Navigating the Gray Areas in Cryptocurrencies
Crypto Asset Classification Explained
The nascent crypto industry has been rapidly evolving since its inception. With the introduction of a cutting-edge market, jargons specific to the ecosystem also surface. Unlike the technology that quickly gains a foothold and spreads far and wide, the language describing this technology often tends to lag behind.
Crypto’s disruptive market is loaded with a lot of information. However, the novelty, as well as the complexity of the industry, leads to quite a few misrepresentations of the key terms describing the market. One of the most common mistakes that people make is related to the asset classification. This is quite understandable, as, frankly, coming up with one single classification system for crypto assets is not a piece of cake.
To solve this issue, we decided to deconstruct the crypto classification structure into its constituent pieces and address each one of them separately. We will provide readers with comprehensive crypto asset categorization models and attempt to cover all possible dimensions that these assets represent. We will get started with the basic categorization and subsequently move up to more advanced and detailed models.
Blockchain vs. Cryptocurrency
To start from the very beginning, it is critical to draw a correct distinction between blockchain and cryptocurrency. Essentially, there exists two parts of Blockchain: blockchain as a technology and blockchain as a decentralized platform that enables a secure value transfer, the latter of which is more commonly known as a cryptocurrency.
Blockchain technology was first introduced in the early 90s as an evolving list of blocks that securely records on-going activities using cryptography. Every single block in the chain contains a timestamp, a cryptographic hash of the previous block and the encrypted data pertaining to the transaction; these parameters make a block immune to any sort of data tampering. What cryptocurrency does is that it takes blockchain technology as a base and creates a digital currency on a distributed decentralized ledger that represents a unit of account, store of value and a medium of exchange. Thus, cryptocurrency is a new paradigm shift that took advantage of already existing blockchain technology and established a breakthrough digital asset class.
Now that we defined cryptocurrencies, we can move forward and discuss the variations among cryptocurrencies according to which we can group crypto assets in several categories.
Coin vs. Token
Broadly speaking, cryptocurrencies can be classified as coins and tokens. Often, and very much erroneously, these terms are used interchangeably.
The main distinction between tokens and coins is that:
- All coins have individual blockchain protocols, on which they execute and carry out transactions.
- All tokens are run on a non-proprietary already existing blockchain platforms.
If coins are those assets that have a personalized blockchain platform created according to specific guidelines, tokens are specific projects that are supported by already existing blockchain platforms. They operate on smart contracts of a hosting database, which represent codes that can easily be programmed and self-executed without a third-party mediation.
Most of the time a coin is perceived as a digital payment system because of its name, which intuitively makes us believe that it is a form of money. This misconception makes us think that a coin can only be a payment system, while token can serve as everything else. Well, the truth is that both tokens and coins can be payment systems, the major distinction is that one operates on its very own blockchain platform and the other does not.
COINS
As we now understand the difference between coins and tokens, we can dive deeper and analyze coins through the prism of additional lenses. All crypto coins are generally sharing the following functional properties, they use:
- blockchain as the distributed public ledger,
- consensus mechanism to approve authenticity of transactions, and
- public and private keys to execute value transfers.
However, different crypto coins leverage different parameters of the blockchain network to solve specific problems more efficiently and effectively. This leads to further classification of coins in different categories. Crypto coins can serves as a payment system, commodity or utility, depending on their purpose and direction.
Crypto Payment systems
Coins that act as payment systems aim to make speedy money transfers, inexpensively and securely on a peer-to-peer network.. As of today, there exists four major subcategories of crypto payment systems. Each one of them puts emphasis on different attributes of the blockchain network and tries to solve a specific problem: decentralization, privacy, scalability and governance. Adjusting and improving specific functional parameters of the blockchain system differentiates one coin from another.
Standard
The very first cryptocurrency, Bitcoin, currently serves as a “standard” among the peer to peer electronic cash systems. All the currencies that have emerged after Bitcoin are collectively referred to as altcoins and they are usually endorsed for more improved and advanced features. Bitcoin leverages the decentralization feature of a blockchain vehicle; it eradicates the need for centralized institutions by distributing the power and authority among the network users and at the same time eliminating the need for trust. Bitcoin Cash, a crypto coin generated by a fork of the Bitcoin network, also represents a standard payment system. However, Bitcoin Cash achieves lower transaction fees by augmenting the block size.
Privacy
Privacy coins stress user anonymity as the major property of their blockchain network. Coins such as Bitcoin and Bitcoin Cash do not necessarily conceal your identity as a user. When using these networks your real identity is masked under a jumbled set of characters unassociated with your real name, however all the transactions you make are accessible on a public ledger. This is often referred to as pseudonymous privacy; your identity is preserved inasmuch as no one knows you are the one under that pseudonym.Privacy coins were introduced to address privacy concerns of account holders and entirely conceal their identities on the system with the help of stealth addresses and private transactions. Zcash, Monero and Dash are some of the examples of privacy coins.
Scalability
Along with decentralization and privacy, the crypto ecosystem also embraces those coins that try to leverage scalability in an attempt to accelerate the time needed for the transaction authentication delivery. A good example of this type of coin is a Litecoin, which attempts to decrease time intervals needed for a value transfer validation by speedier block generation rates.
Governance
Finally, in the last category we have those payment systems that restructure the governance parameter of the blockchain. Rather than counting solely on the miners for transaction validation, the governance coins try to spread out the power held by miners all over the community. The prime example of this type of a payment system is Decred. The coin integrates a community-based governance system in its blockchain protocol, allowing not only miners but also regular users to participate in network consensus. Thus, by restricting the miners capacity in the network, the governance coins reconcile the roles of miners and users and allow for the fairer power distribution.
Crypto Commodities
This category of crypto assets is very unique, as it introduces a facilitation mechanism for commodities such as data, storage, computation, etc. on a dynamic and decentralized platform. Crypto commodities take the idea of creating a decentralized payment system that Bitcoin introduced, utilize the enormous potential of a blockchain technology and conceptualize an array of applications and services. Crypto commodities achieve this by offering smart contracts and programmable money to user that allows for application creation as well as digital enforcement of legal agreements and financial settlements. One of the most well known crypto commodity is Ethereum.
Ethereum is a development and contract platform in crypto space and serves as a decentralized public network for applications. It is an open software platform hosted on its own blockchain protocol that enables the development of decentralized apps. Etherium allows developers to run the programming code of any dapps and create contracts using smart contracts. Furthermore, the users can hold Ethereum wallets where they can store Ether, the official currency of Ethereum, as well as other crypto assets that are built and executed on this platform.
This way crypto commodities create a platform for application development that can address specific issues, provide services and have a wide range of functionality.
Crypto Utilities
Crypto utilities may sound similar to crypto commodities and some people may even use them interchangeably. However, there is a major difference between these two: rather than providing a blockchain platform for developers to build applications, crypto utilities use their own networks for specific goals.
Sia is a great example of a utility coin that serves as an open-source, blockchain based, cloud storage super server. This crypto asset leverages unused hard drive capacity and establishes a data storage arena, which differentiates by low cost, reliability and decentralized structure. Sia wipes out the need for relying on centralized data storage platforms and creates an easy and inexpensive way to store data.
TOKENS
As mentioned in the previous section, crypto commodities allow developers to create applications on their existing blockchain platforms. This results in the creation of crypto tokens, which are hosted on a non-proprietary blockchain channels and serve different purposes. So,for a little bit more accurate asset categorization, we can introduce another layer of dimension that will expand upon the specific sectors that these tradable assets belong to.
Tokens can be split up in three major categories: utility tokens, security tokens and stable tokens.
Utility Tokens
Utility tokens are characterized with the capacity to let holders access the finished goods and services that are provided on the open-source decentralized networks. With a utility token one can use a specific decentralized application provided on the platform of a commodity coin. The supply and demand are the main drivers for the valuation model of these assets along with their attributes. By selling a utility token, a company sells the rights to its good and services in advance, and the buyers gain access to these products before general crowd does. Utility tokens may seem similar to payment systems but the key differentiator is that with utility tokens you can only guarantee access to a specific resource that issued your token.
Built on Ethereum’s blockchain, 0x is a good example of a utility token. It enables a user to exchange cryptocurrencies, digital assets and game items. This trading platform designs a seamless and secure exchange experience, which allows market makers and professional exchanges to host order books to facilitate the exchange of these assets, without worrying about hacking, embezzling and other issues that today’s cryptocurrency exchanges are troubled with.
Security Tokens
Security tokens are type of tokens that serve as claims on a particular assets and promise to provide purchasers with dividends, revenue shares and other traditional asset-holder benefits. To put it differently, these assets derive value from the ownership in a tangible traditional assets and are subject to federal securities regulations. There are two types of security tokens: asset-backed and equity-like.
Asset-Backed Tokens
Asset backed security tokens are said to be the most valuable tokens in crypto space.The simple reason behind it is that these assets take traditional tangible assets and tokenize their value on the blockchain platform; this practice is also known as asset digitization. Additionally, the perks of these tokens come from the fact that their valuation is easier and more reliable due to their connection with a real-world asset class that already carries an established economic value. Furthermore, asset-backed tokens are characterized to be highly liquid, secure and stable.
For instance, Digix Token is a security token, the value of which is pegged by gold, a traditional asset. Every DGX token is backed by 1 gram of gold, which is stored in a 3rd party custodial vault in Singapore. For the sake of transparency, the audits of the vault take place annually as well as quarterly and the information pertaining the digital transactions and ownerships are publicly accessible on the ledger.
Equity Tokens
Another subcategory of security tokens is equity-like tokens. These assets represent an ownership of a business. This group takes traditional asset-holding experience on the decentralized blockchain platforms, and consequently shifts their performance in highly liquid environment.
One of the good examples of equity tokens is Binance Coin BNB, which runs on Ethereum platform and is issued by Binance Exchange. The token holders enjoy high levels of security as well as receive discounted fees for the transactions made on Binance Exchange.
Stable Tokens
Last but not least, we have stable tokens that aim to solve the problem of crypto asset volatility by pegging their value to other tradable assets. Stable tokens are further classified in two categories: fiat-collateralized and crypto-collateralized.
Fiat-collateralized
The first category of security tokens attempts to back a crypto asset with a fiat currency. A good example is a Gemini Dollar. The token offers stability of the US dollar and the security of a blockchain technology. If a user wants to acquire a Gemini Dollar token, s/he makes a deposit in a purchaser’s wallet with US dollars. As there is a 1:1 exchange rate between Gemini and US dollar, the deposited USD automatically converts into Gemini Dollar, which can then be transferred and utilized anywhere on the Ethereum network.
Crypto-collateralized
Second category of security tokens, such as Dai issued by MakerDAO, attaches its value to a crypto commodity Ethereum. Unlike fiat-collateralized assets that do the same value pegg to fiat currencies, crypto collateralized tokens pegg by 2:1 ratio to the Ethereum in order to compensate for the volatility of cryptocurrencies.
Conclusion
The crypto space is a complex market filled with a lot of information. As of today, there are around 2,000 crypto assets. Grouping them into relevant categories is a challenging task due to the diverse and complicated nature of these assets. In this blog, we deconstructed some of the most important and significant categories of cryptocurrencies that one must be aware of in order to feel confident in the industry. It is extremely important to fully understand the essential differences between the major crypto assets, as it will help you shrewdly identify potential opportunities as well as associated risks in regard with your asset allocation and investment strategy. There is always a better chance of attaining a desired goal when you are well informed of the market.
Panda Analytics, Inc
2018
