Unpacking the new blockchain asset class
In part 1 of this series we covered some of the aspects around how blockchains work and why persons are so excited by this new technology. We left off with one of the unique aspects of this technology, the mechanism by which we can observe and engage with the value created; a mechanism known as ‘the blockchain token’.
The ledgers that make up most blockchains are controlled exclusively by tokens. The tokens serve as powerful mechanisms to help maintain the security of these underlying blockchain ledgers. Remember, a blockchain can be thought of as a decentralised ledger. Each token exchange between two parties represents a new entry to that ledger.
The different tokens can also have certain additonal purposes depending on the particular blockchain project. For example bitcoins (Bitcoin tokens) represent the ability to write new entries to the most immutable database we know of; Ether (Ethereum tokens) represents the ability to rent processing capacity from its ‘world computer’.
Each token carries a value. They can be thought of as shares of stock in their respective blockchain projects. The tokens serve to give some idea of the market valuation of the project at any point in time, much like a traditional market cap would. Market caps are usually derived by working out an entity’s aggregate share value, and it is no different in the blockchain world.
Token creation
In most blockchains, brand new tokens are created with each new block in the ledger. This is done through a process called ‘mining’. The new tokens are usually distributed in a random manner through that project’s network to its participants in exchange for some valuable work. The entire process is controlled by the project’s code, and the distribution is usually based on participants submitting some sort of proof-of-value to the network to claim their share of the issuance. These together help to ensure that tokens are created through a hardened process that is not easily changeable.
How tokens are distributed
Each project chooses its specific ‘issuance policy’ (or ‘monetary policy’ in the case of currency blockchains). Projects determine how much of their tokens will ever exist and how these tokens should be distributed.
Bitcoin for example has a policy where a finite amount of bitcoins (21 million) will only ever exist. These are distributed exclusively to persons who expend energy to secure the network, and issuance will decrease at an exponential rate until around the year 2140 when the last new pieces of bitcoin will be minted. With the Dash project on the other hand, its tokens are distributed in a 45:45:10 split with 45% going to securers on the network, 45% going to validators and performers of special services on the network, and 10% going to a fund which is used to finance development activity of the project.
Token price discovery
Once tokens are created and issued, they must then go through the process of price discovery in the open market before any fair valuation can be made of the project. Tokens are usually placed on open exchanges and the token prices are used to extrapolate an estimated of the value of the project at any point in time.
Blockchain token markets are unique in that they never close, are nation-agnostic, allow seamless exchange from token to token, and are granular enough that persons from any financial background can participate. Each of these properties on their own represent a marked improvement on how our traditional markets are run. Together, they create a powerful new paradigm for how global trade and exchange can occur.
Gaining access
The most difficult part of participating in this market is usually the initial on-ramping from traditional national currencies into an appropriate blockchain token. Bitcoin is by far the most popular blockchain token used for this on-ramping process, and the way one does this is by simply buying some bitcoin through any one of the popular exchanges.
The blockchain token space is still relatively new and as of this writing the entire space only accounts for approximately US$14 billion of value. Comprehensive details of different projects, their current valuations and their price histories can be found on sites like coinmarketcap.com.
Managing your tokens
Once tokens are created and distributed, end-users must have some way of storing and sending these. The way this is usually done is through some form of a digital wallet.
Digital wallets are pieces of software that can speak each particular blockchain’s language. The way they work is by storing the public address and the secret keys that one can use to interact with the tokens. The public address can be thought of as much like an email address. It is an address that can be shared freely and that persons can use to send you tokens. The secret keys can be thought of as the password, that allows you to open that address and send those tokens. In this way, blockchain tokens can be thought of as bearer assets where ‘ownership’ is determined simply by “who posseses the secret keys” to any particular address.
Digital wallets come in many forms such as smartphone apps, in-browser applications and even embedded in hardware devices. The particular wallet chosen usually depends on a compromise between security and usability that is made by the end-user.
Other aspects
Due to the nature of these tokens and how they work, they lend themselves to unique applications much like the following examples.
The rise of alternative crowdfunding, the ICO
The initial amount of tokens created at the start of a blockchain project is a curious aspect to be aware of. Projects have the option of either starting with a zero balance and having all tokens distributed through its creation mechanism (mining), or of starting with some balance (known as a pre-mine) and then selling these off at a pre-determined price. This latter option has come to be known as an Initial Crowd Offering or ICO, much like an IPO with traditional companies, and it has evolved into an intriguing crowdfunding mechanism that has been used by a few prominent projects so far (e.g. Ethereum, the DAO project).
Blockchain tokens as currency
At the technical level blockchain tokens are first and foremost tokens, but because of certain properties they can also serve as decent money. Indeed the very first blockchain project, Bitcoin, was described as “A Peer-to-Peer Electronic Cash System” by its creator. A number of tokens are designed specifically for this purpose, and this subset of blockchain assets is often referred to as ‘cryptocurrencies’ stemming from the cryptographic techniques used to secure these tokens.
The question of investing
We’ve now established a basis for what blockchain technology is, where its value is derived from and how that value is expressed through its tokens. Given these the next question naturally becomes, “should I consider investing in this new asset class?”.
This is a multi-part series exploring the question of what a “blockchain asset” actually is. In this second piece, we looked at explaining some of the ideas behind “blockchain tokens” as representations of the value generated from this technology. In the next piece, we will look at the nature of investing in this new asset class.
*Title image & other illustrations courtesy Shutterstock
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Other pieces in this series:
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