Tokens are all about decentralized trust
This issue is the first of the OverTheBlock Tokenomics Series, a deep dive into the blockchain technology’s economic and social implications. We investigate the transformative role of the token and the rise of new business and organizational paradigms.
More than ten years have passed since Satoshi Nakamoto published an innovative solution to the double-spending problem based on a peer-to-peer disintermediated network. The whitepaper gave birth to the first blockchain and the first cryptocurrency, the Bitcoin. Since then, the underlying Distributed Ledger Technology (DLT) has been acknowledged as a foundational technology, with a potential impact likely to match or outstrip the revolution brought by the Internet in the Nineties.
One of the grounding pillars of the blockchain technology is the possibility to reach a shared consensus on a univocal truth describing the history of states of a digital ecosystem, in the form of a ledger of transactions. A mathematical algorithm mediates the achievement of such consensus on a univocal truth. The ultimate implication of relying on a consensus algorithm is overcoming the need for a central authority that is entitled to provide a univocal truth. Therefore, the first paradigmatic shift originates from decentralizing the source of truth and cutting off centralized guarantors.
Talking about “univocal truth” and “centralized guarantors” may sound way too theoretical and far from daily life, but it’s rather the contrary. The most fundamental aspects of our lives rely on a centralized source of truth that acts as a guarantor, starting from our identity. The supreme act of one’s self-determination needs to be certified by a third-party (such as a state administration) to be generally acknowledged. Countless are the scenarios in which you need a birth certificate, an ID, or a passport to carry out your life activities, and central government issues all those documents. The same applies to the management of your finances: when you make a payment, your bank (or credit card issuer) guarantees that the funds on your account cover the expense (or that it is suited to your credit-score).
The first paradigmatic shift originates from decentralizing the source of truth and cutting off centralized guarantors.
The path outlined by Satoshi, detouring centralized sources of truth, paved the way to the overall shift of numerous economic activities. After the launch of Bitcoin, many cryptocurrencies emerged, and a diverse cosmos of blockchains has been developed. Thanks to immutability and transparency, blockchain offers individuals prerogatives previously available only to institutions, transforming actions into transactions and triggering virtuous behaviours. Furthermore, decentralization has been applied way beyond the mere monetary context, embracing different value-based scenarios.
How is this made possible?
Here we dive into what the tokenization of value is, and we try to distill the fundamental essence of blockchain tokens.
The shift from economics to tokenomics
The tokenization process can be described as the encapsulation of value in tradeable units of account, called tokens or coins. The disruptive potential lies in expanding the concept of value that can be partitioned and traded beyond purely economic terms, including reputation, work, copyright, utility, and voting rights. Once tokenized, all these manifestations of value can be detected, accounted for, and leveraged in the context of a system of incentives that may promote fair levels of wealth and power redistribution.
The tokenization process is the encapsulation of value in tradeable units of account, called tokens or coins.
In other words, tokenization represents a form of digitalization of value and, just like the Internet-enabled the free and fast circulation of digitized information, so the blockchain is allowing the “almost free” and borderless flow of digitized value. The blockchain made it possible to algorithmically solve the double-spending problem and introduced the concept of digital scarcity, as opposed to the digital abundance characterizing the Internet of information.
Once tokenized, every kind of value (in a broad sense) can be managed as a digital asset, whose unit of account is a dedicated virtual token. Such virtual tokens can be minted by any individual or organization that defines the set of rules governing them. These include the token features, the monetary policy, and the users’ incentive system. In light of this, the tokenization process can be further described as the creation of a self-governed (tok)economic system, whose rules are programmed by the token issuer.
Here it comes the second paradigmatic shift, namely from economics to tokenomics. In economics, innovation proceeds and propagates by introducing a change in the context of set rules and observing how such a relatively-rigid framework reacts to the change. Therefore the outcome of the proposed innovation is assessed, at first, on a predictive basis. Conversely, in tokenomics, innovation is put forward by designing the rules governing the playground in a way that the stakeholders’ behaviour aligns with the goal pursued. In other words, the second paradigmatic shift moves from the passive observation of the ecosystem’s reaction to a change to the active design of the ecosystem’s constituent laws, aimed at reaching the desired outcome.
The second paradigmatic shift moves from the passive observation of the ecosystem’s reaction to a change to the active design of the ecosystem’s constituent laws, aimed at reaching the desired outcome.
The tokenization process, as well as the shift to tokenomics, revolve around the token. Without neglecting the importance of the underlying infrastructure and its technical features, a deep understanding of the token nature is fundamental to effectively unleash the disruptive potential of blockchain technology.
So, what is a token?
This is a straightforward question, and, as it often happens for simple questions, it requires a not-so-simple answer.
Many tokens have been conceived and deployed in a relatively short time frame: their flourishing has been chaotic, highly experimental, and iterative. At the same time, their adoption and growth followed an evolutionary pattern with many tokens that didn’t survive the process of natural selection. Given the early stage and the broad scope of token-driven innovation, the nature of tokens is still taking shape, and its definition should be approached with a dynamic and iterative mindset. Their highly diverse features and applications pose another challenge in defining the nature of tokens. The extent of this diversity requires a comprehensive taxonomy, similar to what applies to living organisms, resulting from evolution. So far, a relevant number of classifications have already been proposed. Nevertheless, the transition from the initial unruled chaos to an ordered, yet dynamic, taxonomy is still far from being mature and requires a collective effort of scholars, experts, and practitioners.
Before diving into taxonomies, let’s draft an overall token definition with the ambition to cover and include all possible specifications and variations outlined by a hierarchical classification. Such a description must be, at the same time generic, but still meaningful, aiming at the broadest applicability. Given the cornerstone role played by tokens in a tokenization process, their meaning is intimately related to the very concept of tokenization. Following this approach, the token definition moves along two strands: on one side, it addresses the function performed by tokens, and, on the other, it drills to the very essence of what they represent.
Looking at the function performed by tokens in economic terms, a token can be described as “a unit of value that an organization creates to self-govern its business model, and empower its users to interact with its products while facilitating the distribution and sharing of rewards and benefits to all its stakeholders”. In simplistic terms, tokens can be seen as privately issued currencies used to exchange value within an ecosystem (e.g., Bitcoin). In reality, their usage has gone far beyond the mere currency application. The roles that a token may play are manifold and include, among others, giving access to a service, granting the right to contribute to a community, regulating the governance through voting rights. More generally, a token can be intended as a socio-economic dummy tool to promote the coordination of the actors in a regulated ecosystem towards the pursuit of a network objective function, through a set of incentive systems.
A token can be intended as a socio-economic dummy tool to promote the coordination of the actors in a regulated ecosystem towards the pursuit of a network objective function, through a set of incentive systems.
Since it is a dummy tool, the token doesn’t have an intrinsic and self-standing definition, but its nature is determined by what it represents. Sticking to the concept of tokenization as an encapsulation of value, the token is the representation of such value. Therefore, the deep understanding of the encapsulated value provides the key to distill the essence of tokens.
The value represented by the tokens observable out in the wild is diversified and cannot be described univocally: it can be either the right to have a discount on an exchange rate, or the proof of ownership of a gold ingot, or the reward for solving a mathematical problem to validate the next block of the chain, or many other examples. The challenge is to generalize the definition of token-represented value, by chasing a common trait that all these expressions of value share. Looking deeply into the source of token-encapsulated value, the concept of trust occurs over and over.
When tokens represent the holder’s right, for example, to access a service or benefit from a discount or express a vote, within a regulated ecosystem, the token holder grants trust to the token issuer. In particular, the holder trusts that the right represented and originating from the token holds and is enforceable. Ultimately, the holder trusts the token issuer and its capability to honor the obligation associated with the right represented by the token. When tokens represent an underlying asset (or better a real right on an underlying asset), the token holder trusts that the token issuer ensures the enforceability of the right itself and, at the same time, that the underlying asset is adequately managed and holds (or increases) its value. When tokens are the reward for the block validation activity, their value is the direct representation of the level of trust towards the token holders community and its disintermediated and decentralized consensus. Keeping along this road, it’s always possible to bring back the source of value of a token to the concept of trust. Ultimately, it’s possible to define tokens as quantifiable representations of decentralized and disintermediated trust.
A token is a quantifiable representation of decentralized and disintermediated trust.
This wants to be a general definition, and a comprehensive taxonomy is needed to map accurately all the different branches of value representations that tokens can convey. Still, it’s fundamental to keep in mind that trust is core and permeates all the expressions of value brought by every kind of token.
Now that we framed the token concept, how are we going to classify in detail the existing ones? And how can we design new tokens to deliver significant incentives to users and align their behavior?
Follow us and discover it in the next issues of the OverTheBlock Tokenomics Series!
Please cite as:
Freni P., Ferro E., Moncada R. (2020), “Tokens are all about decentralized trust”, OverTheBlock Innovation Observatory, https://medium.com/overtheblock/tokens-are-all-about-decentralized-trust-5471dd35b3
OverTheBlock is a LINKS Foundation’s initiative carried out by a team of innovation researchers under the directorship of Enrico Ferro. The aim is to promote a broader awareness of the opportunities offered by the advent of exponential technologies in reshaping the way we conduct business and govern society.
We are chain agnostic, value-oriented, and open to discussion.
