Smart Tokens Explained!

Blockchain technology is much broader than just bitcoin. The sustained levels of robust security achieved by public cryptocurrencies have demonstrated to the world that this new wave of blockchain technologies can provide efficiencies and intangible technological benefits very similar to what the internet has done. However, blockchains are a very powerful technology, capable of performing complex operations, capable of understanding much more than just how many bitcoins you have currently have in your digital wallet. This is where the idea of smart contracts come in.

At the level of crypto-currencies, a smart contract is a computer program that is stored on a blockchain and specifies contractual terms, along with possessing the means to enforce those terms.

“The Ethereum Virtual Machine or EVM is the runtime environment for smart contracts in Ethereum. It is not only sandboxed but actually completely isolated, which means that code running inside the EVM has no access to network, filesystem or other processes. Smart contracts even have limited access to other smart contracts.”

Here is the comparison between Traditional Contracts & Smart Contracts:

Traditional Contracts

Traditional physical contracts, such as those created by legal professionals today, contain legal language on a vast amounts of printed documents and heavily rely on third parties for enforcement. This type of enforcement is not only very time consuming, but also very ambiguous. If things go astray, contract parties often must rely on the public judicial system to remedy the situation, which can be very costly and time consuming.

Smart Contracts

Smart contracts, often created by computer programmers through the help of smart contract development tools, are entirely digital and written using programming code languages such as C++, Go, Python, Java. This code defines the rules and consequences in the same way that a traditional legal document would, stating the obligations, benefits and penalties which may be due to either party in various different circumstances. This code can then be automatically executed by a distributed ledger system.

The core of a smart contract is the executable code which validates changes to state objects in transactions. State objects are the data held on the ledger, which represent the current state of an instance of a contract, and are used as inputs and outputs of transactions. Commands are additional data included in transactions to describe what is going on, used to instruct the executable code on how to verify the transaction.

The first thing to think about with a new contract is the lifecycle of contract states, how are they issued, what happens to them after they are issued, and how are they destroyed. For the commercial paper contract, states are issued by a legal entity which wishes to create a contract to pay money in the future (the maturity date), in return for a lesser payment now. They are then transferred (moved) to another owner as part of a transaction where the issuer receives funds in payment, and later (after the maturity date) are destroyed by paying the owner the face value of the commercial paper.

There are countless practical use cases where blockchain technology is being applied to achieve significant benefits. While smart contracts are used in most of these applications, Bancor uses smart contract technology to provide the most benefit is in the cryptocurrency world.

Smart Tokens are compatible with the ERC20 standard and can be used by any software that supports this standard, such as Ethereum wallets. However, Smart Tokens offer additional functionality not available to regular tokens. Each Smart Token holds a reserve balance in one or more other ERC20 tokens, thereby enabling anyone to exchange between itself and any of its reserve tokens. The Smart Token’s smart contract issues new tokens (expanding the supply) to anyone who purchases it with any of its reserve tokens, and withdraws tokens from the reserves (contracting supply) for anyone choosing to liquidate the Smart Token. The price of a Smart Token vis-a-vis any of its reserve tokens is calculated as a ratio between the current Smart Token’s supply and its reserve balance, at the pre-set CRR (Constant Reserve Ratio.)

The CRR (Constant Reserve Ratio) is a parameter, set by the creator of the Smart Token for each of the Smart Token’s reserves. The CRR is a key parameter used by the Smart Token as an asynchronous price discovery mechanism, as it determines the ratio between the reserve balance and the Smart Token’s calculated market cap.

For example, a CRR of 10%, for a 100 ETH reserve balance, would price the Smart Token according to a 1,000 ETH market-cap (with each Smart Token being priced as this market cap divided by the number of Smart Tokens in supply, initially configured by the creator, and then dynamic with market buys and sells). Whenever the Smart Token is purchased, or liquidated, the reserve balance increases or decreases, and so does the total Smart Token supply. The result is that for a Smart Token with a CRR smaller than 100%, any purchase of the Smart Token will lead to a price increase, while any liquidation will cause a price decrease.

Smart Tokens are built on top of Ethereum’s Smart Contract and the most important feature of smart tokens is that they can be purchased or liquidated (sold) at anytime, directly through their smart contract, without the need to use an exchange or even be matched to a second party to exchange with.