The Difference Between Protocol Tokens and Traditional Asset Tokens
By way of background, one of our biggest motivations in building the Melon protocol is the creation of an infrastructure for managing digital tokens; what we firmly believe to be a fast-emerging asset class.
In the last two years, hundreds of digital tokens have emerged. To avoid confusion we can break up “digital tokens” into two broad sub-groups;
- Protocol Tokens (PTs)= Digital tokens that are governed by a coded protocol. The rules of the protocol are enforced by the underlying blockchain technology. They are generally not linked to any “centralised” entity or any “traditional” real-world assets.
- Traditional Asset Tokens (TATs)= Digital tokens that represent a “traditional” asset, such as fiat currency (e.g Tramonex’s ERC20 GBP on Ethereum, Decentralised Capital’s ERC20 Euro) or precious metals (Digix’s ERC20 token representing gold). These assets are still dependent on traditional financial and legal systems.
It is important to distinguish between these two sub-groups because they will have different properties over time. Protocol tokens benefit from a very interesting collection of properties which is why we believe they will soon be a critical element in the achievement of diverse portfolio construction.
“Harry Markowitz called diversification a “free lunch.” We spend all our time in intro. econ. figuring out there is no such thing as a free lunch but Markowitz tells us that diversification is a free lunch. “ — Open Yale Courses
Harry Markowitz — 1990 Nobel Memorial Prize winner in Economic Sciences.
The secret to great portfolio management is good diversification and uncorrelated returns. It is hard to find back-tested data on protocol tokens, so we can use the chart below to illustrate that even against asset classes which are considered “safe” such as gold and U.S Government Treasuries, protocol tokens have a surprisingly low correlation.
Some of the reasons for protocol tokens having low correlation to other asset classes come about from their independence from today’s financial system. They are bound by the rules of their underlying protocol, which is supposed to be “un-corruptible”. As such, they are not so exposed to any hidden erosion in value (eg. Quantitative Easing) or traditional financial risks that have emerged over the years in financial markets. Since the total market cap of all protocol tokens is less than 1% that of gold, there is extreme upside potential in this asset class.
The way that Traditional Assets are being tokenized — the processes involved, how they then connect back to the “real world” — is intriguing, and clearly part of a growing trend. The underlying asset of a Traditional Asset Token is typically a “real world asset” which is governed by one (or more) centralised party but exists independently of the token’s existence on a blockchain.
Adding traditional assets onto blockchain technology requires for them to first be held in custody by a centralised party. They can then be tracked via an issuance of tokens which represent the ownership of assets on chain with the security guarantees that blockchains provide. Trading and settlement can happen in a matter of seconds and at minimal cost (compared to t+3 + high fees, for example) due to the underlying technology. In theory, these assets are also divisible into smaller units, and as a consequence become more easily accessible.
We are primarily building “Melon”, as an infrastructure to set up and manage funds built around protocol tokens — an asset class which we fundamentally believe will have a place in every single diversified portfolio ten years from now.
Traditional asset tokens are a newer trend — Assets in the real world are fast becoming tokenizes through a variety of novel and innovative mechanisms. Some examples include art (Ed Fornieles), music (Ujo Music), intellectual property, equities (Overstock & Otonomos), fiat currencies (Santander), real estate (REIDAO) just to name a few examples.
If you believe (like we do), that traditional asset tokens are also an emerging asset class, then it is already possible to apply the Melon protocol vision to that asset class as well. This will enable traditional asset managers to save on costs and pass the savings on to their investors. In theory, there is no reason why you can’t run a truly diverse portfolio across the full spectrum of all these assets in one Melon portfolio with the efficiencies that come along with it!
This idea is incredibly exciting to us as a means of democratizing asset management and allowing a deeper talent pool to rise, enabled through great technology. Hundreds of trillions of dollars worth of assets around the world now have the potential to be tracked, trusted and traded on your favourite blockchain, and perhaps even sooner than you can imagine!
Stay tuned for our next blog: 3 of The Biggest Hedge Fund Failures Ever and How Smart Contracts Could Have Helped Them
About the Author:
Mona El Isa
Former star-trader at Goldman Sachs, promoted to Vice President by the age of 26 and made the “top 30 under 30” list in Trader Magazine in 2008 and Forbes Magazine in 2011 after profitably trading the 2008 and 2011 crashes. Moved to Geneva-based macro fund Jabre Capital in 2011, before deciding in 2014 that the future of finance lay in blockchain technology. She studied Economics & Statistics at the University College London. Today, Mona is the CEO and Co-Founder of Melonport AG, the private company building the open-source Melon protocol.