A point that often adds fuel to the confusion around bitcoin and blockchain is the assumption that both are interchangeable. Yes, a bitcoin is indeed powered by a blockchain, but not all blockchains utilize bitcoin. In fact, some blockchains do not use any cryptocurrency or token. A token varies significantly depending on the type of blockchain or distributed ledger.
Let’s first understand the basics:
What Is a Token?
In it’s simplest terms, its just a unit of value. A token is a specific amount of digital resources which you control and can reassign control of to someone else. A token can take on many forms, of which I’ll explain and provide examples of below:
- Grease the Wheels — The token is needed to power the blockchain
For those of you familiar with the Bitcoin blockchain, the verification process requires performing complex computational math. The first miner to find the solution announces it to others on the network and these miners then check if the sender of the funds has the right to spend the money. If enough approve, the block is added to the ledger. The miner that first solved the problem gets a fee as compensation, originally 12.5 bitcoin. In this example, bitcoin is the financial incentive provided to the miners to perform their function. Likewise, “gas” is the execution fee for every operation and transaction made on Ethereum. Its price is expressed in ether and is decided by the miners, they set the minimum price at which they are prepared to accept a transaction(Let’s decouple this from the market value on exchanges for now.) As there is a cost associated with a transaction, the incentive to recreate that same transaction greatly decreases.
I like to liken them both to the idea of greasing my car wheels in order to ensure the wheels spin and the car therefore runs — the process takes both time and energy. Someone or something needs to be compensated for the effort.
- Asset — A claim to an asset that is fungible and tradable
An asset is anything whose value can be converted to some economic unit, such as cash. Examples include bonds, securities, stocks and even cars and houses. The provenance of that asset can be easily tracked on a blockchain by assigning a “token” to it. We already have centralized registries and systems that allow you to store information about these assets, but blockchains allow you to do so much more. You can prove the ownership history of the asset, divide assets into smaller fractions of ownership, enhance security through encryption and embed additional management and business logic through smart contracts, thereby enabling greater liquidity for that asset.
- Equity — A “stake” or ownership
When companies IPO or go public, buyers of the stock become shareholders of that company. They now have voting rights as owners of the company. Similarly, companies can raise capital through an Initial Coin Offering (ICO). Those who invest in the company are granted tokens, and if the service or product the company is creating is successful, the token often appreciates in value. It can then be diluted into smaller amounts or traded on an exchange. Many would call this a security, free from regulation from any one country. The Securities and Exchange Commission believes that these tokens should be subject to federal securities regulation, and as such, has issued increasing guidance on enterprises seeking to issue these types of tokens.
- Currency — A payment method between participants
A currency token can be used as a payment method, such as buying your morning coffee at the local coffee shop or paying for a cleaning service. This use case has yet to be adopted widely, and frankly is probably one of the least probable scalable applications. As of today, cryptocurrencies are highly volatile and experience wild intraday price fluctuation. This use case assumes that merchants would be comfortable taking on an enormous level of exchange-rate risk. Additionally, blockchains are traditionally a lot slower than credit card networks which can process up to 52,000 transactions a second.
Are these tokens mutually exclusive?
Well actually, no.
A bitcoin can be used to pay for your coffee and “grease the wheels” of the bitcoin blockchain. A bitcoin can also be thought of as an asset or store of value in a similar manner as holding gold. Likewise, Ether helps power the Ethereum blockchain and is considered a store of value.
Are there any blockchains/distributed ledgers that don’t use tokens?
Yes, R3’s Corda and IBM’s Fabric.
Consensus on Corda is reached at a transaction level and only involves parties privy to a transaction. There is no “proof of work” or “miners” in order to verify transactions. As Philipp Sandner explains in his blogpost, “Consensus is based on transaction validity and transaction uniqueness. Validity is ensured by running the smart contract code associated with a transaction, by checking for all required signatures and by assuring that any transactions that are referred to are also valid. Uniqueness concerns the input states of a transaction. Specifically, it has to be ensured that the transaction in question is the unique consumer of all its input states. In other words, there exists no other transaction that consumes any of the same states. The reason for this is to avoid double-spends.”
While tokens can certainly be introduced onto the Corda platform, it is not intrinsic to the platform and is not needed to “grease the wheels”.
A Gentle Introduction to Tokens: https://bitsonblocks.net
Comparison of Ethereum, Hyperledger Fabric and Corda: https://medium.com/@philippsandner/comparison-of-ethereum-hyperledger-fabric-and-corda-21c1bb9442f6