transparent rules that are written into the protocol (software).
The Blockchain protocol is designed on the assumption that everybody’s a crook, and that the least common denominator is money. The role of the native token in a blockchain is to encourage a disparate group of people who do not know or trust each other to organize themselves around the purpose of a specific blockchain. The native token of the Bitcoin Network also referred to as Bitcoin, has token governance rulesets based on crypto economic incentive mechanisms that determine under which circumstances Bitcoin transactions are validated and new blocks are created.
The Bitcoin Network can be seen as the first true DAO that provides an infrastructure for money without banks and bank managers and has stayed attack resistant and well as fault tolerant since the first block was created in 2009. No central entity controls Bitcoin. In theory, only a worldwide power outage could shut down Bitcoin. With the advent of Ethereum however, tokens have moved up the technology stack and can now be issued on the application layer as dApp tokens or DAO tokens. Smart contracts on the Ethereum Blockchain enable the creation of tokens with complex behaviors attached to them. Today, the token concept is central to most social and economic innovations developed with blockchain technology.
Native protocol tokens are only necessary for permissionless ledgers like Bitcoin, Ethereum as some sort of incentive mechanism to guarantee that block validators do their job according to the predefined rules. In permissioned (federated/consortium/private) distributed ledger systems, validators do not require a token, as block-creators may be doing their job for different reasons. In permissioned ledgers, block validators are known to each other, they have legal agreements with each other, and will comply with the rules if they are contractually obligated to do so. In permissioned environments, validators can only be members of a consortium. They trust each other because they are known to each other, have bilateral contractual agreements with each other, and if anything goes wrong, they know who to sue. Permissioned ledgers, don’t need a token to incentivize coordinated action. The term blockchain in the context of such federated ledgers is therefore highly controversial.
Ethereum has made it easy to create issue own token, using a standard token smart contract, with just a few lines of code. ERC-20 is a technical standard used for smart contracts on the Ethereum blockchain for implementing tokens. Due to the simplicity of deployment, together with its potential for interoperability with other Ethereum token standards, it became popular with crowdfunding projects issuing their own tokens through initial coin offering (ICO). ERC-20 defines a common list of rules for Ethereum tokens to follow within the larger Ethereum ecosystem, allowing developers to accurately predict the interaction between tokens. These rules include how the tokens are transferred between addresses and how data within each token is accessed. A clear majority of tokens issued on the Ethereum blockchain are ERC-20 compliant. As of Sept 2018, 119.781 ERC-20 compatible tokens were found on Ethereum main network.
Also published on Medium.