Does a blockchain really need a native coin?

In my previous post I addressed the hype surrounding blockchain — mostly in a context of the application of blockchain technology to the financial industry. Now it is time to think about the hype surrounding coin (or token) — which hype is constantly manifested as endless ICOs, speculation and forks.

This post covers such questions:

  1. What kind of a problem exists?
  2. What is a coin in a blockchain?
  3. How to define a true cryptocurrency vs scam?
  4. What people want to achieve when they create coins?
  5. Which blockchains must have a coin?

What kind of a problem exists?

Most people believe that a coin is absolutely necessary in a blockchain and that in turn motivates them to invest money in an ICO. When situation is either black or white — one has to take sides.

at the same time you read in press:

The terms of this debate are somewhat misleading. And here is why:

  1. Andreas uses the word “blockchains” (plural) without any indication about which blockchains are meant.
  2. Marc probably means the Bitcoin blockchain as a network. But people will obviously extrapolate to any blockchain.
  3. Obviously Bitcoin blockchain cannot exist without Bitcoin — because the only thing it contains is information about bitcoins :)
  4. The poll highlighted in the above graphic mixes all the things together — “blockchain tech”and Bitcoin (Bitcoin with the capital B means a particular network, not a currency, but even if a currency was meant — it doesn’t help).

The first problem lies in a common understanding what is blockchain as a technology.

Blockchain, defined broadly, is a mechanism for reaching consensus regarding the state of a shared database between multiple parties who don’t trust each other.

I know that many people describe blockchain differently. But if you ask “why” enough times, at the end of your inquiry you will find agreement regarding the key features of blockchain. And it happens that blockchain is not about currency, but rather about consensus over some digital asset. Which assets need a blockchain are described here.

What is a coin?

Or in other words, what people mean when they use the word cryptocurrency?

  1. a real decentralized cryptocurrency like Bitcoin
  2. a crypto-asset, backed by something/somebody (IOU in Ripple)
  3. a coin, backed by nothing & pre-mined by creator (very often is a scam)

What could be the role of a coin in a blockchain?

  1. A way of monetization for founders
  2. A stake of the particular blockchain startup
  3. An accounting method, a digital asset
  4. A reward method for miners
  5. A preventive method that stops double spending in PoS and PoW
  6. A payment method between participants
  7. A membership fee

Reason #1 is pretty clear and unfortunately very often read as “ let’s earn money right now using the hype”. Reason #2 is ok, but then it is not a coin, but rather a share (with all of the legal consequences of being a security). Reason #3 is ok too, and since you can account for anything, even tomatoes in a warehouse, to name it a coin is a little bit strange.

What people want to achieve when they create coins?

Reasons #4–7 are more complicated. My guess is that the founders want to create an economy. And an economy needs control. Why do we have national currencies? To control the economy — prices, inflation, subsidization of particular industries, control of competition, etc. If there are no monetary politics then a currency is not needed. But, many blockchain projects introduce a currency, but don’t introduce the economic rules which will make that economy successful. So, if you are willing to create a coin or evaluate one, the first question would be whether the new economy will be sustainable. The second question — which projects should have a coin — is very important. This is because the wrong answer might quickly disappoint the community, investors and other key stakeholders.

Which blockchains need a coin?

To answer this question we need to differentiate amongst various blockchains somehow. The model and reasoning behind this process was introduced in the previous post. Here is the result.

I truly believe that only systems from the top-left quadrant could have a coin because of reasons #4–7. Examples are Bitcoin, Monero etc. I say “could” because Bitmessage provided a very good example of a proof of work system with anonymous nodes which don’t need a coin or even a shared blockchain.

Any proof of stake blockchain does not need a coin. Rather, what is needed is an ideal payment method (or currency) which is recognized by everybody. This universally acknowledged payment method would allow for the handling of security deposits by the miner (security of proof of stake mainly relies on confiscating a stake in case of misbehavior). I am not saying that such ideal currency exists, but I think we are very close. I will describe the criteria for such an ideal currency in the next post.

FBA blockchains (Ripple, Stellar) don’t need a coin at all. In this scenario coin neither increases stability nor effectively defeats spam. Validators are not paid with the fees in any case. They can use any existing coin (bitcoin, ether, etc.) to execute settlements with the highest efficiency.

Private blockchains don’t need a coin by default. Although they can operate based upon a digital asset (representing fiat), or some synthetic currency (e.g., SDRs issued by the IMF). But, until this blockchain becomes the primary source of information about fiat accounts, they must always be backed by something.

In general, if the system don’t manage scarce asset it doesn’t need blockchain at all. The best architecture for such a system is an open network — examples are Tor, Torrent, Bitmessage, DHT etc.

(No) consensus

I think that Ethereum as a smart contract platfrom could exist without a native coin (unless you define Ethereum as programmable money). The same applies to Storj, Waves, List, Maidsafe, Ripple, Factom, Filecoin and many others. It seems strange for consumers to buy another currency in order to pay for storage. Why not to use Bitcoin instead?

Conclusion

There are few strong rationales for creating a native coin in a blockchain. The most important one is the creation of a new economy. But… let’s think for a moment before participating in ICO — could the same technology solve the same problems without the coin?