Everything is Tokenized — Blockchain’s killer-app is a new ecomomic model.
When Bitcoin expecrienced it’s first cycle of hype, the focus was mainly on it’s function as e-money. Barely anyone paid attention to the underlying technology, the blockchain. Fast forward a few years and blockchain, partly due to the latest cycle of hypergrowth in crypto-currencies, starts to look like a household term. Few people seem to understand what the blockchain technology really is or does. Even fewer seem to recognize it’s value beyond the distributed, immutable ledger to save transactions and make them auditable. But there is one application of blockchain technology that has the potential to transform our corporate structures and economic systems dramatically. Tokens. The killer-application of blockchain.
What are tokens and how are they going to change the world?
The ‘What’
On a basic level, tokens are like tickets to a theme-park ride (a.k.a. network). One token gives you one ride. Except that in the case of tokens you also are the partial owner of that theme-park ride, proportionally to your ticket ownership. So if there are 100 tickets in circulation and you own 5, not only are you allowed to ride 5 times but you also own 5% of the ride. Or course, every time you ride you give up part of your ownership. Another inportant aspect is that when you use your ticket, or sell it, there is no Theme-Park Co. that collects it, but another participant. Some participants may buy the token to enjoy a ride themselves, some may hodl them in anticipation of an increase in popularity of the ride and therefore an appreciation in value of the token itself, some may choose to actively participate in the construction and maintenance of the ride and are eligible for a fee as a reimbursement for their contribution to the ride. Tokens provide access to the underlying protocol. Ether, the native token of Ethereum, can be used to pay for computation time and storing of the smart contracts on the Ethereum blockchain.
In short: tokens allow for an alternative, decentralized ownership structure where the user is the owner and network participants are incentivized to contribute to the construction, improvement and maintenance of the network for a fee.
The ‘How’
One of the most significant achievments of blockchain powered networks is the transfer of value. While the traditional internet protocols allow for the transfer of information, blockchain protocols allow for the transfer of value.
Through the decentralized nature of token networks it becomes possible to reassemble current organizational structures in a more efficient, cost effective way that aligns the interests of the users and the owners of the network as they essentially become the same.
The actual, the most powerful disruption that tokens enable is the creation of private economies. These use-case specific token networks allow for the digitization of underlying assets. Real estate, protocols, currencies, labor, telecommunication networks, sports teams, farms, airlines, investment vehicles, transportation networks. Everything can be tokenized. Not only can existing organizations and classic shareholder structures be represented more efficiently. Tokens allow for a representation and capture of value previously not possible, because it would have been to0 inefficient to do so.
This creates massive economic opportunities. Value can be captured, transferred, aggregated and distributed in a much more granular, fluid and frictionless way. Token networks will be everywhere and they will technologically mostly be invisible to the consumer. But they will power and economically represent almost everything you do, consume or contribute to the world around you.
The technology
I will provide a quick overview about the most important technological building blocks, without going into too much detail as the main focus of this article are the economic implications of token networks.
As we have established, tokens are currencies powering their underlying blockchain network. Each token is a unit that allows for the usage of the network.
Undisputedly, Bitcoin was the first token build on top of a blockchain. Due to Bitcoin’s lack of Turing-completeness it is not possible though to implement any further logic into a transaction. Leaving the usecases limited.
Ethereum was first to successfully introduce a Turing-complete blockchain, allowing for the creation of true smart contracts and decentralized autonomous organisations (DAOs). With smart contracts you can create conditions that determine when and under which conditions a contract is executed. You can also use oracles as external verification mechanisms for a smart contract.
It also allows for a relatively simple creation of blockchains on top of the Ethereum network.
While it by no means is or will remain the only platform to enable the creation of token networks, it has enabled the first generation of token networks built on top of Ethereum and hopefully will continue to lead the way.
The economics
The birth of a token network is the token sale, or ICO (initial coin offering). In this economic event the tokens are, similar to a traditional IPO (initial public offering) of company stocks, sold to the public. Except in the case of token networks this event happens at the genesis of the network. This seemingly small difference will lead to a paradigm shift in the economics of investing, wealth distribution and alignment of stakeholder interests. Let me explain why.
Democratization of access to investments
Traditionally investing in new businesses was limited by access, complexity and legal hurdles. Friends & family, VCs, PEs and banks have been seizing return opportunities generated by upstart and successful businesses. By the time the average consumer/private individual was allowed and able to invest in a business through an IPO the first 100x-1000x returns have been taken off the table. Average Joe was left to take the marginal returns in the form of dividents. While there is no doubt that early investors deserve high multiples on their invested capital for taking outsized risk, the traditional model is extremely ineficient for a variety of reasons. As there was no simple, lean and scalable way to offer access to investment opportunities the addressable market of potential investors was limited by complexity. Furthermore, accredited investor status often requires a minimum net worth and investment allocation, excluding most private individuals and consumers from being able to invest into early stage projects. Access to promising investments often is limited by network proximity. Inversely startups may struggle to find the right investors for a variety of reasons.
Token networks, through token sales, allow projects to democratize their funding process by opening it up to everyone. Individual investors can contribute to projects they desire and want to succeed at the same time and under the same conditions as friends, VCs, EPs, and Banks. Increasing the granularity and size of their market reach by several orders of magnitude.
Immediate liquidity
Investing in companies before tokens was not only limited to relatively few people and entities, it also required early investors to wait 5, 7 or 10 years for a liquidity event. Only then could the aqcuired shares be converted to cash. With few exceptions like the sale of secondary shares during an investment round there was no way to take money off the table. This creates a very inefficient and illiquid market environment. Tokens, on the contrary can be sold and exchanged immediately allowing investors to choose the time of liquidation and allowing new ones to get in as they see fit.
Alignment of principal and agent interests
The democratization of the funding process not only increases the reach and likelyhood of success, but also creates a significantly healtier ownership structrures as it aligns the interests of the principal (the owner/shareholder) and agent (the management)
In it’s perfect form, a token network is run by a decentralized autonomous organization (DAO). The DAO eliminates the principal agent problem altogether, as it acts entirely in the interest of the token owners (shareholders) and is ruled by consensus.
But even in a more classic scenario with human management, the interests are much closer aligned as the management is compensated in tokens, or is a significant token holder itself, as in the case of the founding team.
Network ownership effects
One of the most significant effects of the ‘user is the owner’ structure is what can be called the ‘network ownership effect’. It is an extension of the network effect, popularized by Robert Metcalfe as Metcalfe’s Law. It states that ‘the value of a telecommunications network is proportional to the square of the number of connected users of the system’.
Therefore, the network ownership effect not only increases the utility ot the network for existing participants as new users join the network, it also increases the value of ownership within the network. Making each participant’s stake more valuable as new participants join. In combination this creates an incredibly powerful growth mechanism for token based networks. Once more and more use-case and industry specific token networks will emerge and evolve, the propagation of the nwtwork by existing users will become an enormously powerful scaling mechanism.
The power of the network ownership effect can already be observed within the communities around the largest crypto assets such as Bitcoin and Ethereum, which have to date grown to a market cap of close to $100 billion just between the two of them without any marketing spend. A strong product at the core will generate developer engagement and strong community involvement in the product. What happens when there is no product a the core can be seen by the example of an ever-growing long-tail of coins that don’t generate any value and therefore fail to pickup engagement, leaving their growth curve as flat as a dead man’s heartbeat.
Once more and more use-case and industry specific token networks will emerge and evolve, the propagation of the nwtwork by existing users will become an enormously powerful scaling mechanism.
To sum it up:
Blockchain-based token networks will enable the digitization of virtually every kind of asset. Token distribution models will allow for a paradigm shift in investment economics, giving access and distributing the initial 100x-1000x upside to the users of the network, while allowing for immediate and almost perfect liquidity. Newtork ownership effects will allow token networks to scale with much higher cost efficiency. An incredibly powerful economic model that could truly change the world.
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