There is still a significant level of confusion when it comes to terms like cryptocurrency coins, tokens or ICO. Yet, these terms will most likely play an important role in reshaping how we think about our economic systems. Blockchain based technological innovations have the potential to spark a paradigm shift, transforming current economic landscapes into a decentralized token economy.
This article outlines key concepts behind the token economy and attempts to clarify basic terms related to the issue.
It all starts with money
The need of money as a medium of exchange, store of value and unit of account has been present since the dawn of human civilization. With technological progress, it has become increasingly easier to handle money. Long-distance transfers, online payments, debit and credit cards all make our lives much more comfortable. In the current economic system, centralized organizations such as banks and financial institutions act as trusted intermediaries between parties involved in monetary transactions.
Thanks to recent advancements in cryptography, blockchain technologies and the resulting emergence of cryptocurrencies, we might be moving a step closer towards (much more) decentralized token economies. These economies will arguably be fueled by cryptocurrencies and their derivatives.
Cryptocurrency, coins and tokens
Cryptocurrency is a virtual currency that uses a combination of the principles of cryptography and blockchain or DAG technology to secure and record transactions on a public or private ledger. Any computer connected to a blockchain network has access to this ledger.
Unlike traditional currencies issued by national governments, cryptocurrencies are decentralized. This means that they are not regulated by any central entity. The technology allows for direct peer-to-peer transactions between interested parties, eliminating the need for a trusted intermediary entity such as banks or financial institution.
The terms coins and tokens are typically used when discussing cryptocurrencies. These terms are often used interchangeably; however, there are important distinctions to be made when talking about coins and tokens.
What is a coin?
A coin is a unit of value that exists on its own blockchain. It is a digital asset native to the network, directly linked to the network’s blockchain and defined by the network’s protocol. A protocol is a set of rules under which the network operates and by which the participants communicate with each other.
Coins other than Bitcoin are sometimes collectively called Altcoins, which is an abbreviation for alternative coins.
What is a token?
In contrast, tokens are built on top of existing blockchains and therefore are secondary to the network. Generally, they are built on top of platforms allowing the development of smart contracts, i.e. additional pieces of code, added onto the existing blockchain network.
Most tokens today are built on top of the Ethereum platform. Ethereum therefore has a native coin ETH, as well as various Ethereum based tokens (collectively called ERC-20 tokens). A number of other platforms, such as Omni, Qtum, NEO or Waves, also allow tokens to operate on top of their blockchain network.
Who issues new tokens and why?
Tokens are issued by organizations in order to raise funds and are designed for a specific use case. Once issued, the value of a token becomes independent from the value of the network’s native coin. Even if the coin value fluctuates over time, the value of the token itself could increase steadily if the project backed by this token is successful. It is important to note, however, that if the native coin or network collapses, the value of the token will most likely be negatively impacted as well.
The function and purpose of a token can vary widely, but based on their use case the tokens most commonly found in today’s token economy are:
- Securities (security tokens)
- Utility tokens
- Asset-backed tokens
- Equity tokens
- Reward/discount tokens
- And many, many more variants are evolving as the token economy matures
Detailed description of each token type is outside of scope of this article, but is planned to be covered in a future piece. If you want to know more now, you can check out the article Tokenomics: What are the Classifications of ICO Tokens by Alexander Lielacher.
Think of tokens as casino chips
From the user’s perspective, a simplification of the situation is to think of tokens as casino chips. In order to play a game of blackjack, you buy casino chips with fiat money. These chips then allow you to be a part of that particular casino ecosystem. In a similar fashion, people buy tokens to access and enjoy the particular service offered by the issuing organization.
Coins vs tokens
In sum, tokens differ from coins in that they run on top of the existing blockchain networks. They are significantly more diverse in functionality than cryptocurrency coins. With this, each token brings about a unique economic ecosystem that is not necessarily correlated with the price fluctuations of the network’s native coin.
A vast majority of tokens (as well as coins) are issued through an event called an ICO.
Initial Coin Offering (ICO)
ICO, or Initial Coin Offering, is a term used to describe an event when a new coin or token is created and offered to purchase for the first time. Its purpose is to obtain capital to fund new business (or even a non-profit) development and/or operations.
An organization seeking financial backing through an ICO first generally produces a white paper outlining details on the project. It typically mentions the problem, it’s coin/token based solution, project development roadmap, how much money is being raised over the specified period of time, what percentage of the total tokens are for sale, and how they will ultimately be distributed.
ICO investors typically pay for new coins or tokens in virtual currencies such as BTC or ETH, but in some cases fiat currency like USD is also accepted. It is also important to note that coins and tokens can also be acquired after the ICO event through exchange platforms or directly from initial investors.
ICO’s biggest problem: Regulations
There is a lot of confusion on the regulatory side of ICO fundraising operatives. This is especially true for equity and securities types of tokens; mainly, if they are even legal in the jurisdictions where they ICO. As crypto economies mature, a more clear-cut set of regulations issued by official governmental bodies is to be expected.
Scams and hacker attacks
Since there is no barrier for entry, virtually anyone can ICO. Recent hype around blockchain and cryptocurrencies has given rise to many projects led by inexperienced teams and even outright scams. Investors cannot be sure whether the project they are backing will ever come to its completion.
Many also suffered losses due to hacker attacks. To this date, tokens and coins equivalent to millions of dollars in value were stolen during ICOs. 2017 CoinDash ICO hack is an example of 7.3 mil dollars lost.
Once issued, the price of coins and tokens is susceptible to rapid and unpredictable changes in value. This goes both ways, however, and a rapid appreciation is certainly welcomed by all token holders.
Project success rates
There are also many projects that start with good intentions, but the teams cannot bring their vision to market. Or, the blockchain space evolves and there are better alternative that beat them to market. Ultimately, even if an idea or token application is valid, with so many competing to do the same, not all can succeed.
Word of caution
Like with any new technology, there will be scams, short-lived fads, and errors, but hopefully something great will eventually emerge. ICOs are still a great tool for companies to raise funds, and many projects will be successful over time. Those who survive will lay the foundations for a global token economy. Hopefully this gives you a better way to evaluate and understand an ICO, and when you think about getting involved with an ICO you can do it in a smarter and safer way.
What’s the future?
Using blockchain technology, the tools of advanced cryptographic principles and peer-to-peer networks, cryptocurrencies are able to operate independently of governments, central banks and centralized financial institutions. This is truly a revolutionary achievement.
But there is so much more to be gained from the advancement of token economies. It can completely change our view on work and earning income. People often engage in a so called passive work, an activity that generates value but is not financially rewarded. A great example of passive work is ad consuming. Currently, online users are often marketing targets against their will. In the future, they might be rewarded for giving advertisers permission to target them. This is the idea behind BAT, or Basic Attention Token. And many other passive work rewarding tokens are emerging.
Currently, tokens are usually traded through primary coins, on centralized exchanges, but there have been attempts to create ways to easily exchange various tokens across different chains. So called smart bridges, such as ARK token, or methods for decentralized exchange like 0x protocol or EtherDelta, are trying to offer this new kind of solution.
The emergence of the token economy has the potential to create systems that are secure, decentralized and even interconnected, which would be specifically tailored to fit preferences of each consumer and each business at the same time.