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Shermin Voshmgir edited this page Jun 1, 2021 · 1 revision

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.

While the existence of tokens in general and digital tokens in particular is not new, the speed with which these cryptographic tokens are being deployed and issued is an indicator that these tokens might be the killer application of blockchain networks. As of May 2020, an ecosystem of over 5400 publicly traded cryptographic tokens are listed on “Coinmarketcap,” and a total of over 260,000 Ethereum token contracts were found on the Ethereum main network. These tokens are often issued with just a few lines of code in the form of a smart contract that is collectively managed by a blockchain network or similar distributed ledger. As such, they represent the atomic unit of the Web3, they represent “local” part of the entire state of the network. All nodes in the network have the same information about who owns which tokens, and the transfer of those tokens - the state change - is collectively managed.

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. These tokens are created upon proof of a certain behavior (read more: Chapter 4 - Purpose-Driven Tokens).

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 (read more: Part 4 - Asset Tokens & Fractional Ownership).

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.

While more and more people are starting to create and invest into cryptographic tokens, the understanding of different token types out there is still limited. To add to the confusion, terms like “cryptocurrency,” “crypto assets,” and “tokens” are very often used synonymously. The media mostly tends to refer to these new assets as “cryptocurrencies,” which is often used to describe a diverse range of “crypto assets” or “tokens” that could represent anything from a physical good, a digital good, a security, a collectible, a royalty, a reward, or a ticket to a concert. 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. “Cryptographic asset” would be a more generic term that one could use. The term “token” is becoming more widespread since it is more generic, encompassing all token types rather than only asset-backed tokens.

While a lack of clear, agreed-upon terminology and definitions is quite common in emerging domains, precision in language and terminology is a basis for informed decisions and general discourse on the subject matter. It is important to understand that we are still throwing around a set of overlapping terms to refer to more or less the same thing, which generates much confusion. This chapter will, therefore, try to give a brief overview of the history and different properties of cryptographic tokens, from a technical, legal, and business perspective, clarifying some terms along the way.

History of Tokens

Tokens are not a new thing and have existed long before the emergence of blockchain networks. Traditionally, tokens can represent any form of economic value or access right. Shells and beads were probably the earliest types of tokens used. Other types of tokens are, for example, casino chips, vouchers, gift cards, bonus points in a loyalty program, coat-check tokens, stock certificates, bonds, concert- or club-entry tokens represented by a stamp on your hand, dinner reservations, ID cards, club memberships, or train or airline tickets. Most tokens have some inbuilt anti-counterfeiting measures, which may be more or less secure, in order to prevent people from cheating the system. Paper money or coins are also tokens. Tokens are furthermore used in computing, where they can represent a right to perform an operation or manage access rights. A web browser, for example, sends tokens to websites when we surf the web, and our phone sends tokens to the phone system every time we use it. A more tangible form of computer tokens are tracking codes that you get to track your parcel with postal services, or QR codes that give you access to a train or plane. In psychology, tokens have been used as a positive reinforcement method of incentivizing desirable behavior in patients, especially in a hospital setting. Cognitive psychology uses reward tokens as a medium of exchange that can be exchanged for special privileges within the setting of a hospital stay. Another example of inventive tokens are customer loyalty programs that offer bonus points for using an airline that can be redeemed for other goods or services.

A recyclable bottle is an analogue example for a token. In some countries, bottles you buy in supermarkets are issued with their recycling value, of usually a few cents, printed on them. This recycling value is paid on top of the initial price of the product and has become a method for governments to encourage the recycling of materials and subsequent reduction of litter in public places. Upon return of the bottle, the recycling value will be reimbursed. Losing the bottle is, therefore, equivalent to losing money.

A garbage bag could also represent a token. In some parts of Switzerland, for example, you can’t just throw out your trash using random bags. You have to buy special-purpose plastic bags that include a dumpster fee, issued by local authorities, and you can only use those bags to dispose of your trash. As opposed to most other countries, where you pay your garbage bill monthly, as part of your utilities bill tied to the rent of your apartment or house, this system requires you to purchase special-purpose plastic bags.

Tokens always need a substrate that ensures their validity, including some inbuilt anti-counterfeiting measure. Historically, tokens have been issued and managed by centralized entities, to ensure validity, and have had security mechanisms built into the substrate. Central banks issuing coins and bills need to make sure that their tokens, the coins and bills, are hard to copy. The same is true for a concert organizer issuing tickets to a concert. The validity and security of cryptographic tokens is managed by the smart contract that created them, together with the underlying distributed ledger by majority consensus of the network nodes.

Cryptographic Tokens

Cryptographic tokens managed by a distributed ledger can combine all above mentioned concepts. They can represent access rights to a property or service that can be either public (Bitcoin network) or private (an apartment that is rented out by a private person). They represent a set of rules, encoded in a special type of smart contract, also referred to as the token contract. In the context of blockchain networks, tokens don’t manifest as digital files; instead, they are represented as an entry in the ledger and are mapped to a blockchain address which represents the blockchain identity of the token holder. Tokens are therefore only accessible with a dedicated wallet software that communicates with the blockchain network and manages the public-private key pair related to the blockchain address. Only the person who has the private key for that address can access the respective tokens. This person can, therefore, be regarded as the owner or custodian of that token.[^1] If the token represents an asset, the owner can initiate transfer of the token by signing with their private key. If the token represents an access right to something somebody else owns, the owner of that token can also initiate access by signing with their private key. The same applies to tokens that represent voting rights (read more: Part 1 - Cryptography).

The first blockchain tokens were the native tokens of public and permissionless blockchain networks. These native tokens—also referred to as protocol tokens—are part of the incentive scheme of blockchain infrastructure. With the advent of Ethereum, however, tokens have moved up the technology stack and can now be issued on the application layer. Such application tokens can have simple or complex behaviors attached to them. Ethereum made it particularly easy to issue tokens with a few lines of code. Standardized smart contracts like the “ERC-20” standard define a common list of rules for Ethereum tokens, including how the tokens are transferred from one Ethereum address to another and how data within each token is accessed. These token contracts manage the logic and maintain a list of all issued tokens, and can represent any asset that has features of a fungible commodity. A vast majority of early tokens issued on the Ethereum network have been ERC-20 compliant fungible tokens. Fungibility refers to the fact that every token has an identical value with any other token of the same kind and can be easily traded.

Over the last year, however, more complex token standards have emerged that can represent any asset or access rights with special properties, including identities and voting rights. “ERC-721” introduced a free and open standard that describes how to issue so-called “non-fungible tokens” on the Ethereum network. This has introduced the era of building more complex features into the tokens. ERC-721 has made it easy to create a token that represents any type of collectible, art work, property, personalized access rights, or voting rights. These non-fungible tokens have special properties that make the token unique, or that are tied to the identity of a certain person, and therefore represent less fungible or non-fungible assets and access rights. ERC-721 enables the emergence of a much richer spectrum of smart contracts that exceed the possibilities of the fungible tokens, which have been dominating the narrative in the early years of the technology, paving the way for a diverse set of use cases.

Different ledger systems have varying standards that are often incompatible. At the time of writing this book tokens issued on one network are, for the most part, incompatible with other networks and cannot cross ledgers directly. The different standards make it currently infeasible for wallet developers to provide multi-token wallets, which means that very often we will need multiple wallets to manage different token systems directly. This is a usability bottleneck. However, token interoperability and standardization are issues that are being tackled by interoperability protocols like “Cosmos” and “Polkadot” and other standardization efforts worldwide. Interoperability and standardization will influence potential mass adoption of tokens and resulting network effects.

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.

We are still in the very early stages of exploring different roles and types of tokens. Many of the terminologies we use today will adapt to the realities of emerging use cases, and should be considered as temporary. With every new network and every new token application, we will collectively learn by trial and error about possible use cases of cryptographic tokens, and resulting classifications thereof. The taxonomy presented here intends to give a broad overview of the different properties and types of tokens, but it is far from complete. It is a big picture of the most important economic, technical, and regulatory questions tied to such taxonomy. Classifying the properties of a token is necessary for modeling tokens (development perspective) and evaluating tokens (investor perspective). A classification and taxonomy of the token itself would be legal, business, economics, and social sciences questions. A legal taxonomy is furthermore subject to a specific jurisdiction, and would be far beyond the scope of this book.

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 (read more: Part 4 - How to Design a Token System). 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. I would, therefore, like to 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.

Token Properties

Technical 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). Second-layer tokens can also be issued by a sidechain and are more dominant in the Bitcoin ecosystem. Sidechains that allow the creation of second-layer tokens are, for example, “Elements,” “Liquid,” or “Rootstock.” They interact with a blockchain to manage the state of the tokens. Due to network effects, the value of application tokens and other second-layer tokens is likely to be interdependent with the value of the underlying native blockchain token. An example thereof is the value of ETH (the native Ethereum token), which rose in the ICO bubble of 2016 to 2017 due to the large amount of ETH that was needed to buy app tokens issued through ICOs (read more: Part 3 - Token Sales). Multi-asset ledgers like “Ripple” and “Stellar” allow the creation of multiple tokens on the native level. Stellar allows anyone to create token contracts with all kinds of variables. On Ripple (XRP), everyone can issue any kind of token on the network, but they are issued as IOUs,[^3] essentially debt. XRP is therefore considered as credit, which is why some call it the “credit network.” To get to use these tokens, others must enable trust to one’s wallet, which means that one transfers debt. Ripple and Stellar can therefore be regarded as a settlement bus for other assets. The tokens XRP and XLM are essentially protocol tokens, but in their networks, they are representations of other assets and those representations are used to track credits and debts in a multi-dimensional value space. One can think of them as nascent cryptographically enforced foreign-exchange networks.

Where tokens are generated - Technocal Perspective

Rights Perspective: Tokens can represent a right to some underlying economic value, whether digital or physical, long term or temporary. A token can represent (i) a right to an asset I own, or (ii) limited access rights to assets or services that others own or provide, or a (iii) voting right. The economic definition of an asset is a resource that has an economic value and is controlled by an individual or a legal entity or a country. The legal definition of an asset is anything which has monetary value attached to it. Ownership right is the legal right to possession of a thing, including all usage rights, both physical and intellectual. In some countries, ownership is only possible in connection with physical things. Rights of use, or access rights, are contractual rights to use something in possession of someone else. Therefore, a token could represent any asset or resource, representing one’s ownership or the right to use said resource. These can be public or private assets, utilities, or services of any kind.

  • “Asset tokens” can represent a unit of account (fungible) or a unique good (non-fungible). Fungible tokens represent ownership of any fungible physical goods, like fiat money, silver, petrol, gold, diamonds, shares in a company, or any collateralized debt instrument. They can be compared to commodity money and are therefore sometimes referred to as crypto-commodities. Asset tokens can also be unique and therefore non-fungible. Some refer to them as crypto-goods. Examples would be real estate tokens, crypto-collectibles, or tokens that represent unique pieces of art. Representing such an asset with a token makes the asset more easily tradable and divisible, thus creating more liquidity for some assets that might not have been that easily tradable off-chain.

  • Examples of “access right tokens“ that are limited in time or in scope of using an asset someone else owns or a service someone else provides are: an entry ticket to a concert, a public transport ticket, apartment sharing access, car sharing access, a time slot for a doctor‘s appointment, membership access to a club, or access to network services.

  • “Credentials tokens” can be used to attest identity related information of people, organizations and machines. They are a prerequisite of access rights use cases, such as the verification of a person’s age or other personal details to allow you to rent a car, buy alcoholic beverages, board an airplane, enter a hotel room, vote, cross a border, collect a tax refund, or get a discount, and many more.

  • “Hybrid tokens:” This is not a binary classification, as many use cases might be more hybrid in nature, like mining rights on a piece of land, which are an access right but also represent a productive asset. A security token that represents a share in a company could also include voting rights. Native protocol tokens like Bitcoin (BTC) and Ether (ETH) can be seen as assets, but also represent access rights to the network, as they are needed to pay for network fees.

Rights Perspective of Tokens

Fungibility Perspective: 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 (read more: Part 3 - The Future of Money?).

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.

The more easily divisible a token is, the more fungible it is. Divisibility refers to the fact that you can send a fraction of the token to someone else. In the real world, many real assets cannot be divided, which makes them less easily tradeable. Cryptographic tokens can represent assets that were not easily divisible before, and can now be fractionalized at lower transaction costs than with established systems. Physical goods that are non-divisible can be first tokenized and then divided and sold off in different parts. Fractional tokenized ownership might allow a new array of asset classes, like real estate or art, and make those assets more liquid and fungible. However, there are practical limitations of redeeming a represented asset, for example, a piece of art (read more: Part 4 - Asset Tokens & Fractional Ownership). While in theory, there is no limit to making tokens divisible to 100 decimals, it is not economically feasible to do so. The overhead is huge when dealing with trillions of addresses that can and will hold leftover “dust.” Dust in this context refers to very small amounts of unspent tokens that are often not worth it to transfer, as the transaction fees might be higher than the dust is worth. There is a point where the marginal utility of extra divisibility is outweighed by the extra computational effort (storage and bandwidth). Furthermore, dusting attacks, where minuscule amounts of tokens are sent to random addresses to make them easily traceable, will be more feasible.

Fungibility Perspective of Tokens

Privacy Perspective: 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 (read more: Privacy Tokens).

Transferability Perspective: 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.

Tokens from a Transferability Perspective

Durability Perspective: 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.

Regulatory Perspective: 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 (read more: Part 4 - Asset Tokens & Fractional Ownership). 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.

Incentive Perspective: 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. (read more: Part 4 - Purpose-Driven Tokens).

Token Supply Perspective: 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 (read more: Part 2 - Institutional Economics of DAOs). 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.

Stability Perspective: 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.

Token Flow Perspective: 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.

Temporal Perspective: 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.

Non-Fungible Tokens

Non-fungible tokens (NFTs) are unique in nature, with varying properties that can be distinguished from each other. NFTs can represent digital, unique, and thus scarce assets, such as art and other collectibles or real estate. NFTs can also represent identities and certificates, such as licenses, degrees, keys, passes, identities, wills, voting rights, tickets, loyalty tokens, copyrights, warranties, software licenses, medical data, and certificates of any kind, such as supply chain or art certificates. Before the emergence of the Web3, identification and certification systems, as well as unique and scarce assets, were costly to manage, as they relied on the validation and security of the centralized issuing entities. Distributed ledgers, on the other hand, enable a decentralized and publicly verifiable infrastructure to issue and manage these assets at very low operational costs.

In 2013, “Colored Coins” was one of the first projects that attempted to attach unique properties to a token. The idea was to use Bitcoin tokens to represent real-world assets like stocks, bonds, commodities, or the deed for a house. “Counterparty” was another project that built on this idea, but went one step further. It enabled users to create their own virtual assets on top of the Bitcoin network. With the emergence of the Ethereum network, both projects struggled to gain wide adoption. NFTs started to attract a lot of attention when the ERC-721 token standard was introduced, especially following the success of “Crypto Kitties,” a game on the Ethereum network where players can collect and breed digital cats, and where each cat’s unique digital “genetic code” is stored on Ethereum’s ledger.

The ERC-721 token standard allows for more detailed attributes that make a token special, beyond the attributes that can be found in ERC-20 tokens. It allows the inclusion of metadata about an asset and information about ownership. When validated, such additional information can add value, guaranteeing the provenance of art, collectibles, or along the supply chain of other goods and services. The success of ERC-721 probably also triggered other blockchain projects, such as the NEO network, to develop their own non-fungible token standards.

  • Crypto-collectibles & Crypto-games: Crypto-collectibles allow the tokenization of unique goods, either of virtual collectibles or of a collectible in the real world. NFTs can be used to represent any in-game asset, to be in control of the user instead of the game developer. Crypto Kitties spurred a lot of attention to this new asset class when it clogged the Ethereum Network. Major League Baseball in the US has launched “MLB Crypto”; now, “MLB Champions” is one of the few blockchain-based games on Google Play where unique digital items can be traded outside of the game itself on marketplaces such as “Opensea.” Just to have an idea of how much is already in development, here is a selection of games, collectibles, and marketplaces that trade them: “Cryptofighters,” “Decentraland,” “Etherbots,” “Ethermon,” “Gods unchained,” “Plasmabears,” “0x universe,” “Hyperdragons,” “Loom,” “Spells of Genesis,” “Crafty,” “Superrare,” “FlowerToken,” “Unico,” “OpSkins,” or “Rarebits.”

  • Asset Tokens: Asset tokens allow unique investments tied to a physical object, like unique artwork, real estate, or any other real-world assets and securities. One could tokenize a building, where some tokens could grant simple ownership titles of a fraction of the real estate, while other tokens could grant special privileges like access rights. Non-fungible tokens can also be used to represent artworks. Such tokenization of existing assets in the real world can give investors a chance to expand their portfolio, and provide the market with more liquidity. NFTs can grant token holders different levels of control over their assets (read more: Part 4 - Asset Tokens & Fractional Ownership).

  • Identity Tokens, Certificates, & Reputation: Anything that uniquely represents a person could be represented as a non-fungible token: any type of ID or certificate like school transcripts, university degrees, or software licenses that are tied to the existence of one single person. A diploma could be issued and collectively managed by a distributed ledger with no need to be translated, manually notarized, or verified. Wallet-like software could manage all personal data without the need for centralized institutions storing our data. The token would represent a container for identity information related to a specific person without giving information about what is identified. Certification claims can be associated with the token, which would be issued by the trusted entities that issue these certifications. If properly designed, reputation tokens could be attached to identities and resolve challenges like “fake news.”

  • Access Tokens: NFT could be used to manage any type of access right that is tied to a special person, a special property, or a special event. Collectively managed distributed ledgers using public key cryptography can offer more secure and decentrally verified access-rights management than centrally managed digital access-rights management solutions and can replace physical keys, digital keys, and passwords.

  • Transfer Tokens: When someone passes away today, the will often needs to be split between multiple people, which can produce considerable bureaucratic overhead and coordination costs to split the value of these assets. This is especially true in the case of intangible assets that have a lengthy process to liquidate before the value can be split among the beneficiaries. While fractional ownership is possible today, transfer tokens managed by a distributed ledger would make the transfer of assets in the case of wills much more frictionless.

Chapter Summary

Tokens might affect the financial world similar to how the Internet affected the postal system. They can represent any assets or access rights, and are collectively managed by distributed ledgers. Tokens can be issued with just a few lines of code in the form of a smart contract.

Tokens are accessible with a piece of software, a wallet that communicates with a blockchain network or similar distributed ledger and manages the public-private key pair related to the blockchain address. Only the person who has the private key for that address can access the respective token.

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 for a more transparent, efficient, and fair interaction between market participants, at low costs. Tokens can also incentivize an autonomous group of people to individually contribute to a collective goal. These tokens are created upon proof of a certain behavior.

Tokens are not a new thing and have existed since long before the emergence of blockchain networks. Traditionally, tokens can represent any form of economic value. Tokens are furthermore used in computing, where they can represent a right to perform some operation or manage access rights. A more tangible form of computer tokens are tracking codes that you get to track your parcel with postal services, or QR codes that give you access to a train or plane.

Cryptographic tokens can represent property rights, access rights, or voting rights.

The term “token” is simply a metaphor. Contrary to what the metaphor might suggest, a token does not represent a digital file that is sent from one device to another. Instead, it refers to an entry in a ledger that is collectively managed by a network of computers.

The most important perspectives from which we can deduce 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; (ix) Token flow perspective; (x) Privacy perspective; and (xi) Stability perspective.

While fungible tokens are identical, non-fungible tokens are unique in nature, with varying properties that can be distinguished from each other. Non-fungible tokens are a more diverse asset class and can also represent identities and certificates, such as licenses, degrees, certificates, keys, passes, identities, wills, voting rights, tickets, loyalty tokens, copyrights, supply chain tracking, medical data, software licenses, warranties, and many more.

Chapter References & Further Reading

Footnotes

[^1]: From a regulatory point of view, however, it is not definitively clear whether or how it is possible to acquire ownership or possession on such tokens. Therefore, concepts like custodianship would probably need legal modifications in many jurisdictions.

[^2]: Sidechains are separate blockchains, compatible with the mainchain, and have been used to resolve scalability issues in Bitcoin (read more on Sidechains: Annex - Scalability Solutions)

[^3]: Abbreviation for “I Owe You,” a written promise that you will pay back some money that you borrowed. It is an informal document acknowledging debt. They usually specify the debtor, the amount owed, and sometimes the creditor. They differ from promissory notes in that they do not specify repayment terms, like the time of repayment.

Token Economy: How the Web3 reinvents the Internet.
Second edition, first amended printing, Nov 2020. The first edition was published by BlockchainHub Berlin https://blockchainhub.net in June 2019 under the title “Token Economy: How Blockchain & Smart contracts revolutionize the Economy” and had two amended editions.

Author: Shermin Voshmgir
BibTeX: @book{voshmgir2020token, title={Token Economy: How the Web3 reinvents the Internet}, author={Voshmgir, Shermin}, year={2020}, publisher={Token Kitchen} }

LICENCE: Copyleft 2020, Shermin Voshmgir:Creative Commons CC-BY-NC-SA This license allows reusers to distribute, remix, adapt, and build upon the material in any medium or format for noncommercial purposes only, and only so long as attribution is given to the creator. If you remix, adapt, or build upon the material, you must license the modified material under identical terms.
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Comments: There are various possibilities of forking the text of the book: You could add code contributions to the theoretical examples mentioned in this book, create future iterations with new /modified chapters or translate this book into another language, and distribute it non-commercially (for free). To do this you can fork the wiki and start translating the texts under your own Github account anytime and publish the modified/translated book on Github directly. I can send you the original AI files for creating translated version of the graphics. Please not that with this licence you are not allowed to sell the book or use it for other commercial projects, but I can try and support you get funding with a Gitcoin Grant or any other crowdfunding campaign, so you get money for the work you put in. 

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