There is often talk of tokenization. I try to explain in more detail what this process consists, starting from tokens: what they are, how they can be classified, what are the right questions to ask to design them.
It should be emphasized that the literature on this subject is still at an early stage and that most of the sources are distributed among posts, forums, tweets; only a small part of the material is of academic origin.
Let’s start from the first distinction, the one between cryptocurrencies and tokens: the former are native components of a blockchain (eg bitcoin, ether), the latter are create on top a blockchain and regulated by smart contracts (eg Augur built on Ethereum) . Recall that smart contracts are pieces of code embedded in a blockchain that automatically manage clauses and conditions of execution of a contract.
To make a comparison, a cryptocurrency is like the SMS service, integrated in the mobile network, tokens are like the messaging apps like Whatsapp, built over the same mobile network taking advantage of this technological infrastructure.
Tokens digitally represent a value associated with a good, a service, or a right. They are united by some characteristics that summarize the advantages:
· Liquidity, thanks to which they can easily be transformed into currency or cryptocurrency.
· Divisibility, which allows the division of the value into even very small units.
· Tradability, which makes it possible to carry out the sale and the consequent transfer of ownership.
· Immutable proof of ownership.
The tokenisation process also introduces the characteristic and the benefit of programmability, that is the possibility of introducing certain business logic into smart contracts, allowing the realization of automated events. Examples are payments that occur when certain conditions occur.
There are several approaches and methodologies used to find a classification of tokens.
We can start from a role-purpose-characteristics scheme . For example, a token can represent a benefit / reward (role) and has the purpose of redistributing it through a profit-sharing (characteristic).
· Currency, which contains the case of cryptocurrencies. Tokens act as a “pure” digital currency whose price is established by market forces.
· Security, which represents the value of an underlying asset. Owning a token does not imply a share of the “issuer” company.
· Equity, similar to the previous one but which implies, for the owner, a ownership share.
· Utility, which makes coins tokens, coupons that can be spent within the ecosystem of a platform for the purchase of goods and services.
· Debts, ie tokens that represent underlying debts, similar to bonds or mortgages.
At this point it should be stressed that classification is also important for the regulator. In recent months many ICOs (Initial Coin Offering, financing a company through the tokens sale) have failed or, worse, turned out to be fraudulent. The institutions of the various countries that deal with financial market regulation, such as the American SEC, have therefore established that many types of tokens fall into the category of securities and as such subject to the same rules: they are considered securities, in the previous categorization, the Security, Equity and Debt tokens.
Let’s go back to the problem of finding an effective classification that captures the heterogeneity and variety of token usage.
A framework developed by Thomas Euler classifies tokens based on five dimensions; each of them responds with three options to a specific question about tokens.
The dimensions are complementary, since many tokens can fall into some or all these dimensions. For example, ether is a native, hybrid network token and, for me, it is also a cryptocurrency. In this regard the fact that the term “cryptocurrency” is used in two different dimensions (purpose and legal status) does not make the scheme particularly clear.
From the use of this structure emerge patterns that allow to group the tokens into four “archetypes”: cryptocurrencies, asset tokens, network tokens and token-as-a-share (similar to securities).
In my opinion, the best classification -clearer and more comprehensive — is made by the University of Zurich through the paper “ To Token or Not to Token: Tools for Understanding Blockchain Tokens “, written by Luis Oliveira, Liudmila Zavolokina, Ingrid Bauer and Gerhard Schwabe. In this work is described not only a categorization but, thanks to a concrete case study, is provided a decision tree able to guide the design and the issue of tokens.
Firstly, starting from the existing literature and from empirical data, thirteen token parameters have been identified, grouped into four classes: purpose, governance, functional and technical parameters.
On this basic scheme a table is constructed that lists eight token archetypes:
· Cryptocurrencies, which are or aspire to become global digital currencies.
· Equity Token, which give the holder rights on capital gains, such as profit sharing.
· Funding Token, a financing vehicle for the project team and the community, perceived as long-term investment.
· Consensus Tokens, through which are remunerated the nodes of a blockchain that guarantee data validation and consensus.
· Work Tokens, compensation to users who complete certain actions or exhibit a certain behavior.
· Voting Tokens, which confer the right to vote to their owner.
· Asset Tokens, which represent the property of an asset.
· Payment tokens, payment instruments within a platform / ecosystem.
Each of these archetypes can present a series of attributes related to the four classes of parameters mentioned above. For example, these attributes can be associated with the Funding Token :
Tokenised Security / Utility Token; Usage- / Work-Based; Right / Value Exchange / Toll; Physical / Digital; Schedule-based / one-time fixed / discretionary; Enter Platform / Use Platform / Stay Long-Term / Leave Platform; (Not -) / Spendable; Tradable; (Not -) / Destroyable; (Not -) / Expirable; (Not -) / Fungible; Blockchain Native / Protocol / dApp; New / Forked Code, New / Forked Chain / on top of Protocol
A workshop with several participants involved in a project called Car Dossier (data of the life cycle of a vehicle stored in a blockchain) has contributed to refine the work of the University of Zurich team. In the end, a general decision tree was created: by answering the questions in this tree it’s possible chooses the correct type of token that a project should implement. Obviously, the project must have a valid and well-designed business model.
The token that can be reached through the decision tree (which can be seen in the paper mentioned) can have, in addition to the main purpose, secondary uses: a funding token, for example, can also be used as a means of payment and to confer voting rights.
A shared categorization of tokens is a necessary step to make tokenization processes really work.
The token economy, although promising, must still overcome several obstacles; we have already mentioned the problem of regulation, a work in progress that should create international standards valid in all jurisdictions given the transnational nature of blockchains. This would also help to improve the reputation of ICOs, which today guarantee many benefits for startups and companies and in practice no protection for investors.
There is also the need for a shared legal infrastructure to translate traditional contracts into smart contracts.
Update: with the permission of the University of Zurich researchers, I have created an interactive version of their token decision tree. You can test it here.
Albert Ho, “How does tokenization work, anyway?”
William Mougayar, “Tokenomics — A Business Guide to Token Usage, Utility and Value.”
Luis Oliveira, Liudmila Zavolokina, Ingrid Bauer, Gerhard Schwabe, “To Token or not to Token: Tools for Understanding Blockchain Tokens.”
Gregory Van den Bergh, “How tokenization is transforming real-world assets on the blockchain.”