Tokens Classification: Framework Walkthrough

This issue is the third of the OverTheBlock Tokenomics Series, a deep dive into the blockchain’s economic and social implications. We investigate the transformative role of tokens and the rise of new business and organizational paradigms.

The framework presented in the post was accepted for publication by the Journal of Blockchain Research and Applications (link).

Photo by Aron Visuals on Unsplash

In the previous issue of the OverTheBlock Tokenomics Series, we presented a new Tokens Classification Framework based on General Morphological Analysis. Such a framework aims to describe a token from multiple perspectives at once, being as comprehensive as possible.

Here we provide a walkthrough to the OverTheBlock Morphological Token Classification Framework, looking at the details of each dimension and set of values that are available for the token description.

Let’s start by recalling the domains in which the dimensions are grouped, namely:

• Technology domain, including all the technical characteristics of the token, referring to the level of integration along the technological stack, the blockchain infrastructure, and protocol;
• Behaviour domain, including all the inherent functional characteristics of the token, that rule the possible actions that can be performed with the token (capabilities or restrictions);
• Coordination domain, including all the token dimensions that enable coordination among the actors of the token-based ecosystem.

When you approach the classification of a token, the best starting point is the token whitepaper. This somewhat-technical document usually contains a detailed description of the blockchain-based ecosystem, the token characteristics, and its underlying functional mechanisms.

Afterwards, you can go through the classification framework considering one dimension at a time. For each dimension, the set of values provides the qualitative alternatives among which you can choose the one(s) that best apply to the token you are analyzing. Generally, as far as the Technology and the Behavior domains are concerned, you should select one single value for each dimension. In contrast, in the Coordination domain, some dimensions require more values to be thoroughly described.

It’s now time to deep dive into the classification dimensions. I’ll guide you through each of them so that you will be able to use the Token Classification Framework yourself.

Technology Domain

The Technology Domain comprises five dimensions: Chain, Permission, Number of Blockchains, Representation Type.

Generally, within this domain, the values assigned to each dimension are straightforward since they are retraceable in the whitepaper or the token’s information.

Chain

This dimension indicates the characteristic of the blockchain on which the token is issued. In particular, a token can be chain-native, which means that it’s created together with the respective blockchain, and it’s essential to the functioning of the infrastructure and the consensus protocol (e.g., Bitcoin, Ether). When the token is chain-native, but the respective blockchain results from a “fork”, either “New Chain, Forked Code” or “Forked Chain, Forked Code” applies. In detail, the former value refers to new blockchains that replicate the codebase of an existing chain, changing some parameters (e.g., Dogecoin, ZCash). The latter value is used when a chain results from a “hard fork” (e.g., Ethereum Classic). Finally, a token can also be issued on top of an existing protocol, leveraging an existing blockchain (e.g., ERC20 tokens).

Permission

This dimension is more related to a characteristic of the token’s underlying blockchain. When the possibility to participate in the network (either validating blocks, sending/receiving transactions, or reading the ledger) is open to everybody, then the underlying blockchain is “Permissionless”. Conversely, when the nodes of the network must be accredited to join it, the blockchain is “Permissioned.” That is a very brief summary and, if you want to understand better the difference, you can start from here.

Number of Blockchains

This dimension indicates if the token can be used on a single chain or across different chains. Cross-chain tokens are still in their early days, but they are expected to play a fundamental role in Decentralized Finance (DeFi).

Representation Type

This technical dimension is quite subtle and distinguishes between “Common” and “Unique” tokens. It relates to the possibility to trace a token that is characterized by a distinctive and unique representation.

In most cases, the tokens of a blockchain-based ecosystem are “common”, in the sense that they share the same set of properties, and their representation is a balance — or quantity — assigned to the account addresses of the respective owners. This way, a change of one of the token’s properties — let’s say the price — automatically applies to all the tokens issued. Therefore, if a token has a “common” representation, it’s possible to trace only their balances in owners’ accounts. On the contrary, the tokens with a “unique” representation can be individually identified and tracked, and do not benefit from bulk properties change.

It’s essential not to mistake the “Representation Type” dimension with the “Fungibility” one (described later). The concept of fungibility refers to the interchangeability of tokens based on their value, although they may have other unique properties. A very clarifying example is banknotes: they are fungible since they have the same value, and are unique since they have a serial number to trace each of them.

Behaviour Domain

The behaviour domain includes six dimensions: Burnability, Expirability, Spendability, Fungibility, Divisibility, Tradability.

All these dimensions refer to the token’s inherent functional characteristics, defining what can — or can not — be done with the token. Here we consider the behaviour of the token itself, not the token holders’ one. Usually, the abilities of the token are well defined in the whitepaper. Those behaviours can be invoked either by a stakeholder of the ecosystem or a smart contract.

Burnability

This is a binary dimension (“Burnable” or “Non-burnable”), and it indicates if the token can be burned — generally by the token issuer — to create artificial scarcity, terminate a right, or revoke access. Since this token behaviour can be used to adjust the overall token supply, it typically relates to the ecosystem’s monetary policy.

Expirability

This is a binary dimension (“Expirable” or “Non-expirable”), and it says if the token can expire, that means that it will be programmatically burned after some time. For example, expirability suits well tokens that provide a discount or temporary access to a service.

Spendability

This is a binary dimension (“Spendable” or “Non-spendable”), and it indicates if the token can be spent within the ecosystem, for instance, to gain access to services or to pay fees. Conversely, tokens that are used to account for users’ reputation or to distribute voting power are generally non-spendable, to avoid misbehaviours and crookedness in the ecosystem’s governance.

Fungibility

This dimension refers to the possibility to interchange a token with any other alike, with specific reference to its value, or value representation. As anticipated, fungibility has not to be confused with the “Representation Type” because “Unique” tokens can be fungible. In addition to “Fungible” and “Non-Fungible” tokens, there exist also “Hybrid” tokens. They are tokens whose fungibility is limited to a subset of all the available supply. Concert tickets provide a clear example. Let’s say that your favourite artist is in town and will perform three dates in a row: a ticket for one date can be swapped indifferently for another on the same date (they are perfectly fungible), but not for a ticket on a different date. So, even if all the tickets have equal value, their perfect fungibility is restricted to their date, and they are “hybrid”.

This peculiar “hybrid” fungibility usually occurs in tokens representing partitioned real assets, such as real estates, cars, boats.

Divisibility

This dimension defines if the token can be split into sub-units (“Fractional”) or if it represents an indivisible “Whole”. In the first case, decimal figures are allowed in counting an amount of token (for example, in an account balance or a transaction), while in the latter token’s quantities can be measured using only integer numbers. Finally, “Singleton” tokens admit a quantity of 1, with no subdivision, that means that there is just one token, and it cannot be partitioned. Such tokens are quite rare, and they can be found, for example, in gaming contexts or in the digital representation of art pieces.

Tradability

This dimension illustrates if the token can change ownership, both within a platform or on secondary markets. Most of the tokens at present are “Tradable”. In general terms, their swift and cheap exchangeability constitutes one of the most significant advantages in DeFi applications. Nevertheless, there are cases in which tokens are “Non-Tradable”. In line with the considerations drafted for the “Spendability” dimension, tokens that represent users’ reputation or give voting rights are usually non-tradable for the very same reasons they are not spendable.

Finally, the utility of a token can be transferred with no change in ownership. In this case, the token is “Delegable”, which means that a token owner can transfer the rights deriving from holding — or staking — the token to a third party. This specific token behaviour is essential in the blockchain ecosystems relying on the Delegated Proof of Stake consensus protocol.

Coordination Domain

The coordination domain includes four dimensions: Underlying Value, Supply Strategy, Incentive Enablers, Incentive Drivers.

The dimensions belonging to this domain describe how the token is leveraged to promote specific behaviours in the actors — stakeholders — of the ecosystem. Recalling the definition drafted in the first issue of the OverTheBlock Tokenomics Series, 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. How the token can promote such coordination is described by these dimensions, whose values are the result of the token design process, as framed within the concept of tokenomics.

If the characterization of the Technology and Behavior domains is straightforward and relatively easy to derive from the whitepaper, the Coordination domain presents a few more challenges.

When you analyze a token, all the previous dimensions are invariant with respect to the actors: those token’s characteristics are intrinsic, and their definition can be achieved looking only at the token itself. On the contrary, the Coordination domain’s dimensions are defined in relation to the incentivized actors’ behaviour. It follows that selecting the most suitable values for those dimensions requires a more in-depth assessment of the ecosystems, including the relevant stakeholders, their motivations and behaviours, and the elementary cooperations that they establish (a guide to this assessment will be available in the next issue).

Underlying Value

This dimension describes the source of the token inherent value and the dynamics that drive value fluctuations (appreciation/depreciation of the token). The available classification values are three:

• Asset-based: the underlying value is tied to the value of real-world assets, such as, for example, gold, real estate, traditional financial products (market stocks, bonds, and shares), art pieces. The underlying asset can also be another crypto asset: that’s the case of Wrapped Bitcoins, an ERC20 token whose value depends on BTC’s value. Price fluctuations of Asset-based tokens reflect the changes in the value of the underlying assets. On a side note, most of the stablecoins are asset-based.
• Network Value: the underlying value is the representation of the level of trust towards the network itself and the utility that the token can provide to token holders. The Metcalfe’s Law can be recalled as a notable — still simplified — example of network’s value assessment. In this case, price fluctuations are driven by the token supply and demand equilibrium. Network driven demand may arise, for example, from the token’s usage to access services and, in the case of fixed supply, this leads to a price increase. On the other side, tokens’ supply can be adjusted by the token issuer to create inflationary or deflationary trends, with direct consequences on the token value. So, the supply strategy has a significant impact on the price of Network Value tokens.
• Share-like: the underlying value and the price fluctuations follow the same principles behind traditional market shares. Here, you need to evaluate if the (present/future) value of the token is generated by the work of token holders or third parties’ work. In the former case, the token falls back into the Network Value classification, while, in the latter, it behaves like a share. Such an analysis is, in fact, the Howey Test, which identifies as “investment contract” a transaction that “involves an investment of money in a common enterprise with profits to come solely from the efforts of others”. This test’s outcome has critical regulatory implications since, in several Countries, Share-like tokens are considered actual securities, and they must comply with the same laws that safeguard investors in traditional markets. The U.S. Security and Exchange Commission (SEC) provides a relevant reference in the matter.

Supply Strategy

This dimension illustrates the tokens supply structure adopted by the token issuer, being an organization, or a set of smart contracts. Furthermore, it provides a summary of the monetary policy put in place and is crucial in shaping the token’s dynamics. This influence holds especially in the case of Network Value tokens, as previously anticipated.

Finally, it’s essential to stress that the Supply Strategy plays a fundamental role in defining the Token Velocity, which is a measure of how often the owner of the token changes in a set period. The concept of Token Velocity is non-trivial, and it deserves a dedicated focus (you can start from here and here).

The classification values that you can choose from are:

• Schedule-based: tokens are minted and distributed based on a programmatically defined schedule. This supply strategy can be embedded directly in the consensus protocol — as it happens for Bitcoin — or implemented via one or more smart contracts governing the ecosystem.
• Pre-mined scheduled distribution: tokens are all minted at the ecosystem’s birth — Token Generation Event — and distributed afterwards, according to a set of rules defined by the token issuer and implemented via smart contracts. If the Token Generation Event is leveraged as a fundraising opportunity, it may be referred to as ICO, STO, or IEO.
• Pre-mined one-off distribution: tokens are all minted at the ecosystem’s birth — Token Generation Event — and distributed afterwards altogether. In this case, the Token Generation Event can be an ICO, STO, or IEO.
• Discretionary: tokens are minted and distributed with no predefined schedule, but according to the will — or need — of the token issuer. This kind of supply strategy is typical of non-fungible tokens that are created on-purpose to represent a real-asset.
• Matching demand: tokens are minted and distributed — or burned — according to the current demand. This way, the level of supply is “artificially” kept in line with the demand to create a stable equilibrium. This strategy can be put in place, for example, to limit token’s price fluctuations.

Incentive Enablers

This dimension is core to the coordination domain since it’s one of the two building blocks’ categories of token-based incentive schemes. In particular, Incentive Enablers are those characteristics of the token needed for the incentivized behaviours to happen. They indicate what an ecosystem’s stakeholder can potentially do with the token. Therefore, they are an essential pre-requisite for the incentive to be effective, but they are not sufficient to trigger the actual behaviour of the actors involved. In a way, we can say that these features play a “passive role” in the incentive scheme.

To identify the suitable values describing the Incentive Enablers dimension, you can ask yourself: “What are the reasons for the ecosystem’s stakeholders to acquire the token? Why are they buying or earning them?”.

The answers may be one or more of the following:

• Right to work: the stakeholders must hold or stake tokens to be able to contribute to the ecosystem, generally by providing a service — implying direct work — or sharing resources, such as computing power in a distributed network. Staking-based participation is leveraged to ensure that network contributors have “skin in the game” and to disincentivize selfish behaviour.
• Right to use: tokens are needed to access services and content made available within the ecosystem. Since only stakeholders owning tokens can “use” the services provided, this feature is particularly useful in jump-starting adoption, overcoming bootstrapping issues, and fundraising. Regarding the last point, ICOs — or STOs, IEOs — have heavily relied on decoupling the purchase of a service from its actual availability, that is postponed in time. The token is a sort of “coupon” that future users buy in advance — de facto financing a project — and that they will be able to redeem when the corresponding service is delivered. All of this implies a good dose of trust.
• Right to vote: in this case, holding or staking tokens is a requirement to influence the decisions that shape the rules of the ecosystem. Token-based voting is fundamental in decentralized governance contexts and DAOs (Decentralized Autonomous Organizations).
• Unit of account: tokens can measure the value of something (e.g., services, assets, labour, liabilities), fulfilling the same corresponding function of money.
• Medium of exchange: tokens can be used to intermediate the exchange of services or goods, fulfilling the same corresponding function of money.
• Store of value: tokens represent an asset that keeps its value and purchasing power over time, fulfilling the same corresponding function of money. Therefore, they can be held by stakeholders as a liquid financial reservoir. Again, quite a dose of trust is implied.

Apart from these six values for the Incentive Enablers dimension, you may incur into tokens that alter the impact of a stakeholder’s action within the ecosystem. For example, there are multi-tokens ecosystems in which if a user stakes an amount of a dedicated token, its voting/working influence increases (have a look at Steem). This kind of token is a modifier and can be considered a “weighting coefficient” applied to actions performed using other tokens in the ecosystem. Since they have an ancillary function, those tokens inherit the Incentive Enablers’ value of the incentivized behaviour they alter.

Incentive Drivers

This dimension is complementary to the previous one and represents the other cornerstone building blocks’ category of token-based incentive schemes. In detail, Incentive Drivers are those characteristics of the token that actively promote the actors’ incentivized behaviours. If, on one side, Incentive Enablers describe what can be done with a token, on the other, Incentive Drivers express why an ecosystem’s stakeholder engages the incentivized behaviour. As such, this dimension’s values are conceived as the triggers that push the actual behaviour of the actors involved. Therefore, these features play an “active role” in the incentive scheme, as opposed to the function of Incentive Enablers.

To identify the suitable values describing the Incentive Drivers dimension, you can ask yourself: “What are the reasons for the ecosystem’s stakeholders to use the token? Why are they spending, staking, selling, or burning them?”.

The answers may be one or more of the following:

• Get access: the token grants access to services and content within the ecosystem. Generally, token holders need to spend or stake their tokens, activating the incentivized behaviour enabled by the “right to work/use”. “Get access” is one of the most common Incentive Drivers occurring in token-based ecosystems, and it’s often leveraged in ICOs, STOs, or IEOs.
• Get discount: token holders can benefit from a discount on services/content available in the ecosystem. Redeeming such a discount requires stakeholders to hold or stake some tokens for a minimum period, or spend tokens to buy the services/content instead of using other currencies. These mechanisms are usually put in place by the token issuer to boost early adoption and control the token velocity (that plays a significant role in defining the overall value of a token-based ecosystem).
• Get revenue: the token acts as a substitute for fiat currencies in the intermediation of economic transactions, and it’s, therefore, used to collect payments for services/content. Either the token issuer or other stakeholders in the ecosystem can be paid using tokens. In the former case, the token-based payment is associated with a price reduction, so the prevailing Incentive Driver is to “get a discount”. Conversely, in the latter case, the ecosystem’s actors can monetize the “right to work” — that they gained acquiring tokens — providing services/content to other stakeholders. Such a scenario is typical of blockchain-based platforms that can be framed within the “gig economy”, or classified as multi-side marketplaces. Finally, you must pay attention to the fact that the “get revenue” Incentive Driver applies when such revenue results from the direct effort of the actor who is cashing in the tokens. If the earning originates from others’ effort, different Incentive Drivers apply, namely “Dividend/Earning Potential”. This distinction follows the Howey Test, previously mentioned, to identify share-like tokens.
• Get reward: again, the token replaces fiat currencies in the intermediation of economic transactions. Unlike the previous Incentive Driver, in this case, tokens are paid in exchange for actions that are not usually valued economically. Social media and social networks provide a perfect example: traditional platforms don’t recognize to their users the work they do in producing, sharing, and curating — like or comment — content. On the contrary, the corresponding token-based platforms reward users for their contribution to the ecosystem. In this regard, the token promotes a new economy creation that someway expands and blurs the boundaries of the “gig economy”. One particularly significant variety of such token-generated economies is the “attention economy”.
• Dividend/Earning potential: token holders benefit from the ecosystem’s success and can get a share of the profits by staking — or holding — some tokens. As previously mentioned, in this scenario, the earning of the token holder originates from the work of a third party and, therefore, share-like tokens generally leverage this Incentive Driver. In this context, the token issuer may pay token holders by minting new tokens, unlocking some tokens from a reserve pool, or sharing part of the profits using other currencies (either crypto or fiat). In analogy with traditional financial instruments, we can refer to Dividend potential in the first two cases and Earning potential in the last one.
• Appreciation potential: token holders expect a price increase of the tokens they own. In this case, the Incentive Driver induces stakeholders to keep their tokens — reducing token velocity — as they consider them a store of value whose market price is foreseen to grow. The appreciation potential is particularly powerful on crypto investors who are moved by a financial speculation purpose.
• Participate in governance: the token can be used by the stakeholders to shape the ecosystem’s rules, influencing its evolution, and being actively involved in the governance. This Incentive Driver is usually coupled with the “right to vote” enabler. Furthermore, participation in governance is crucial in some consensus protocols, such as Proof of Stake (PoS) and Delegated Proof of Stake (DPoS).
• Gain reputation: the token is a way to quantify and account for an actor’s reputation in the ecosystem. Reputation can be viewed as a non-monetary reward for contributing to the ecosystem. It’s fundamental in counteracting misbehaviours and helps to reinforce widespread trust among the stakeholders.

The eight listed Incentive Drivers are often combined, and the resulting incentive scheme can be pretty elaborate. Moreover, other underlying drivers take part in the incentivization of stakeholders’ behaviour. These further drivers are somewhat secondary, non-specific, and shared among the ones previously identified. Stakeholders may be induced towards desired behaviours also by the possibility to exclude others and leverage smart contracts.

Excluding others is made possible because token-based ecosystems are “closed”, in the sense that you need some specific tokens to operate and benefit from them. This fact, combined with controlled supply and distribution of tokens, can create exclusivity dynamics, that are especially compelling for innovators and early adopters. At the same time, smart contracts are a peculiar feature of most blockchains. They can be themselves a sufficient reason for some stakeholders to join and act within a token-based ecosystem.

The Token Classification Framework that we developed and hereabove detailed it’s not carved in stone. Since tokens and blockchain ecosystems are in continuous evolution, the methodologies that describe them shall be flexible and prone to adapt to the emerging paradigms.

Therefore, if you have any feedback or suggestion, please share your thoughts to progress it further.

Please cite as:

Freni P., Ferro E., Moncada R. (2020), “Tokens Classification: Framework Walkthrough”, OverTheBlock Innovation Observatory, https://medium.com/overtheblock/tokens-classification-framework-walkthrough-d4ac02f7a6b9

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.

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