In the amazing world of tokens

By February 3, 2020Ethereum
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A complete analysis of token definitions, their main uses, the future of decentralized applications and token-economy, in an evolutionary path that goes beyond the 3.0 paradigm, crosses that of Industry 4.0, to attain a Society 5.0 concept. These are the contents of this article that, starting from the examination of the term “token”, very often confused in its own meaning, wants to offer the reader a scenario vision, supported by an analysis of the fundamental principles.

Why we use tokens

Offering a universally valid definition of token is a difficult and, in all likelihood, worthless undertaking.

Even before attempting a taxonomic exercise, it’s perhaps useful to think about the common use of tokens and what are the main reasons that support their use in our daily life.

Generally speaking, we can assume that when we need to manage an asset in its value or in its existence, without having to report to it punctually and in all circumstances of use, the creation of a token becomes essential, where it is able to represent a surrogate. Why on earth would we need to report to an asset considering only its representation? To answer this question, look at the good that, in an economy of trading, must be able to be allocated, transferred and extinguished. If we thought we could use the asset in every transaction (and not its representation), we would have quite a few difficulties in most cases of use. This very simple concept allows us to think about a couple of considerations that lead back not so much to the concept of token, but to that of "tokenability".

The use of a tokenized good allows the efficiency of a large number of processes, but it is necessary that someone guarantees the legitimacy, or rather the goodness, of that "good-token" coupling at the origin, both from the point of view of valorisation and attribution. Where this guarantee is met, the benefit of using tokens in exchange transactions is undeniable.

We already use tokens... but we don't notice it.

Let's make some examples of "tokens" (deliberately between double quotes) taken from the common world.
The meal voucher expresses a value related to an employee benefit. When we use the vouchers, we are certain of their nominal value, guaranteed by the issuer and we know that we can spend them at the restaurants that accept them, thanks to an agreement with the emitter itself.

The casino chips represent an accumulative and expendable monetary value for the enjoyment of the games within the casino; the player knows that they can buy and exchange them at the central cashier and are certain that the croupier will accept his bets, paying with the same eventual winnings.

The car wash token allows us to take advantage of the service offered by the washing pumps that automatically activate and deliver everything needed to clean our car. The value of the token is commensurate with the duration of the service and each of us knows that this value corresponds to a certain number of minutes during which we can suck the mats, or a quantity of splashes of perfume and so on.

The points that are used within a promotional mechanics, allow us to be rewarded for our loyalty to a brand; the value of each point is established by the brand holder who can define the rules of allocation (depending upon the products we buy, or correlated to the quantities, as well as the time of purchase) and exchange (on the basis of which we know what reward we can get by redeeming a number of points).

Why should we use tokens via blockchain (… and why might we tokenize by the blockchain)?

So far we have been talking about what could be considered, from a functional point of view, the simplest definition of token, but we have not yet talked about how (and why) the token could be exchanged on DLT platforms, such as a blockchain. In order to prepare ourselves for a better understanding, it is appropriate to share some reflections that, without hesitation, we could consider "essential".

In each of the examples given we must highlight how, although not always consciously, there is a requirement assumed as implicit, but necessary for the proper functioning of the case of use described: the trust. The company, the employee and the caterer, trust the issuer of the meal voucher, otherwise they would not (or could not) use the voucher. The croupier and the player trust that the casino will provide the necessary liquidity to pay the chips. People who wash their cars at a car wash trust the automatic program that controls the pumps. The consumer believes in the brand and knows that he or she can redeem the accumulated points at any time, obtaining a reward in return for the trust he or she has decided to place in it.

Well, the exercise of that trust, or rather the way in which that trust is guaranteed, in each of the exchanges we have described along with the use case, is not always carried out efficiently and, in some unfortunate circumstances, could be affected (or attacked) by the episodic occurrences of corruption. The controls in the different processes analysed in the above examples, could be more efficient where there is a distributed business logic, which operates in respect of a (more) decentralized governance. And that's where the blockchain comes in.

Proceed now with a more detailed examination of tokens and tokenisation in the Distributed Ledger context.

A didactically useful definition of token

Who writes - convinced of the "didactic usefulness" of such a definition, rather than the sound lexical correspondence - by token means a "digital binding" of the legitimation of a right to the right represented by the cryptoasset[1] itself , that allows to create a link between a physical or digital asset (or, more simply, an "off chain" asset, i.e. that is outside the blockchain) and a native asset of the blockchain.

The token is exchangeable on Distributed Ledger platforms and in a token transaction on such platforms, the validity of the underlying legal transactions could be "technically guaranteed" by a blockchain protocol, using appropriate Smart Contracts[2].

The expression "technically guaranteed" is intended to indicate that the Smart Contract (waiting for the legal enforcement of them …) must be able to guarantee an unstoppable execution of the transaction and preserved from contamination risks, such as those that may affect the quality of the software, or that arise in the face of the occurrence of corruption.

Having regard to the opportunity to make efficiency, while ensuring a good level of guarantee of the validity of the trading, from these very first few lines it’d already be sufficiently clear what the main benefits of using tokens on blockchain are.

Each of the assets considered in the exemplified use case, when they were "tokenized" and exchanged thanks to the execution of a Smart Contract operated on blockchain, could be managed with processes (perhaps) more efficient, ensuring compliance with a series of distributed controls, in accordance with rules inscribed in decentralized governance models.

A possible classification of tokens

A possible classification of tokens wants to decline the typology in at least three macro-categories that we will describe shortly.

The Security Token, to which it refers identifying a new product obtained thanks to the contribution of the technology that shares some characteristics with the traditional security and that could not be connected to a real[3] asset.

The Asset Tokens, representing rights on assets including non-financial assets, exchanged between different parties and adopted in the technological context made possible by the blockchain to create a new channel for the exchange. Where they represent financial securities, this makes their market expandable and increases their liquidity. When referring to non-financial values (think of the case where they represent a digital identity or voting rights under a decentralised governance model), the new channel allows them to be managed more securely than centralised systems.

Finally, the Utility Tokens, i.e. securities representing the future use of the product or service provided by the company that "issues" them, not designed to be investments and executed in accordance with a blockchain protocol.

A technological definition of token

From a more technical point of view the token can be understood as an algorithm implemented as Smart Contract, executed on blockchain. Each Smart Contract contains a list of addresses that allow the identification of those who can have the tokens (the so-called "token holders") and their balance. It is the algorithm itself that defines the characteristics of the token (see below the details of some types of Ethereum tokens). The tokens are accessed by the token holder, demonstrating the ability to dispose of them through knowledge of the private key associated with the public key from which the above address is derived[4].

Let's now deepen the more technical nature of tokens, explaining their possible "programmability".

The tokens issued on Ethereum

The largest number of tokens in circulation is issued on Ethereum[5] and it is appropriate to present a macro-classification to which to inscribe them: ERC20[6] and ERC721. Both categories characterize tokens by their ability to have a value, to be transferable, fungible or non-fungible, to be able to count a balance sheet when used in an accounting system.

The first category, unlike the second, sees tokens identical and divisible into sub parts, while in the second, each token has a unique identifier and is not divisible.

Imagining the ERC20 token as an object that prepares to the interface - at least - the following functions: totalSupply, balanceOf, transfer, allowance, transferFrom, approve and that is able to report events like Transfer, Approval, one can easily understand how it can be used by Smart Contract, allowing the development of decentralized applications (the so-called Dapp).

ERC721 tokens, conventionally referred to by the term Non-Fungible Token, require the interface to pass the unique identifier (_tokenId) to certain functions or to be uniquely associated with the occurrence of certain events.

The main use case of tokens (Fungible and Non-Fungible)

Having clarified what a token is and how it is used within a Smart Contract, let's now describe some of its main uses. Due to the substantial differences between Fungible Token and Non-Fungible Token, different use case must be appropriately depicted.

The first category normally includes all the uses in those contexts where there’s a need to plan a monetary policy (for the control and value of the token itself) and where their use supports economic and financial mechanics. By way of example, in such adoption contexts fall all the initiatives based on the so-called "programmable money" that enable, albeit with different degrees of openness and flexibility, the development of a "purposed money" that can be adopted in the areas of insurance, welfare, donations, public funding (just to mention a few examples).

This type of token also lends itself to support some potential developments of CBDC Central Bank Digital Currency (particularly those involving both "wholesale only" and "general purpose"CBDC digital tokens issuance and distribution models). Similarly, Fungible Tokens can form the backbone of a stablecoin whose uses are the basis of many DeFi Decentralized Finance projects.

Widening the range of observation, we can see countless cases of use of these tokens in the context of so-called branded currencies (also known as branded tokens). Used as tools to tokenize “corporate value” (think of the development of loyalty programs on blockchain), they enable new dynamics of engagement between consumer and brand or increase the efficiency in such promotional mechanics based on multi-brand loyalty programs, in different co-marketing initiatives.

A further field of application for Fungible Tokens is represented by the development of sharing economy models, where the value of reputation is expressed in specific Reputation Tokens, whose attribution and verification is programmed by Smart Contract, appropriately designed to support the commercial dynamics (transactions, interactions, controls) typical, for example, of Decentralized Marketplaces.

The Non-Fungible Token typology, among the applications that are best suited to capture the value of tokenisation on blockchain, are those that require the need to uniquely identify an object or, in a broad sense, an entity. For example, the following applications can be found in the range of such applications: Digital Identitymanagement (in particular in the DID Decetralized Identity and Verifiable Claims scenarios), traceability and automation of supply chain processes, e-voting in those contexts where a decentralized governance model is adopted (e.g. Decentralized Autonomous Organizations), systems based on the colletibles[7] matrix (such as most online games).

In a broader sense, we can include any application that manages tokenized assets or, better, “assets that could be tokenized, in the Non-Fungible Token field. The emphasis placed not so much on the token but especially on the tokenisation, implies reflecting on the nature of the tokenisable asset. Where this is digital (e.g. a digital property that can be traced back to online games or a digital document), or where the exchange and negotiation process has already been digitized (e.g. security, letter of credit, legitimacy or intellectual property), the blockchain is an excellent opportunity to streamline the processes underlying its management.

If, on the other hand, the original asset has a "physical" nature (e.g. a property - house, land, work of art -, a temperature or humidity level or, in general, a measurement detectable by sensors), the use of so-called "digital twins", i.e. digital copies obtained, for example, through the joint use of smart objects in an IoT (Internet-of-Things) context and digital certificates, can be of great help in tokenisation processes. The passage of such tokenized information to the Smart Contract, however, when there is no super-partes third party able to guarantee by law the ex ante genuineness or accuracy of the data itself (i.e. before entering the blockchain), requires the use of so-called oracles, systems through which one (or more) parties can contribute to the interaction between Smart Contract and everything that is off chain.

Broadening the scope of Non-Fungible Tokens

The scope of application of the Non-Fungible Tokens represents, in the writer's opinion, a ground on which to move with caution, being aware of how much their adoption can express particularly relevant and pervasive levels of disruption.

By raising our eyes a little and projecting it towards not so remote horizons, we can understand how it is possible to tokenize business models, thus creating the conditions for the development of an authentic token economy, in which the relationship between brand and consumer, as well as the relationship between infrastructure manager (think of the cloud) and user, exceeds paradigm 3.0, crosses that of Industry 4.0, to arrive at a scheme of Society 5.0[8], a model of "super-society" in which man and innovative technologies coexist, mutually beneficial contributions and benefits. A model in which the democratization of data and access to them, made possible by the blockchain, makes it possible to express in an effective and sustainable way a universal value that frees man from the risk of depersonalization, placing him at the centre of the techno-evolutive dynamics of an ecosystem of which he is both author and interpreter.

This article was also published in Italian on Blockchain4Innovation: http://bit.ly/2RlLGE5

[1] For "cryptoasset" we can assume a digital representation of univocal value made unique thanks to the use of cryptographic mechanisms; cryptoassets can be "placed" and "exchanged" on Distributed Ledger platforms respecting the rules of a blockchain protocol.

[2]With Smart Contract we can understand a set of instructions expressed in computer language and visible to all,

which are automatically executed by a DLT platform when predetermined events occur. Once the Smart Contract is activated, its execution is guaranteed and cannot be stopped. In some platforms a smart contract is also able to receive and send transactions.

[3] A "real asset" is defined as any tangible or intangible entity capable of economic valuation, whose rights related to use and exploitation may be concentrated in financial securities representing the rights themselves; the assets are exchangeable on traditional exchange platforms.

[4] Token holders can manage their tokens through appropriate wallets that contain both the private key and the Smart Contract address.

[5] There are also other Distributed Ledger platforms that allow the issuance and management of tokens, including Hyperledger Fabric (via chaincode) and Corda.

[6] The acronym ERC means Ethereum Request for Comments.

[7] The most widespread use of ERC721 tokens is represented by the collectible CryptoKitties, an online game that allows you to collect NFT that impersonated cyber cats.

[8] The concept of "Society 5.0" builds on some initiatives launched in Japan during 2017-2018, defining itself as a human-centered society that integrates cyberspace and physical space.

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