Tokens for laymen
This is the third part in a series focussed on introducing the layman to blockchain technology and its offerings.
Tokens aren’t new. If anything they’ve existed since the beginning of human coordination. Tokens can be defined as representations of economic value. Stones, shells, beads and metals were/are probably the earliest types of tokens used. Newer, more current types of tokens are, for example, stock certificates, bonds, REITs, casinos chips, vouchers, gift cards, flyer miles, loyalty program points, tickets, , memberships, etc.
Tokens aren’t just used to represent ownership, but even utility.
In computing, they can represent a right to perform some operation or access a function. For example, A web browser sends tokens to websites representing information as we browse the web. Our phones send tokens to the phone system every time we get on the network.
In psychology, tokens have been used as reinforcers of behaviours, used to incentivise desirable behaviour. Cognitive psychology uses rewards as tokens in order to facilitate the normalisation of a behaviour. For example, we use dog treats to train a dog to achieve a certain behaviour, like sitting.
In Sociology, recyclable bottles, are a good example for non-traditional tokens. In most European countries, bottles you buy in supermarkets are issued with recyclable value of upto a few cents. This is what you would pay over the initial price of the product, and has become a method for governments to incentivise environmental consciousness. So upon returning these bottles to a supermarket or recycler, you will be able to redeem the value stated upon the token you return — the bottle. Losing the bottle is equivalent to losing money.
In the grand scheme of things, cryptographic tokens on a DLT like Blockchain can combine these historic concepts: access rights to an underlying economic property, or permission to access a collective good/service. This good/service can be public (Bitcoin) or private (a rented apartment). “Token” is simply a metaphor though. Contrary to what you might infer, cryptographic tokens aren’t something that are transferred between devices. Instead, they refer to a record of ownership that is maintained over a network, in the form of a ledger.
Cryptographic tokens represent records that follow a set of rules, encoded either within the network it’s based on or through a smart contract on the network. These records can be looked at as spreadsheets, with people on one column and the units owned on the other column.
The owner is represented as a cryptographic address/account. The public-private key pair linked to the cryptographic address is what people call a “wallet”. And the tokens are accessible only by the owner/manager of said wallet. Only the person who has the private key for their wallet can access its underlying properties on the network/ledger. If the tokens are fungible, the owner can initiate transfers of said tokens by signing transactions using their private key. Apart from basic transactions, token holders can sign interactions like a vote.
Being an immutable and irreversible system, blockchains enable the authenticity of tokens, their rules, their owners and their interactions. The realisation of these characteristics enable the transition of tokens from theory to real world applicability. Currently we’re seeing a lot of experimentation with use cases previously envisioned as well as new ones that weren’t considered before.
Blockchain acting as the necessary substrate for tokens, ensures validity, including inbuilt anti-fraud measures. Historically, tokens have been issued and maintained by centralised entities, to ensure their authenticity, and have had security mechanisms facilitated by said entities. Central banks issuing fiat currencies, for example. Another example would be an event organiser issuing tickets. Blockchains act as an alternative to these centralised entities, offering the necessary foundation that validate and secure the authenticity of the tokens via a smart contract or the network itself.
The first blockchain-based tokens were native to public & permission-less blockchains like Bitcoin, Ethereum, and the like. These native tokens were directly inbuilt into their respective protocols. Over time, with the advent of smart contract platforms like Ethereum, tokens moved up a layer on their technology stack and were issued and managed using smart contracts, rather than the network itself. Such tokens come with rules independent to the network, and behaviours that varied. Ethereum made it particularly easy to issue such tokens with a few lines of code. The community even standardised a smart contract template to issue tokens titled “ERC-20”, which defined a common list of rules for basic fungible tokens, including how they’re transferred from one wallet to another, and how data within each token is managed/accessed.
Over the last year, however, more complex token standards and types have been realised. Ones that can represent ownership or access not just to virtual assets but even physical, real world ones.
1. Currency token — Medium of Exchange.
2. Security Token — Tokens that are backed by a real world asset.
3. Utility Token — Used primarily within a specific application.
Currency tokens - This is the first (and most straight-forward) form that a token takes. Tokens are categorised as currencies if they’re purposed to act as mediums of exchange, stores of value or basic units of account. Most today aren’t used as a means of payment for goods and services outside their token-run networks. Bitcoin, for example, is seen as a currency because it was developed with the intention of replacing fiat money. As such, Bitcoin users are able to purchase goods and services from supermarkets, online retailers and other vendors with their Bitcoin already, and its network effects just keep growing.
Utility tokens - These digital tokens are designed to deliver something other than a means of payment to users. It usually takes the form of exposure to a given product or site. Most cryptocurrency exchanges, for example, have issued tokens native to their exchanges, allowing tokenholders to bypass trading fees as incentive. The primary difference between a currency token and a utility token is that possessing the latter allows access to a good/service offered by the issuer of said token.
Security Tokens - Security tokens are far more complex than currency tokens and utility tokens as they have components pertaining to the real world. While currency tokens and utility tokens are fully digital, security tokens are backed by some real world asset. This requires real world facilitation. Security tokens can be compared to traditional securities that back specific assets. For example, shares represent companies, REITs represent real estate properties, bonds represent interest paying debt.