Blockchain Tokens – a quick primer


I’ve been involved in Nxt, which pioneered ICOs since 2014. In 2014 and 2015, it’s Asset Exchange was the first place to go for ICOs, although at a much smaller scale than the Ethereum platform has managed to do it.
And still, even then it was clear we needed to know where we stood, and I have always advocated at least getting educated instead of “just doing it”. I am sure there are people who will want to portray that as pandering to the authorities, but that’s just a shame, then.

SEC Report

A few days ago, the SEC issued a report in which it states the DAO tokens constituted a security and are thus subject to regulation.

This report, which was not really unexpected, still send massive reverberations through the crypto world.

At a time when ICOs are very popular, the report is a warning that both creators and investors in ICOs need to be aware they are on the radar.

As of June 2017, $327 million was put into ICOs, outstripping VC investments into the blockchain industry. However, there is a *massive* lack of understanding what tokens are and even that there are distinct differences between them.

We can distinguish at least two types of tokens:

Native Tokens

Native tokens are spam protection tokens for any blockchain network. Simply said, you need to spend these if you want to make a transaction or otherwise miners or stakers will not be incentivised to include them.

The bitcoin, Ethereum, Nxt or whatever token fall into this category. You need to add a fee to your transactions in order to get them included.

This spam protection is needed to ensure the network doesn’t get flooded with useless transactions, grinding it to a halt, or to ensure recursive smart contracts can’t run indefinitely.

Native tokens are to blockchains as fuel is to an engine. They have a very distinct function within a platform and they are necessary. Of course, because they need to have value to perform this specific function, they also take on some monetary characteristics. If a native token is value-less, fees are not going to help as spam protection.

No one can create Native tokens on platforms. They are hardcoded into the software and any new tokens are created via the protocol of that system.

However, there is a second kind of token:

Asset-backed Tokens

When most people talk about tokens, they talk about Asset-backed Tokens.

These are user-created tokens on platforms that allow for this, like ERC20 Tokens on Ethereum or Assets or Currencies on Nxt. Both Counterparty, Mastercoin (now Omni) and Nxt pioneered these tokens in 2014, after they were already tried on a small scale on Bitcoin as Colored Coins.

The main difference between these tokens and Native Tokens is that they are completely arbitrary tokens, with no inherent value than what they are backed by. Gideon Greenspan mentioned them in his seminal article on blockchain projects in 2015.

Most, if not all, tokens you see in ICOs are of the Asset-backed type. They represent a promise to the owner by the issuer, with all the problems associated with such a promise.

Asset-backed Tokens are only as good at the promise is, and that carries a much higher risk.

There are some ways of mitigating the risk, of course. ERC20 is just a minimum standard, and tokens can be programmed in such a way they could be safe and secure and at the same time necessary for the project. They then mimic the function of Native Tokens.

Alternatively, Asset-backed tokens may just be place holder tokens for Native Tokens on a new platform, like the ARDR token which will be exchanged into ARDR Native tokens, or the Aeternity tokens which will be ERC20 tokens that will be exchanged to Native tokens on the Aeternity platform.

In addition to being in essence promissory notes, Asset-backed Tokens can be used to pay the equivalent of dividends on platforms. This makes them even more alike to securities.

Know what you are talking about

Native Tokens and Asset-backed Tokens are completely different things. It is important, just like in any trade, to know what you buy and what you can do with it.

Native Tokens carry different risks than Asset-backed Tokens. The latter will be under much more more scrutiny from organisations like the SEC. Just like in any investor-issuer relationship, they constitute a trust relationship and these are regulated.

Bas Wisselink
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