The Four Domains of Blockchain Applicability

When Bitcoin was the only cryptocurrency in existence, the blockchain industry was much simpler than today. Ethereum came along and brought about a myriad of utility tokens, security tokens, and hybrid tokens. It quickly became apparent, after the cryptocurrency hype and subsequent crash near the end of 2017, that applying tokenization — or blockchain technology in general — to different areas of business was not as easy as initially anticipated.

As with all new technologies, people have tried, experimented, and failed with the utilization of blockchain tech. Between 2016 and 2018, for example, we saw an extremely high failure rate among ICOs. It is difficult to attribute this overwhelming underperformance to a single factor such as unrealistically ambitious project goals or the sheer impact of the recent crypto winter. But one thing is for certain: Mass consumer adoption has arguably yet to be seen from an ICO-based company.

Due to the ICO frenzy and accompanying regulatory uncertainty surrounding token issuances, it became popular to distinguish between “security tokens” and “utility tokens”. However, almost nobody endeavored to root a classification of blockchain applicability in the context of business. After Ethereum made it fairly easy to create various tokens with a few lines of code, people began thinking of things to tokenize — oftentimes just for the sake of tokenizing things, resulting in some often short-lived financial products. But sometimes a token — although technically possible — does not make much sense from a business perspective. Therefore, if there is no token, and thus no regulatory ambiguity regarding an issuance, is there any need to distinguish between “utility” and “security”, when the project is essentially a technology product versus a token?

This article aims to categorize blockchain applicability from a more fundamental perspective by analyzing a small grid of four domains addressing two simple questions:

a) Can you physically touch the store of value? In other words, is the store of value tangible. You can touch a piece of metal and, for the context of our discussion, you can even “touch” a service as it processes something from an initial state to a processed state. For example, if you visit a hairdresser and get a haircut, the “something” in the previous sentence refers to you. In this case, the “initial state” is you with hair, and the “processed state” is you with less hair. Software, on the other hand, cannot be touched. While you can touch the hardware components housing the software, the software itself is intangible. Therefore, a Bitcoin cannot be touched either. While you can touch the paper containing the private key, you cannot touch the coin itself — it is software.

b) Can you take custody of the value yourself? If you are the custodian of a store value, then you can give it to someone else without requiring anyone’s permission. The value is yours. For example, by holding a Bitcoin on your wallet, and maintaining the private key, you can give the Bitcoin to someone else (by transferring the private key or the coin directly). Generally speaking, you have custody of a store of value if you can transfer it freely to others without the use of an intermediary. If you do not have custody of a store of value, you cannot give it away without either first obtaining custody of it or asking the custodian/intermediary to give it away to someone on your behalf.

To begin the analysis, draw a horizontal line, dividing the intangible assets in the upper half and the tangible assets in the lower half. Then draw a vertical line, dividing the values you can hold yourself on the left side and the values somebody else holds for you on the right side. You get four domains as follows:

I) Virtual values have no representation in the real world. They are simply bound to a private key (or rather an address but this practically implies the same). You can hold them directly because you can physically own and hold the private key. If your coins are held on an exchange, however, then the exchange holds the coins — not you. This does not make them less virtual or less ownable. The value itself is virtual. It comprises ones and zeroes, and their meaning depends on a functioning internet. In other words, virtual values cannot exist outside of the internet.

II) Digital values are pieces of software like audio and video files or 3D printing matrices. Unlike virtual values, digital values are made up of real data. This data can be downloaded and its meaning extracted even without an internet connection. Consequently, such data can be copied. While the existence of copies of virtual value would be inconsequential, since a blockchain inherently prevents double-spending, having multiple copies of software of domain II presents issues as such data bears value. 
 Therefore, it is critical that a distinction exists between data ownership of the valuable raw data and ownership of whatever is made from the data. This distinction is important, for example, from the viewpoint of someone looking to sell their digital data without it being copied and re-sold without the original owner’s permission. It is essential that the owner remains in control and maintains possession of the raw data. The beneficiary thus only obtains the output/product of that data. Technologies for such purposes exist already. Ownership and beneficiary are separable, and a system’s technical capabilities will dictate how complex the protection mechanism is. By introducing a token into this business application, the token could grant you the right to consume digital data. Unlike physical items, the copying, and transport or distribution of software is extremely easy. The trick is to only sell the product of the software and not the raw data — and blockchain can be applied to solve that.

III) Custodial values are tangible items. If they are represented by tokens, then such tokens grant you some right derived from the properties of the tangible item. The right can vary from a claim for that physical item or service to all imaginable forms of utilization rights. You can use custodial values e.g. as a means of payment. The token, however, is not the physical asset. For example, this is analogous to shares of a company or to payment tokens with backing. In this case, the token is not the share nor the money in the bank account. Rather, it is a placeholder; merely a right to be executed. Giving the token to somebody is possible, but because it is effectively an “IOU”(I Owe You), this passing-on of a claim might not be recognized by the custodian (the regulator or any other player who has a say on financial conducts within a particular legal sphere). Unlike Bitcoin, even if you are in possession of such an “IOU” coin, this model means that somebody actually can deny you your right to obtain the value (or pass it on to somebody). This domain is essentially dominated by asset-backed tokens or utility tokens, some of which have been created during the ICO frenzy

IV) Finally, there are tangible items that are not under anybody else’s custody. You maintain possession of these items at all times. They do not require a token whatsoever. While a token could be applied, it would be for a different purpose. For example, a token could be used to prove the authenticity or ownership of an item. In such cases, there would only be one token associated to an item — not multiple tokens. Blockchain technology can be used in a different manner in such contexts, for example tracking the path of an item. This premise could be applied to all sorts of tangible items. Pharmaceutical products, watches, clothes, cars, and many more. Tokens play only a peripheral role here, although they might be useful, too.

Virtual values (Domain I) were and still are the most natural form of “application”. Each new blockchain comes with an intrinsic token to pay for “gas” or to simply transact that virtual value. The tokens are traded on exchanges, and they may or may not become the next largest cryptocurrency by market capitalization.

Custodial values (Domain III) enjoyed high popularity in the last years as it can easily be applied to any physical item, service or other tangible good. Most items in this domain are or will be deemed a financial product in the one or other way. Utility tokens, payment tokens, and security tokens are classical examples

Digital values (Domain II) remain underexplored. They are extremely attractive because, following the crash in cryptocurrency valuations, the industry will now enter a cycle in which values matter. Since digital values are quickly copied, their safekeeping and protection against unauthorized replication using blockchain will undoubtedly trigger one of the next big waves in blockchain applications. This is mostly about Digital Rights Management, using the blockchain.

Real life tangible assets (Domain IV), which are not merely locked up somewhere or held in custody demands innovation to be brought into the blockchain ecosystem. A likely use case will be centered around creating smart contracts and blockchain logic that support a given business model. For example, audits and reports, product tracking, backup integrity checks, and certificates of authenticity would all be good examples.

We hope that this article, which favors an analysis of blockchain applicability over only regulatory concerns, helps to identify and distinguish use cases for this revolutionary technology.

This article is brought to you by @Johannes Schweifer, CEO of CoreLedger.

As a prominent blockchain infrastructure provider, CoreLedger is making blockchain technology simple for businesses to use. With CoreLedger’s offerings, clients can readily tokenize their offerings with fast-to-implement resources that will allow them to modernize their services. Thanks to our in-house developed software solutions and experienced blockchain specialists, CoreLedger is ready to help you make your next move with blockchain technology.