This panel discussion was held at the Blockchain Connect Conference: Academic 2019, on Jan. 11 in San Francisco.
The panelists discuss some of the challenges of tokenization, costs and reaching critical mass, via incentivizing actors — such as content creators, or users.
They also talk about establishing an advertising equilibrium between content creators and consumers via tokenization. The central idea is that with token ownership, participants can be somewhat like shareholders in a company, except on a network. Tokenization also offers the potential for higher quality content, since clickbait is fostered by the current advertising model of driving eyeballs over value.
The discussion further included empowering developers via tokenization and blockchain.
Panelists:
Colin Harper – Staff Writer at Bitcoin Magazine
Henry He – Co-founder & CEO of SesameOpen
Sichao Yang – Co-Founder of Canonchain
Yi Lu – CEO of U Network, Co-Founder of SV Insight
Yilun Zhang – Co-Founder & CTO of NKN
As we have previously talked about the central aim in the development of an enterprise or economy is linking the individual’s interests with the whole organization in order to achieve optimal overall outcomes.
In very small communities it may not be very difficult to maintain that connection. In small communities, people can see that their efforts contribute directly to the overall value created and the overall value created is in turn linked back to the benefits that they will gain.
Likewise, there is limited need for centralized coordination. Thus no great concentration of wealth in the system and people may feel that it is fair.
The problem with this model is that it doesn’t scale and allow for more complex economic systems with specialization of work. As a consequence, over time larger more complex organizations come to subsume these smaller more basic forms.
If you want really good scientists, builders or teachers they are going to have to specialize in those activities, which will, in turn, require large systems of exchange.
We invented formal centralized institutions, monetary systems, large market exchanges so as to achieve specialization, mass production, and complex economic organizations.
However, as we did scale, there came to form a disconnect between the individual’s contribution and the value to the whole. Which creates the potential for both negative externalities, large concentrations of wealth, extraction and inequality.
As the scale of the economic systems that we are engaged in has increased, the interconnectivity and interdependence between any two random members has decreased – because they are farther apart in the network. This has worked to disintegrate traditional cooperative institutions that are based on local interactions and interdependencies. In the absence of tools for interconnecting everyone within a large national society, we have had to create the large bureaucratic centralized institutions of today.
But these centralized institutions have created notorious divides within the modern capitalist system, between owners and workers, between producers and consumers.
With the rise of information technology and globalization, we are creating organizations that span the entire planet, creating massive divides between producers, owners, and consumers, with the interests and incentives becoming increasingly misaligned.
Clothes are produced in Bangladesh by people who get paid half nothing. Revenue is sucked up into a global financial system to pay shareholders. While end users have no loyalty or care for the organization from which they buy their products.
There is a massive misalignment of incentives that creates a hugely inefficient overall system.
MISALIGNMENT OF INTERESTS
We can analyze the incentives structures of this organization by looking at the centralized technology platforms of today. Here we see on one side we have value creators and the other side we have value consumers, they’re all coming together through some type of central server platform.
For example, with Uber you would have the value creators on one side, being the drivers, sending their information to a central server and on the other side you’d have the riders that are using the transport service from the platform. In the middle you have the platform and of course the reason that these companies are doing it is for-profit. So a portion of the profit or all the profit goes up to shareholders.
The users of the system do not care if the value of Uber goes up or down, all they care about is getting from point A to point B. That is their involvement with the organization and that’s the limited vested interest that this centralized structure is able to take advantage of.
The drivers likewise don’t care about the value of the overall organization, they just want to get paid and the shareholders and management are only interested in the quality of the service and the conditions of the workers to the extent that it affects the profits of the organization.
Likewise, we can look at Facebook and see that it is at odds with its users. Facebook’s founders and shareholders have made massive amounts of money.
Yet its users didn’t, despite contributing the key personal information and content that is the central value proposition of Facebook.
Profits are drawn inwards and upwards to the top management and shareholders. With its billions of users and high engagement, Facebook has become enormously powerful in our world. Yet it’s controlled by a small handful of people. This is dangerous for society. Especially given the fact that it is not really structured to handle such responsibilities.
The only reason that these companies or shareholders are putting forth the products is for the money that they can make and that is the entire business plan. It is to maximize profits and that drives our whole economy.
What you have here is a split between the users and the beneficiaries rights and that creates a huge degree of misaligned interest. Not only this, but there is no user vested interest, the users don’t really care about the success of the company in which they’re using that product. That really leaves a lot of value on the table, because the user’s engagement can be hugely beneficial.
TOKEN SYSTEM
Token economics offers the potential to reintegrate this whole system. Break down divides between users and producers, between workers and owners; working to align their incentives within a whole ecosystem.
By connecting people peer-to-peer and automating the operations of the network, blockchain technology enables us to take out the centralized component and reintegrate producers and consumers into a much more functional ecosystem of exchange.
As illustration, we can think of the production of a movie. Currently, this is achieved through a centralized organization for-profit that then hires producers, directors, and actors to make the film which people then pay to see with profit going to the investors.
But this could be turn into a token network. We use a blockchain network to create a token, call it a “movie coin.” Actors, directors, and others get paid in that coin that viewers have to buy in order to see the film. People can purchase the token before production to raise the initial capital to fund the project, thus cutting out the intermediaries.
As another illustration, we can think about the fact that the average tenure of an employee in Silicon Valley is less than two years. One of the causes is the lack of alignment between employees and the owners. This is called the Principal-Agent Problem. Every group of people has principles, which are the owners, and agents, which are the employees, and it is easy for them to become misaligned. What may be good for the employee may not be good for the company.
In startups, principals and agents are the same. That’s why they are all really motivated to work together and can create a great amount of progress rapidly. But as the organization grows there becomes a growing gap between owners and employees and growing potential for the misalignment of their interests.
By creating micro-economies we can work to reintegrate the two. Distributed organizations have no centralized management structures for controlling and coordinating the organization. The architecture of the code is the rules of the organization and people may have an input on how that code is altered. The aim is to have autonomous actors who feel integrated with the organization to create true user engagement. By functioning as both equity and currency the token can work to link the value of the ecosystem with the value that people exchange within that market.
Moving to decentralized ecosystems you really have the same parties involved but, you removed the centralized entity completely, thus closing the economic loop of that company with a peer-to-peer token exchange. Instead of sending money to a centralized body with fixed fees on both sides taking off a profit margin, these companies can introduce a token.
Because of the linkage between the value of the exchange token and the value of the network, in the token system, the value generated gravitates not upwards within the hierarchy but naturally propagates to the token layer that reflects the value of the whole ecosystem and goes into the pockets of anyone holding the token.
Because it is also a utility token it means that the value goes to those using the network, the producers and end-users.
In the example of Uber, imagine every single user paid in a native currency or a native token of the actual organization itself and then every driver receives that token and then they sell it back to people that need to have rides. This closes the economic loop and aligns the interests of everybody in the organization. You now have unprecedented vested interest, every single person involved in that corporate ecosystem is now invested in the success of the organization.
Just as everyone holding a Bitcoin will promote the digital currency to their friends, anyone holding the token of any network will be incentivized to promote the use of that network, so you are turning the users into evangelists.
Another example would be Brave. Brave is a new token network for the digital advertising industry. It pays publishers for their content and users for their attention. This service creates a transparent and efficient Blockchain-based digital advertising market relative to the traditional model.
An Ethereum based network that radically improves the efficiency of digital advertising by creating a new token that can be exchanged between publishers, advertisers, and users. By connecting all parties involved directly via a token market, publishers receive more revenue because middlemen and fraud are reduced. Users, who opt-in, receive fewer but better-targeted ads that are less prone to malware. At the same time, advertisers get better data on their spending and more engaged users.
What we start to get are economic networks that are really like a cross between private enterprise and public utility. We are getting a hybrid of the community system with its vested interests, where the work you produce is connected to the value of the ecosystem, but also getting the option to exchange within broader systems involving high levels of specialization and complex coordination.
Token economics represents the merging of economics and information technology. It shifts economics into a more technical realm.
In the past, we could really just tweak around the edges. But now we can really design economies like we never could before.
Once we shift business and economic organization into this more formal and technical realm, we can begin to bring very powerful mathematics and analytical tools to bear on what we are doing.
One aspect of this is using the models from game theory to design these incentive systems.
Game theory is the study of the strategic interaction between adaptive agents and the dynamics of cooperation and competition that emerge out of this.
A much more recent extension of this is mechanism design. Mechanism design is a field in economics and game theory that takes an engineering approach to designing economic incentives toward desired objectives, in strategic settings. Because it starts at the end of the game, then goes backward, it is also called reverse game theory. It has broad applications in the management of markets, auctions, voting procedures and is of particular relevance to token economics.
As an economic theory that seeks to determine the situations in which a particular strategy or mechanism will work efficiently – compared to situations in which the same strategy will not work as effectively – mechanism design theory allows economists to analyze and compare the way in which markets or institutions lead to certain outcomes, because of their inherent incentive structures.
With mechanism design, we are trying to design the system towards a certain desired equilibrium state. With this approach we first think about what outcome we would like to see from the system. We can then build a set of rules that will hopefully lead to those optimal outcomes.
Legal systems are a kind of mechanism, as they are a method for shaping human behavior. A particular set of laws is usually trying to shape a particular type of outcome through the imposition of a set of penalties, fines, rewards or incentives such as tax breaks, etc.
Of course, these existing systems are centralized in their design, but with token networks, we are looking for a mechanism design that does not depend upon a centralized authority specifying and enforcing the rules, but instead some kind of peer-to-peer value exchange mechanism that is self-regulating through direct information feedback loops.
FEEDBACK SYSTEMS
As previously mentioned coordination within distributed systems, like token economies, is not achieved via centralized coordination, but instead by the interaction between members and the incentive structures created by the exchange of tokens. The primary dynamic for us to consider then is that of the feedback loops that are created out of people interacting peer-to-peer. We are trying to enable cooperative structures without imposing them and that is achieved through peer-to-peer interaction.
Creating optimal outcomes for the whole system means effectively linking the payoffs of the individual to those of the whole system and thus reducing negative externalities.
Every action that an agent takes has an effect and we can ask what are the repercussions of those actions and who bears the costs and benefits. When an actor gains from an action but the costs are born by others this is a negative externality.
Pollution is the classic example of a negative externality. So too, excessive inequality may be seen as a negative externality of people’s greed.
Negative externalities incentivize actors to overperform a given action as they are not bearing the cost and leads to unsustainable results overtime, as that cost is being born by someone else, the whole system or environment.
Building systems of cooperation in such a context means enabling ongoing interaction, with identifiable others. With some knowledge of previous behavior, lists of reputations that are durable and searchable and accessible, feedback mechanisms, transparency etc.
The development of current web platforms is good illustration of where we are going as they often incorporate many of these design components.
Sites like TripAdvisor and Yelp exist as standalone feedback platforms, while Amazon and eBay legitimize their products by allowing users to place feedback on their purchases.
Feedback systems are used to rate and rank content on social media like Reddit and Facebook.
All of the above have become an essential part of how we identify quality products and services that meet our needs.
But while the internet gives a voice to all, misinformation has become an accepted reality. Competitors may falsify reviews to discredit a product, while the review platforms themselves may modify or delete feedback that doesn’t fit their agenda.
The combination of blockchain tech and advanced analytics could take the possibility of bias and corruption out of current feedback systems, with an end-to-end process designed to pick out quality feedback and then safeguard it.
Revain is one blockchain platform that works to secure feedback systems. All incoming reviews will have to pass an initial screening test, with IBM’s Watson AI platform analyzing emotional and unconstructive language. Users are rewarded with RVN tokens for submitting a review, while companies can use the token to purchase quality feedback, direct from its customer base. And at the end of the whole journey, consumers have access to transparent, high-quality feedback to aid their decision-making.
Uber is an example of mechanism design. From this perspective, Uber just adds to the financial contract of paying someone to take you somewhere a reputation feedback system.
Uber adds reputation for both drivers and for riders and adding reputation into the system actually significantly influences the way that people behave within that system.
The goal is to shape the behavior of the participants and adding that additional reputation can have a significant impact.
But of course with blockchain systems, this can all be tokenized, and because tokens can represent any form of value exchange – natural capital, social capital, cultural capital, industrial capital etc. – we can build in many different forms of feedback loops and different forms of mechanism design.
Incentives are a central part of economics and blockchain networks give us new ways to design and build incentive systems.
As Mike Goldin, a lead engineer at ConsenSys noted “Blockchain gives us programmable money. When you can program money, you can program incentives, and when you can program incentives you can program people.”
Programming people may sound a bit funny but in fact, it captures something of what is now possible. Like never before we have the capacity to rapidly build and implement large-scale structures for incentivizing human behavior towards certain ends.
We are increasingly moving into a world where we can analyze, design and adjust real-world economic and social outcomes by deploying new protocols on the internet. This is a new capacity that we now have, one that offers both huge potential and is at the same time frighteningly powerful.
How to create incentive systems that align the interest of the individual with the overall beneficial outcomes for the organization or economy, is a central issue of interest in business management and economics in general.
A central premise of economics is that people respond to incentives.
One of the key insights of Adam Smith was that overall beneficial outcomes for society and economy should not depend upon the virtues of the individuals within the system but instead, optimal outcome should be achieved by designing incentive structures that link the individual’s self-interest with beneficial overall outcomes.
This is captured in his famous passage “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our necessities, but of their advantages.”
This is a very important insight and history will teach us time and time again that we should not depend upon the virtues of the agents within the system, if we wish for long-term stable functional outcomes. Over time the most virtuous of leaders can turn into the most brutal of dictators.
The only way we can assure long-term stable outcomes is by a clear analysis and design of the incentive structures in the system. The only way we are ever going to get really functional economic systems is by really understanding the incentive structures in the network and designing those so that they are aligned with the overall desired outcomes.
Every misalignment of incentives will over time turn into a dysfunctionality within the network.
The structure of the incentives within the system is critical to whether the economic system will thrive or fail. Capitalism has succeeded to a certain extent where communism failed precisely because of its incentive structure.
A good illustration of this is The Jamestown Colony, the first English-speaking colony in North America founded in 1607 in Virginia. The colonists spent the first 10 years of their existence hungry, they never had enough food, with over 80-percent of the colonists perishing in what became known as the “Starving Time”.
But then after those first ten years, the colony thrived, the colonists had plenty of food and their numbers increased and it took off. It was the same people using exactly the same techniques so what changed. Before 1615 they all went out to the field they all worked and then they took the output from that field and divided it up equally. In such a system people have no incentive to work harder than the minimum required; there was no linkage between individual incentives and overall beneficial outcomes. In 1615 they made a very simple change to the rules, they divided up the farmland so that each person had their own individual plot of land. You could now do whatever you wanted with the food that you grew, they grew their own food, they ate it, they sold it to each other, they gave it to their families and the colonies thrived.
It was a change in incentives that ended the starvation and brought about abundant food supplies.
Human beings have always been bad with incentives getting ourselves into all sorts of situations we don’t intend to because of how we try to direct the ways that groups behave.
We can look a what the incentive structure that a deregulated financial system has caused, or anonymous political donations of money. The reality of how incentive systems play out in the world is complex and typically beyond the designer of the system’s capacity to foresee. As a consequence we often just lurch from one model to the next as we react to the unintended consequences of the previous system.
The central aim of economies is to enable people to work together within a combined enterprise. To do this we have to align the behavior of the individual with the whole.
Blockchain networks are all about protocols that enable coordination between actors. The great innovation of blockchain networks is as a new system for incentivizing a network of autonomous nodes towards maintaining a shared infrastructure.
Token economics builds upon this underlying technological innovation. With tokenization, we are going to start to incorporate explicit incentive systems into more and more spheres of life. We are attempting to build these micro-economies around every source of value so as to align people’s individual incentives with delivering an overall functional ecosystem.
TRUST EQUILIBRIUM
In every socio-economic organization, there is the opportunity for collaboration and cooperation which leads to optimal outcomes for all and there is the opportunity for competition and conflict that will lead to suboptimal overall outcomes and unequal pay-offs for actors. The point of a social or economic institution is to achieve coordination and optimal overall outcomes.
Every game has two equilibria. There’s a good equilibrium where everybody cooperates resulting in everybody gaining and there’s a bad equilibrium when nobody cooperates, nobody gives in and nobody gets anything. The optimal overall equilibrium is typically very fragile. It’s enough for one person to deviate from the good strategy and the whole system can deteriorate. The bad equilibrium though is very stable. Trust is about our ability to stay in the good equilibria, what do we do to live in a society where we all benefit because everybody has a short-term incentive to betray the public good. But the moment people start betraying the public good things deteriorate quickly?
The traditional way that we have solved this equation is through a centralized authority that mandated that all act according to the economically or socially beneficial outcome. Token economics attempts to achieve this alignment through peer-to-peer exchanges of value that incentivizes the actors to operate according to overall effective outcomes.
To illustrate this dynamic we can think of the torrent file sharing system. In a torrent network, anyone can share their files with a decentralized group of peers. The idea was that people would download them and keep sharing the file with the network for others to download. If you were downloading a file, then you were expected to seed as well. This is what we would call an honor system, which is a system operating based on honor or honesty without having strictly enforced rules governing its principles.
The problem is that humans are not always the most honorable of creatures and without any economic incentives it made no sense for people to keep seeding a file which took up unnecessary storage space and bandwidth.
What token economics adds is the capacity to incentivize these peer networks. Unlike open source software, peer-to-peer file sharing or creative commons where the infrastructure is dependent upon the goodwill of the actors, tokens incentivize the peers to participate. So instead of a file storage system being dependent upon a centralized for-profit organization or people’s charitable willingness to provide the resource, it gives those members tokens to incentivize their provisioning of the resource.
The fact that tokens can be used to define and exchange any form of value means that these distributed organizations can be used to deliver all forms of services; both what has been previously delivered by private organizations but also services that have previously been the purview of the public sector.
Public services like cleaning up litter, maintaining parks, public security, care for the elderly, reduction in noise pollution, civic engagement etc. Indeed anywhere value could be generated by the coordination of members, we can define a token for that value and use it to incentivize the agents towards the coordinated behavior, thus enabling the delivery of the service through peer-to-peer token markets.
The Ethereum developer, Karl Floersch, summarizes the current situation well when he notes: “Incentives drive behavior and open access to programmable incentives sets the stage for radical change. This is a really unique moment in history, this change can be good or this change can be bad, we can program incentives which promote cooperation and equitability and general happiness, everyone’s goal, or we can create incentives which prop up a few people and give them way more power than they already have. This is like kind of terrifying, so we need to design mechanisms, test them in the real world and share our findings and do that over and over on a large scale.”
Token economies can be understood as a new way of coordinating human activity in a decentralized fashion, this being done through peer-exchanges within market networks.
As Primavera De Filippi of Harvard puts it, “Today the blockchain is marking the beginning of a new digital revolution, whose focus is not just human communication but rather human interaction and cooperation. What the internet has done to achieve global interpersonal communication the blockchain could do today to achieve global and systematic collaboration.”
It is common to compare the invention of Bitcoin and the blockchain with the internet. In this respect, it is often said that the blockchain is Internet 2.0 The internet has been a powerful tool that has revolutionized the way we interact. But if anything this comparison undersells the significance of the blockchain. As the authors of a recent article on “The Blockchain Economy” suggested, a better metaphor for the blockchain is the invention of mechanical time. Before the modern mechanized measuring of time, human activity was temporally organized by natural cycles: the crow of the rooster in the morning, the gradual descent into darkness at night. The problem with this though was variability, there was simply too much variance in the measurement of time for it to function as a widespread system for synchronizing economic activities.
Mechanical time opened up entirely new categories of economic organisation that had until then been almost unimagined.
During the industrial revolution, the effect of the reduction in the variability of time measurement was felt in almost all areas. Mechanical time allowed trade and exchange to be synchronised across great distances. It allowed for production and transport to be coordinated. It allowed for the day to be structured, for work to be compensated according to the amount of time worked — and for workers to know that they were being compensated fairly. Working life became routinized around this new objective standard of time measurement.
The blockchain and token economics may well be such a systemic transformation in human coordination.
DECENTRALIZED COORDINATION
The blockchain is a new coordination technology that relies on a decentralized network of computers in order to coordinate individual actions in a decentralized manner.
We can think of token economies as a way for people to mimic the social dynamics found in certain highly social creatures like bees, ants, and termites as a way to promote and ideally achieve effective collective organization.
By recording individual actions on a distributed database the blockchain makes it possible for people to coordinate themselves indirectly and collaborate on a global scale, without any centralized authority or hierarchical structure. This is something quite new in human civilization. Until very recently the basic premise has been that order and organization are achieved by centralized authority.
CENTRALIZED INSTITUTIONS
Throughout history, we have achieved widespread coordination and economic organization via centralized systems that imposed common standards. The evolution of civilization can be understood as the rise and fall of ever larger more complex systems of human organization.
Economies are built around networks of trust and common protocols. Traditionally these have come from either a government institution or from some form of Church which are structured in a pyramid form.
In those power structures, you’re able to do business, you’re able to trust people who are not your immediate family because the centralized authority provides the common standards, the protocols, the regulatory and legal structures for you to trust each other and exchange; fiat currencies being one good example of that.
Although centralized systems have their advantages they also have their disadvantages and are inherently limited when it comes to the formation of very complex organizations.
ALIGNMENT OF INTERESTS
One of the primary issues with current centralized organizations is that they are not general purpose as each organization acting as an authority also has its own vested interests. This creates a misalignment of incentives between the centralized authority and users of the system. If we are lucky and we get virtuous members in the center of the organization the interests of the centralized authority may be aligned with those of the network, but equally, they may not.
As we will discuss in the coming module, there is really a misalignment of interests at the heart of centralized organizations.
We have this problem today where most of our most important economic and financial functions are provided by centralized for-profit organizations. The incentive of the organization is to create profit for its owners. The result of this can be that profit gets sucked into the center and upwards, reducing the quality of the network delivering the function and accentuation inequality.
BOTTLE NECKS
Likewise, centralized coordination creates bottlenecks. Resources are brought into the center, processed and then pushed back out to the edges. The system always works much better close to the center and then coordination drops off the further out you go.
This is why, for example, Zimbabwe is a much better use case for cryptocurrencies than say Singapore, because Singapore is close to the center of the global financial systems while Zimbabwe is out on the edges.
Centralized systems have problems delivering structure and functionality all the way out to the edge of the network. The result is that we end up with a trickle-down economy with the edges always being dependent upon the center, but the center not being properly incentivized to deliver services all the way to the edges. Those at the center get a good service but those at the edges don’t. The billions of people who are left out of the global financial system because they are not economically worth serving is illustration of this.
FRACTURED SYSTEM
Centralized systems end up forming either monopolies or a fractured overall system.
Centralized systems have a specific locus as their center and then push out until they meet another organization. The end result, is either a monopoly where one comes to dominate overall others or a fractured system, with lots of different patterns forming. The nation-state is a good example of this. Within a given jurisdiction we have a monopoly of public services but on the global level, we remain with a fractured system.
PEER-PRODUCTION
The alternative to these centralized systems is decentralized peer-to-peer networks. Without centralized authority being used to achieve coordination, this coordination is achieved via direct exchanges of information and value peer-to-peer, such as in a pure market, where the price is decided by the interaction between members.
Token economics turns these centralized institutions of the industrial age into distributed token markets. The critical change that is coming about is that we are now able to design token systems that work to incentivize people’s behavior towards coordinated outcomes, without that coordination being imposed by some centralized authority.
What is different now is that we have the technological means that we can design economies instead of just organizations. Economies that create the right incentive systems and feedback loops to coordinate the activities of the organization in a decentralized fashion.
Token economies build upon the development of peer-production, an alternative model to economic activity that has arisen with the development of the internet.
Peer-production is a process taking advantage of new collaborative possibilities afforded by the internet and has become a significant mode for the division of labor within post-industrial economies.
Free and open source software and open source hardware are two examples of peer-production.
With the development of web 2.0 technology, it became possible to coordinate a large number of people using software systems as the coordination mechanism instead of any centralized authority. This was exemplified by projects like Wikipedia.
But these networks were lacking the critical element of economic incentive. Token economics provides a new way to fund and incentivize these newly formed distributed networks.
Juan Benet, founder of Protocol Labs, describes well what is happening today, “One of the interesting properties here is the ability to create markets where there wasn’t a market before… what [blockchain] application platforms can do is suddenly cut out this huge middleman with a protocol and that is a massive cost-saving for the entire network… you can turn this into a protocol that will optimize the entire process much faster than any centralized company can do, because it turns it into a market. The moment you can take a very complicated process and translate it into a market where a whole bunch of different actors can vie for opportunities and just beat each other, you have this amazing optimization power, where it will just fit the function much better than a centralized entity could have.”
The blockchain provides the infrastructure of trust, secure record keeping and peer interaction required to create general purpose networks for the provisioning of economic and financial services via distributed markets.
The challenge of doing this though is one of designing incentive systems and this is what we will talk about in the coming module.
The blockchain originates out of the purely digital realm of Bitcoin. Thus blockchain networks themselves can only ever manage what is on the network. This is fine if the asset is simply a digital token. But going forwards we find ourselves increasingly wanting to use these networks to manage real-world assets. Thus these value networks will have to interface with the real economy and this interface between the physical and information realms creates major issues.
Economies are, at the end of the day, still very much physical systems of technology, land, natural resources, buildings etc. if we are serious about migrating our economic systems to the blockchain, major consideration has to be given to that interface to ensure that the tokens are securely and accurately connected to their underlying physical assets.
In a digital system like Bitcoin, there is always consistency. Transactions obey the rules of the software and there are no exceptions.
In the real world, there are often exceptions. Cars are stolen, houses destroyed, videos turn out not to be properly licensed, commodities fail to be delivered. Humans sometimes don’t obey the rules. Therefore the key challenge for any system that involves tokenizing real-world assets, is to ensure that the digital token stays linked to the real-world asset.
Very few people in the blockchain world have an appreciation for the complexities of the physical systems that run our economies and their regulation; such as containers passing through customs at a port.
There is a huge gap between this very light dematerialized culture of the blockchain and the very heavy culture of traditional physical assets and the national legal structures that they are embedded within.
Today this interface is secured by laws and ultimately the physical force of a government that backs those laws. If you have a legal document that says a piece of land is yours and someone comes and resides on it you can go to the government and they will physically remove that person from your property if need be.
Imagine a token that represents a fractional interest in a set of gold bars in a vault. If a gold bar is taken from the vault, how will that be reflected in the digital token? Who will make sure that the token value stays linked to the gold bars that should be in the safe? Who will bear the risk and how? If the buyer of a token can’t be sure that the token is properly linked to the real-world asset, then the value of the token will fall or even become zero if no one has faith in the correspondence between the two.
ARBITRATION
At present blockchain systems are still dependent upon traditional legal frameworks for this linkage between the digital representation of an asset and the asset itself.
Currently, arbitration is seen as one of the most effective ways of mapping between what is happening on the blockchain and what is happening with the physical asset and the legal systems it might be embedded within. Arbitration is a long since used method for creating legal agreements in international commerce where both parties agree to bind themselves into a legal contract of their making.
An arbitration award is legally binding on both sides and enforceable in the court of choice.
One way of linking legal systems to what is happening on a token network is through what is called a Ricardian Contract. A Ricardian contract places the essential elements of a legal agreement in a format that can be expressed and executed in software. The aim is to make the document both machine-readable and readable as an ordinary text document, such that lawyers and consenting parties may read the essentials of the contract conveniently.
From a legal perspective, the use of markup language embedded within a largely legal prose document leads to reduced transaction costs, faster dispute resolution, enhanced transparency and improved enforceability. From a computing perspective, the Ricardian contract is a software design pattern to digitize documents and have them executed within financial transactions, such as payments, without losing any of the richness of the contracting tradition.
It is robust through use of identification by cryptographic hash function, transparent through use of readable text for legal prose and efficient through markup language to extract essential information.
Mattereum is one such project that tries to use Ricardian contracts to create an effective linkage between records on the blockchain and the established off-chain legally binding dispute resolution of arbitration thus giving what happens on the blockchain full legal weight under natural language contract.
Mattereum is the first, what it calls “Internet of Agreements” infrastructure project for legally-enforceable smart contracts, enabling the sale and lease of physical property and other transfers of rights in assets. Mattereum is billed as a court that understands the nature of cryptocurrencies, making physical property and intellectual property transactable on a blockchain.
In a case where you might buy a physical asset using a fraction of a Bitcoin and the seller does not follow through, it is difficult to explain this to a judge in a small claims court. This is where Mattereum comes in, enabling technically competent arbitrators to make rulings in these cases instead of a judge. As the founder of the project, Vinay Gupta describes it “Mattereum.com is my bid to get the necessary legal frameworks in place to make direct control of physical property using the blockchain recognized in 150+ countries. I want to break the door open to the material world so you can change the status of a smart contract, and have a real-world court recognize that legal ownership of a fiat asset has changed hands. Fiddly, but it’s necessary infrastructure for all of our next steps together.”
TECHNOLOGY
The alternative to depending upon traditional centralized legal institutions is depending on technology. Code may be the law on the blockchain but outside of those networks, Big Data and IoT will be law.
Big Data is going to give us new insight into what happens when and where with high levels of statistical assurance. While at the same time IoT will put code into all of the technology around us that we are now so dependent upon and that is a new form of law enforcement. If you have the code that can stop a car or open a door lock then you control that system and can enforce whatever contract is on the blockchain.
As an illustration, we might think about a blockchain IoT securitization of gold. We create an automated warehouse, people are allocated secure sealed lots within the warehouse. We deposit a stock of gold in one area and when someone purchases a block of gold the system automatically moves it to the owner’s container and the owners gold token account is calculated by summing up the gold in their container. This is a simplified representation of a blockchain cyber-physical system where blockchain records and tokens are linked directly to the underlying asset through automated technology. By an extension of this model whole buildings, cars and other assets could be directly connected to blockchain tokens thus bridging the gap between the virtual token and the physical asset.
The first application of blockchain technology may have been in currencies, but people are becoming increasingly aware that a secure distributed ledger system of this kind could in fact potentially support all economic activity one day.
Today startups around the world are feverishly building new frameworks for migrating ever more spheres of financial and economic activity to distributed ledger technology.
Many believe that the next stage in this process is the conversion of capital markets to token networks as it is becoming increasingly apparent that the management of securities of any kind, from stocks and bonds to real estate, could be brought into the age of information through tokenization.
There is currently great interest by financial intermediaries and technologists in figuring out how to move real-world assets onto blockchains to gain the advantages of distributed ledgers, while keeping the characteristics of the asset.
The conversion of capital markets to token networks would create many efficiencies. It could take the somewhat elite world of high finance and make it accessible to any and all. Creating new opportunities for investors and new sources of equity for organizations.
Our capital markets of various kinds today hold trillions of dollars of assets that are being used far from their potential. Locked up by high transaction costs, low transparency, layers of middlemen and bureaucracy.
The tokenization of this system could radically improve the efficiency of transaction processing by removing the layers of bureaucracy created by centralization. It could unlock vast amounts of currently locked up fix capital. It could create a quantum leap in transparency, opening up capital market data to advanced analytics in unimaginable new ways. Likewise distributed ledgers are tamper-proof making them less susceptible to fraud.
CAPITAL MARKETS
Our world is full of different forms of assets: oil, basic foodstuff, stocks, carbon credits, real estate, gold, etc. Many of these assets are difficult to subdivide or physically move around. So buyers and sellers instead trade pieces of paper that represent ownership of part or all of those assets.
However this existing system composed of paper and lengthy legal agreements is cumbersome. Assets are difficult to transfer and can be hard to track.
Tokenization of securities is the process of converting rights to an asset into a digital token on a blockchain.
Any asset that is currently traded on a capital market as a security, such as commodities, shares, bonds, or various forms of derivatives, could be tokenized by linking them to a blockchain register.
Indeed any asset at all could be securitized by linking it to a digital token. This might include any form of property, such as a house. It might include loans or mortgages, all of these could be converted into security tokens and traded on markets.
The most obvious use of this system is the raising of initial funding for a new project. Already huge amounts of funds have been diverted from traditional forms of venture capital in to directly funding projects through ICOs.
Many industry observers believe that mainstream companies will one-day issue shares through ICOs, either in place of or in addition to traditional public offerings.
ICOs are a good example of where we are heading as we shift more of capital markets onto the blockchain. They illustrate the capacity to open up these markets to the many, as venture capital has gone from the domain of a few investors, to being accessible to anyone on the planet with internet connection and a few dollars.
They illustrate the direct peer-to-peer nature of token economies. But what we have seen so far is really just the tip of the iceberg as what has happened to venture capitalism could literally happen to all of capitalism. As all capital could be tokenized. A number of platforms are currently in operation or being built to do exactly this.
TOKEN PLATFORMS
LAToken is one such platform. LAToken is an asset tokenization platform that allows users to convert tangible assets, such as real estate or precious artworks, into tokens, thereby making them sellable in fractions. You can tokenize your asset on their platform and sell it in fractions to investors. Investors may then sell the tokens on a secondary market and you can buy back the asset later on, or sell it on the settlement date.
Imagine an artwork by a famous artist with 100 copies. The art prints could be tokenized by having ownership held by a company that has a standing offer to the public to redeem tokens for either a single art print or a fraction of one copy. In this way, buyers could obtain an easy-to-transfer token and a secondary market could transact in fractions of the art prints.
This could potentially be a source of financing for the artist and a way for the broader public to participate in the art market that is currently inaccessible to most.
Likewise, commodities could be converted into security tokens and traded.
Imagine a group of companies that want to trade aluminum with one another. Normally they’d exchange paperwork and keep their own lists of trades. If they could move to a blockchain-based system for trading their aluminum, they could potentially reduce paperwork and have more robust record-keeping.
SELF-SECURITIZATION
One of the fascinating aspects of distributed ledger networks is that they can enable people to securitize their own assets.
Tokenization is an extension of the more traditional process of securitization, which is the conversion of an illiquid asset into a record that can be traded to increase liquidity.
Whereas previously the creation of securities was the domain of large highly regulated centralized organizations, blockchain networks can automate this process and make it accessible to all. People and organizations of any kind could securitize any asset that they own. They simply lock it on the blockchain and receive liquidity in return, when the liquid capital is returned the illiquid asset is unfrozen.
Sweetbridge is one token platform that is essentially enabling people to be their own banks when it comes to loans. This is done through creating a blockchain network where people can register and lock up their own assets as collateral, against which they can borrow money at low-interest rates or even no interests rates at all.
Users are essentially lending themselves money without a credit check because they are lending it against their own assets they have locked up.
What is happening is that when you lock an asset into the network, the network grows in value and gives you the tokens equal to that growth in its value, which you can then exchange for other tokens of fiat currency. Because you are creating the currency and not renting it from somebody else you don’t need to pay much interest on it or even no interest at all.
Where this gets exciting is not in developed economies, it is in places where you have a highly ineffective and inefficient formal economic system and a high level of informality, such as the developing nations of Africa and Asia.
In these environments, interest rates tend to be very high and loans tend to be very difficult and yet these are the roots of the supply chains of the world. This is where the food is grown, where the minerals come from. In these frontier markets it can be really tough to get financing of any kind and if you do it’s very expensive. It may be 10 to 20 percent. With a security token platform like that of Sweetbridge, no credit rating would be needed. You just lock up some asset and get liquidity in return at a low-interest rate.
This can be revolutionary, making a massive difference, not just for global trade but in the lives of the most vulnerable.
REAL ESTATE
Real Estate is another asset class that is set to move to token networks in the coming years.
The stock of real estate assets is enormous, it is the biggest asset class in the world, valued at well over 200 trillion dollars.
At just 1.4 trillion in transactions every year, most of this market sits stagnant and does not really trade. Real estate is a very illiquid market and one of the least transparent. Buying and selling property especially on the global market across borders is full of frictions, middlemen, and lengthy procedures.
You can hold a piece of a corporate or a government debt in a bond, but it is very difficult to hold a piece of property and there is a lot of friction to trading property. While at the same time for many assets in real estate people will pay up to 20% more for one that is liquid versus one that is not. So tokenizing these assets could release huge amounts of untapped or underused resources.
Atlant is one platform that is working to tokenize real estate. It does this by linking the property to a special purpose vehicle (SPV) which is then converted into tokens. The property is purchased and transferred to the SPV. The SPV is split into many shares that can then be traded on the platform with almost no friction. Now a person sitting in Taiwan can at the click of a button invest in the creation of a new factory in Poland or a section of an office space in Mexico City.
Likewise, through this tokenization of property, the physical asset can be split up into extremely small units of equity, that make the whole market greatly more liquid. Say for example you have a shopping center, the platform can tokenize it by dividing it into a million centimeters of floor space. People can then exchange those small units or rent the property they own out.
PHYSICAL LINKAGE
In all of this conversation around the tokenization of real-world assets remains one big elephant in the room, which is the question of how exactly do you put assets on the blockchain?
The linkage between the information software layer of the blockchain network and the physical real-world asset is of course of critical significance and in many cases remains an unanswered question as to how exactly that linkage is secured. So in the next module we will pick up on this very topic.
Discount tokens are one of the new innovations made possible at a large scale, within a blockchain-based token economy.
In short, discount tokens are digital assets that give their holders a specific claim to receive discounts on purchases of products or services from an organization — such as an enterprise, a cooperative, or a blockchain network.
Unlike gift cards, discount tokens are not invalidated when used but remain active and in possession of the holders.
The specific size of the discount that the token delivers for its owner is designed to grow in proportion with the overall utilization of the network. The discount token itself allows the holder to access the discount.
This can be seen as a royalty model. But instead of claims to a fixed stream of revenue, it’s rights to receive a proportion of total services offered.
Given the growth in economic activity on the network, the owner may utilize more discount on the service they receive directly or sell/share the surplus.
While simple in its essence, it has profound implications. In a discount token economy, creators and users of the network are clearly aligned. While passive investors and speculators find themselves at an economic disadvantage. This is because discount tokens are more economically valuable to users than passive investors and thus work to discourage unconstructive price dynamics seen in other classes of crypto assets.
The discount is fundamentally linked to the adoption and growth of the network. The discount grows proportional to the growth in network service delivered.
The overall returns to the active token owners surpass the returns to passive token holders: the investors.
The discount token enables next generation, technology-enabled mutual companies, and cooperatives while working to reduce speculation.
While tokens themselves allow for transactions, capital formation, investment, and speculation, the discount token model is an interesting way to incentivize the growth of a crypto-powered network.
The discount token is loyalty to the growth of the network. And not just for pure speculation because it is always better to hold a discount token if you are a user of the network rather than simply a speculator.
This creates alignment between the customer and the provider that doesn’t occur with shareholders, with loans or bonds or other classical financial instruments used.
The discount token model is applicable to a broad range of business models. Businesses that most benefit from it are those that desire and expect significant long-term business from its customers through ongoing subscriptions, recurrent fees, or frequent repeat purchases.
For such dedicated customers the discount that the token offers means real money to them. But for others that have no great interest or use of the network, the token will have limited value.
The SweatBridge blockchain project is one of the strongest proponents of the model of a discount token. In their paper, they write about the reasons for using a discount token over a simple utility token. “As creators who desire to be both responsible and compliant, we find ourselves in search of a class of token economics that would (1) underlie a broad range of decentralized organizations and networks; (2) align incentives between investors (both early and late), creators, and consumers; (3) be demonstrably distinct from securities and Ponzi structures in the incentives they generate; and (4) align with existing regulatory precedent.
The discount token framework is designed to meet these requirements. While simple at its core, it has profound implications.”
Discount tokens are a good illustration of the kind of economic and financial innovation that is being unleashed with token economics.
It is not just about making things faster and more efficient, but discount tokens illustrate how we can really think about basic economic structures and incentives and then build currencies that work in totally different ways to the ones we have today. In so doing try to solve major economic issues – such as excessive financial speculation and better rewarding those that are actually interested in the development of the given economic network’s functionality.
With major technological, social and economic processes of change underway we are fast moving away from the well-established model of the Industrial Age and into a new form of digital networked economy, where the traditional well defined parameters of economics are being once again revisited as we search for a new model better suited to this new reality.
One aspect to this is a reconceptualization of the very foundations of economics, that is to say, the idea of value. With token economies, we are really re-exploring what value is and how we quantify and exchange it.
Part of this equation is the differentiation between intrinsic and extrinsic value.
The economic system that evolved over the course of the modern era has come to be based on utility as a measure of extrinsic value.
Token economics is a more generic form of economic model that lets us define not just utility but also intrinsic value. To make sense of this we need to first look at what we mean by utility and intrinsic value.
Things can have value both in and for themselves and as means to other ends. For example, a tree has some kind of value in and for its role within an ecosystem. But it also has value in use as firewood for heating.
The first form of value we can call intrinsic value and the second extrinsic value or utility. It is important to make this distinction because the two have very different properties. For example, most of us recognize that having many friends and connections has a certain value. But we also recognize that this is different from financial capital. Buying friends is not the same thing as having friends. Why is this so?
Because money is a measurement of utility while friendship and social bonds are seen to have some form of intrinsic value.
Though our traditional monetary system does not capture this form of social capital in some way token systems can. For example, likes on social media can be a form of tokens, with those tokens representing your social capital.
This subtle difference between intrinsic and extrinsic value and how we may harness and capture them through tokens is very complex and something we are just beginning to explore.
INTRINSIC AND EXTRINSIC VALUE
Our traditional financial system and the basis of neoliberal free market economics is the construct of value as utility.
Utility is the value that something gives to some person. Utility implies that it has a general and immediate usefulness that people would be prepared to pay for.
Utility is a measure of extrinsic value.
Utility is instrumental, like a tool or an instrument, we just use it for what it can achieve, we don’t care about the system itself.
Utility is always relative to what someone is prepared to pay for it.
Due to this we can measure the value of something by looking at its supply and demand curve to derive a single price, that is defined as the measure of its value.
In contrast to utility is intrinsic value. Intrinsic value is the value that something contributes to the maintenance and functionality of a whole system.
With intrinsic value, we have a unit that values the functionality of the whole network.
For example, the social capital contained in the bonds of a society that enables it to function as a community is a form of intrinsic value.
A mangrove swamp that preserves a local ecosystem and prevents coastal erosion is a form of intrinsic value. When we chop the mangrove down that may deliver something we can exchange on a market and utility, but it has lost its intrinsic value in maintaining the functional integrity of that ecosystem.
Utility is a measure of some derivative value, while intrinsic value is inherent to the network or system that delivers the value. For example we are able to quantify, buy and sell wood but not the functionality of an ecosystem.
We are able to buy care for elderly people but we are not able to buy with money a functioning community that might provide this service organically.
Intrinsic value is like a fixed asset, it is non-liquid. You can cash in the value of an ecosystem or of a community or culture, as we have done in many ways, but you lose a massive amount of the value when you do that. For example, research has shown that a mangrove swamp is worth orders of magnitude more when it is left intact than when it is cashed in.
As a metaphor, we can think of utility as the lowest denominator, being divisible into many things and easily exchanged.
Whereas intrinsic value is the highest denominator being non-divisible and non-exchangeable. Because it is intrinsic, it is inherent to the system and can’t be easily ported to other contexts.
TOKEN SYSTEMS
Traditional currencies and the free market system only let us quantify and exchange utility, they do not account for the value that may be inherent to a system that is not of immediate utility to any actor. But token systems enable us to expand economic activity beyond the realm of utility.
Token economies can be understood as a natural evolution to our economic system that responds to the broader set of values that people come to hold in post-industrial economies.
The industrial age was all about the provisioning of basic tangible products, which the market system and utility captured effectively.
A post-industrial economy – which all advanced economies are today – goes beyond this basic provisioning of goods as people’s basic needs are met they move up the hierarchy of needs and start to care about and value a broader spectrum of services.
The traditional model of utility tells us about the exchange and consumption of goods. It does not tell us about the quality of the social, cultural or natural environment within which agents exist. Thus actors can end up living in a severely degraded social, cultural and natural environment – which significantly reduces their quality of life. While still, the economy is churning through vast amounts of resources so as to make up for this, and our metric of utility – in this case, GDP – would still tell us that the system is in an optimal state.
The economy is supported by a vast heritage of natural capital – such as clean water, sunlight, oxygen etc – which stays providing the conditions for the inflow of natural Resources.
Whereas in the previous industrial age these may have seen infinite, today it is becoming more apparent that they are finite and we are increasingly looking for means to quantify and integrate them into market decisions.
Likewise, an economy is embedded within, and dependent upon, a massive nexus of social and cultural institutions that are required for it to function effectively. This value that is in social bonds that enables trust and frictionless exchange is called social capital and the economy benefits all day, every day, from huge complex networks of social capital that go unaccounted for. But again we are starting to take note of the value of social and cultural capital as important to the success of enterprises and economies.
Increasingly, what people in advanced economies want from their economies is not just GDP but quality of life, which is a much more complex thing involving many different forms of value. This is why a post-industrial economy is a services economy and the best model for a services economy is a token model. Because token networks can potentially capture and incorporate all the different forms of social, cultural, natural and financial capital needed to provide quality of life.
PROGRAMMABLE TOKENS
By excluding intrinsic value we have created the notorious divide within the industrial economy between the market and the public sector.
Markets were previously limited to utility exchanges and dependent upon public institutions to regulate the supporting social and natural capital. However, this is what changes with token economies as we can now begin to quantify, account for and exchange social and natural capital.
Going forward we will be increasingly able to express social values through tokens via their programmability. Because tokens are digital they may be programmed with certain rules and when you have moved assets on to the blockchain, those programmable rules can be used to define what kinds of activities the token network supports or does not support.
For example, if our society decided tomorrow that we no longer thought the eating of meat was a good thing and wanted to move away from it, we could do that by simply no longer purchasing meat products and the entire industry would disappear quickly.
In a digital token economy, we can put our money where our mouth is, as a proof of what we value. We could create a veggie token, that could be programmed so that it could not be used to purchase meat products. Or as another example, we may have a weapons-free token, which is programmed so that it can not be used to purchase weapons. If our societies only had tokens of this kind then weapons could not be purchased and they would disappear.
We could then see how much our society value peace by looking at how closely that token traded relative to another token that was the same but could be used to purchase weapons.
If there was a big difference and the token traded at a very low price then our society obviously doesn’t want the token and is not willing to lock itself into a weapons-free world.
We can see how this integrates social values with economic value in new ways and helps us escape from a world where people and politicians say one thing and do another. In many ways, it reflects the underlying blockchain proof of work or proof of stake system.
The way that we prove that we value something is by locking ourselves into it. The way that we express our social values through an economic token is by locking ourselves into networks that express those values.
This multi-value token system enables us to recognize and mobilize existing networks in new ways. Tokens help us to expand the economic system to incorporate more value systems and thus harness people’s motivation along more dimensions, rather than simply for utility-based profit.
Tokens, because they are more generic enable us to quantify almost any form of value, both extrinsic and intrinsic.
When you hold a currency to an asset you are making an investment in that network, by are saying that it has value to you. If no one wanted to hold Dollars then the Dollar would have no value. By creating all these little economies with their own distinct currencies we are able to say exactly what it is we value and invest our resources in that ecosystem.
By holding the Liverpool pound or the Bristol pound we are saying that we value that ecosystem and will invest our resources in it. When we cash our Liverpool pound in for a British pound we are saying that we don’t really value it; we are not prepared to restrict ourselves to making purchases only in that network and support the community value that it creates.
This is why it is important to not think of tokens as being like traditional currencies because they represent the possibility for a new kind of information services economy that is fundamentally different from the one we know and is a necessary evolution in our economic structures. Just a significant as the evolution from a pre-modern feudal system to a modern industrial economy.
Likewise, it illustrates the issues we are having surrounding regulation. A token economy is a different form of economy to the industrial economy. It will not fit inside the box of the industrial model.
Because token economies expand the nature of markets to include a broader spectrum of values they can be self-regulating, which stands in contrast to our existing industrial age logic of the utility based market, which always requires external regulation and support because of their incompleteness and narrow set of values that they incorporate.
The token economy offers the possibility of creating self-sustaining economies by incorporating all relevant value systems within multi-value tokens and multi-value markets.
While in the industrial economy all forms of value could be reduced to a single metric of utility. A services economy is inherently a multi-value economy.
While extrinsic value may be reduced to a single metric, intrinsic value is many inherent forms of value each requiring their own distinct token that is irreducible.
To really understand the significance of token economies is to appreciate that society and economies evolve and change over time and part of what is happening in the world today is an evolution in what people value and that is a very profound thing that in turn really requires a new economic model to capture and develop.
Michel Bauwens of the P2P Foundation describes this well when he says “The three revolutions in human productivity: so the first invention is coercive labor that gave us civilisation, slavery, serfdom. That’s how we created castles and temples. In other words the motivation there is external negative motivation: I conquered you, I could kill you, but out of the goodness of my heart I let you live and you can work for me for the rest of your life. This is the social contract of slavery. I think capitalism introduces something new which is, well it’s not just about that, but also about self-interest. In other words positive extrinsic motivation: I’m doing something because I’m going to get something for it, which really give a boost to human science and technology, etc. I think we’re going through a third revolution now, which is about actually moving from extrinsic to intrinsic. So we are building systems — open contributory systems — like Wikipedia and others where people are actually there for variety of motivations but they are mostly intrinsic motivation: I want to create a global internet encyclopedia, I want to create this, I want to learn from it, there are various motivations.”
Token economies is a new way for us to try and represent intrinsic motives. It enables us to create economies that better reflect both peoples’ intrinsic and extrinsic motives, but that relationship between intrinsic and extrinsic motives is extremely complex and subtle. Figuring out exactly how that works is a long learning process ahead.
A token is a generic quantified unit of value that is registered on a blockchain network.
Today tokens are understood to come in two kinds: utility tokens, and securities tokens.
Security tokens represent fixed assets of some kind, it may be a piece of property such as a house or a share in a company.
A utility token is a more liquid medium of exchange that gives one access to the value created by a blockchain network. Utility tokens really represent access to a service delivered by a blockchain based ecosystem.
To understand token economies it is best to think in terms of services and not products. Utility tokens represent the service delivered by a network. The utility tokens are quantified units of services that can be accessed within a given network.
Tokens are generic units of value. This means that they can represent any kind of value. Wherever there is a network delivering a service, a token can be created to define that value.
We can create a token for any different type of network and service.
For example, a community watch scheme where people look out for each other’s houses to make sure there are no trespassers or burglars. This is a community that is delivering a valued service of securing peoples houses.
We can then define an economy around that community, by creating a token that quantifies the service delivered and a blockchain system that keeps track of who is delivering the service and who is using it.
This utility token is then used as a medium for the exchange of that service. Those who consume the service have to give tokens to those the provide it. In this example, we can see how token economics works to formalize what was previously informal and merges economics and social communities in new ways.
The service can be of many kinds. Health care services, for which we might have a health coin; it could be cleaning services, a clean coin; a transport service.
For example, the DAV Token is a form of utility token. The DAV network is a blockchain platform currently under development that connects transport and logistics service providers with those who need those services – in particular, it focuses on connecting autonomous vehicles.
Members of the ecosystem can earn DAV Tokens by providing transportation services, by say, letting your self-driving car give rides to passengers when you’re not using it, or having your drone help with deliveries. While users of the service pay tokens to be transported anywhere or to send and receive packages through the network.
A utility token, such as that of the DAV Token, should then reflect the quality and quantity of the service that the network can deliver. The better the quality the more people will want it, and the greater the quantity of service delivered, the more tokens will be needed.
DIGITAL CURRENCIES
Some people classify digital currencies as a third type of token, but they can just as easily be understood as a utility token.
For example, we might think of Bitcoin. Ultimately, Bitcoin’s value comes from its capacity to be exchanged for some service or exchange for some other currency that can be used within a national economy, such as the Euro.
Currencies like the Dollar or RMB have value because we believe they have value. But ultimately they rest upon the fact that they are supported by the massive real economies of the US or China. Really they are utility tokens that give you access to the services delivered by those economies.
If the Japanese real economy disappeared tomorrow the currency would crash because people would stop being able to buy things with it.
Currencies are just mediums of exchange and agreements about what we value but they are supported by real economies and governments that make sure those currencies can be used to access the goods and services within their economy.
Bitcoin may not be directly linked to any one national economy, but at the end of the day, it is linked to the global economy in one’s capacity to exchange it for other fiat currencies that are linked to national economies.
Thus we can see how currencies are a form of utility token that provides access to the services created by a given economy. Whereas fiat currencies provide access to a national economy, tokens provide access to a blockchain based network economy.
ICO
Because tokens have a price, they can be issued and sold at the inception of a new network to fund its development. Similar to the way startups have used crowdfunding platforms like Kickstarter to fund product development. The money is typically received in digital currency form and goes to the founding organization that is developing the network and issuing the tokens.
In the same way that a company increasing sales is an alternative to raising money, token launches can be an alternative to traditional equity-based financing and as we will discuss in a future module, can be an effective way to fund previously unfundable shared infrastructure, like open source projects.
Utility tokens, also called app coins or user tokens, represent future access to an organization’s product or service. The defining characteristic of utility tokens is that they are not designed as investments. If properly structured, this feature exempts utility tokens from legal regulation covering traditional forms of securities.
By creating utility tokens, a startup can sell “digital coupons” for the service it is developing, much as retailers accept pre-orders for a good that may only be available weeks later.
Filecoin, for instance, raised over two hundred million by selling tokens that will provide users with access to its decentralized cloud storage platform. Thus we can see that the traditional divides that defined the industrial age financial system become blurred and redefined within the new model of token economics.
The question is though, why do we need hundreds or thousands of different types of tokens? Why can’t we just pay for everything in Dollars like we used to or even in bitcoins, wouldn’t that be simpler?
Answering that question goes to the heart of the distinction between token economics and traditional industrial age economic systems and we will talk about this in the coming module.
