Digital Tokens 101: What Does it All Mean?
The term ‘token’ can lead you to think about the plastic casino chips, or that thing used to swap to get a beer under a particular platform or within a particular market such as a festival.
Let’s explore the origin of this term ‘digital token’, and then have a look to the area of cryptocurrency tokens, differentiating between blockchain-native tokens like BTC on Bitcoin or even ETH on Ethereum, along with asset-backed tokens like IOUs on Ripple.
How Digital Tokens appeared
Chances are that we’ve all seen a digital token before, even though we didn’t realize it. Let’s think about when subscribing to an online service or newsletter.
After you enter an email address into a site to join a mailing list, you are often asked to look at your email and click a hyperlink. The link you get to confirm your subscription may look something like this:
https://www.website.com/confirm_email? token=4bdebebc-135b-4748-b7ab-25b31a285df8
In cases like this, the ‘token’ is that this series of characters that was delivered to you. This number or string of characters is unique, so the company who sent you the confirmation email will know it’s your email address if you click on it.
So, the site sent you a token, and you shipped it back, demonstrating you had control of the email address.
But the term ‘token’ is presently being utilized in a totally different manner to identify different items in the cryptocurrency world.
Cryptocurrency Tokens
Cryptocurrency tokens do not exist as a number like the one in the example above (they’d be simple to replicate ), but instead, they exist as entrances on a ledger (a blockchain). You have those ‘tokens’ since you’ve got a secret which allows you to make a new entrance on the ledger, re-assigning the possession to another person. You do not store tokens in your own pc, you save the keys that allow you to access or reassign the amount.
Those ‘tokens’ could be considered as electronic resources that you can have control of, and you may reassign control to somebody else.
“Cryptocurrency” can refer to both tokens and coins, but differences exist between the two labels.
We’ll cover two kinds of token:
- “intrinsic”, “native” or “built-in” tokens of blockchains
- “asset-backed” tokens issued on the blockchain by a third party onto a blockchain, which can be redeemed at a later time
1. Intrinsic tokens (also called ‘native or ‘built-in’ tokens)
Intrinsic tokens are conceived for their usefulness.
Here are some famous examples of intrinsic tokens are:
- BTC (Bitcoin blockchain)
- XRP (Ripple network)
- NXT (NXT platform)
- ETH (Ethereum)
Check out the top 100 cryptocurrency tokens, and the entire list on Coin Market Cap.
All these ‘coins’ or ‘digital tokens’ stand at the core of their projects and blockchain. Without them, the blockchain wouldn’t work. It’s not rare to find digital tokens as part of a reward system, which encourages users to create blocks by validating transactions on the blockchain. Each blockchain has its own digital tokens system, although some can look alike.
How are intrinsic tokens created?
These tokens are created by computers and are not backed up by anything. It’s like writing down on a piece of paper “I have 1 billion coins”.
In reality, if you did this, then kept a fantastic record of those friends you gave them to, and in the event that you could record forward trades as your buddies gave them to other friends, you’d do pretty much exactly what these digital ledgers do.
Let’s take the most famous digital tokens for instance:
- Bitcoin, BTC
Bitcoins are ‘mined’ according to a schedule. The recently created coins are made to reward to the block-maker. The entire amount of bitcoins increases with time. They can be then traded.
- Ripple, XRP
The digital tokens XRP, were ‘pre-mined’ (created all the beginning) and shared among key participants. Each trade has a small XRP fee. These XRPs are destroyed over time. The entire amount of XRPs circulating goes down with time.
- NXT, NXT
The NXT tokens were pre-mined. Each trade on the NXT system includes a commission in NXT. The fee goes into the block-maker (in NXT that is known as a ‘forger’ as opposed to a ‘miner’). The entire amount of NXT stays constant with time.
- Ethereum, ETH (‘Ether’)
Ethereum has been pre-mined. Transactions and smart contracts require an ETH fee to be created and to operate, and the block-maker is rewarded with ETH. The block-maker also receives a block reward.
What is the purpose of intrinsic digital tokens?
The primary purposes of intrinsic digital tokens appear to be:
- Block validation incentives (‘miner rewards’)
- Transaction spam avoidance (if all trades cost a token, it restricts the capacity to create spam transaction and jam the network)
Even though these coins have worth (you can purchase and sell some of them on a cryptocurrency exchange for some other cryptocurrencies or fiat), they are not supposed to represent anything. They just exist as a digital token.
2. Asset-backed tokens
If we take a look at the history of money, we can observe an antique practice people had. In the old times, you could deposit gold at your goldsmith’s shop, and get a receipt or “I Owe You” (IOU) note from them. These notes could be moved from person to person, and anyone holding these notes could go back to the goldsmith and get into the possession of the actual gold.
Asset-backed tokens would be the electronic equivalent. They’re claims within an underlying asset (such as the golden), that you have to maintain from a particular issuer (the goldsmith). The trades are listed on the blockchains, as tokens become passed between individuals, and also to maintain the underlying asset, you ship your token into the issuer, and the issuer sends you that the underlying asset.
Asset-backed tokens are claims on an underlying asset, by a particular issuer.
Popular assets for all these schemes are currencies (USD, EUR, etc) and precious metals (Cryptocurrencies seem to attract the same crowd as silver and gold). People monitoring these assets on ledgers by producing a digital token to represents each of them.
How do asset-backed tokens work?
Let us take the case of Coins-R-Us, a false Bitcoin exchange, issuing Euro-backed digital tokens.
You send fiat money to Coins-R-Us by logging into your internet banking. It’s like a normal bank payment you sent Eur to the Coins-R-Us’ bank accounts. Let’s say you sent 100 Eur. Then you log into your account and see 100 electronic asset-backed tokens known as Coins-R-Us-EUR.
The production of the tokens is listed on a blockchain. This could be on the Bitcoin Blockchain, or as a resource on Ripple or NXT, or even a smart contract on Ethereum. Now you can send these digital tokens to your friends (possibly in return for some thing or as a present), and also the tokens continue to be monitored on the exact same blockchain.
At some point, one of your friends will want to exchange this asset-backed token to get something real. He would have to go back to Coins-R-Us, set up an account on their platform, tell them his bank account number, and send them the Coins-R-Us-EUR he got out of you. They would then sent him Eur to his bank account from their bank account.
What are Cryptocurrencies?
What is the definition of cryptocurrency?
A cryptocurrency is a virtual or digital currency which is encrypted (secured) using cryptography. Cryptography refers to the usage of encryption methods to secure and check the transport of trades. Bitcoin represents the very first decentralized cryptocurrency, which can be powered with a general public ledger that lists and validates all trades chronologically, known as the blockchain.
A Cryptocurrency is a math-based, decentralized digital money that’s protected by cryptography
Cryptocurrency is a short expression for “cryptographic” money. Cryptocurrency integrates the principles of cryptography to execute a distributed, decentralized, protected information market.
Cryptocurrency is a kind of “virtual money” compared to fiat money that’s used more commonly, like the dollar or the euro. Virtual currencies are supposed to be utilized as money; they are mainly meant to be utilized as a medium of trade. Though some persons speculate about the value of one currency versus different money, the aim of these currencies is to be used as a medium of trade rather than as an investment.
In 2015, the Commodity Futures Trading Commission (CFTC) from the United States, declared that “Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.” However, because virtual currencies aren’t securities, they aren’t regulated by the Securities and Exchange Commission (SEC).
Briefly, this is how a blockchain functions:
(Source: The Bernie Group)
Cryptocurrencies have been around before Bitcoin was created, but its creation marks a significant milestone in the domain of digital currencies, mainly because of its decentralized blockchain and user adoption.
The development of Bitcoin precipitated the growth of a verdant and much more varied ecosystem of different coins and tokens, which are frequently regarded as cryptocurrencies generally, even if a lot of them don’t fall under the definition of “money”.
Digital tokens vs Cryptocurrency
The cryptocurrency discussion is always changing, and it can be confusing and mysterious, especially when we start talking about digital tokens.
Ever noticed tokens being known as coins, and coins as slogans? Or what about cryptocurrency together with tags like “safety” and “usefulness”?
It’s important to understand the concept of cryptocurrency because digital tokens do fall under it.
Cryptocurrency is encrypted and decentralized with cryptography and is a form of digital money made and saved on the blockchain. There are many cryptocurrencies, all of which are utilized to control the production of financial units and also to check the transfer of capital. The expression “cryptocurrency” identifies all coins and tokens.
Therefore, what’s the difference between a digital coin and a digital token?
Coins (Bitcoin and altcoins) have their own independent blockchain and their objective is to replace cash and to be used as a unit of account, store of value and medium of transfer.
Tokens, on the other hand, are usually an addition to a blockchain and reflect an asset or a utility. Digital tokens belong to a platform (e.g. the Ethereum network), to exist and function, and are created when a crypto project launches an Initial Coin Offering (ICO). Tokens, also known as crypto-tokens and digital tokens, are often given to early investors in exchange for cryptocurrencies such as Ether, Bitcoin, or even some other Altcoins, and can also be used as a kind of payment for utilizing a platform, or app.
Now, how do you tell exactly what token does what? There is a number token and they all exist independently. However, the main types of tokens are security tokens and utility tokens.
In the crypto space, people refer to digital tokens as crypto tokens.
Think of digital tokens the same as you would think of the tokens that we utilized in actual life actions. The most important intention of the tokens would be to provide clients with an equivalent priority for maintaining an item or something that the tokens belong to.
For example, in banking, they utilize tokens to facilitate the customers’ access to their account.
Digital tokens work in a similar manner, but they’re primarily utilized at the idea of ICO.
Coins vs Tokens: Categorization of Cryptocurrencies
It’s essential to be aware that all coins or tokens are considered as cryptocurrencies, even though the majority of the coins don’t be a currency or medium of exchange.
The expression cryptocurrency is a misnomer because money technically signifies a unit of account, a store of value and a medium of trade.
These features are inherent inside Bitcoin, also since the cryptocurrency area was kick-started by Bitcoin’s production, some other coins conceived following Bitcoin is normally believed to be a cryptocurrency, although most don’t meet the aforementioned qualities of genuine currency.
The most frequent categorization of all cryptocurrencies are:
- Choice Cryptocurrency Coins (Altcoins)
- Tokens
Altcoins
Cryptocurrency which is not Bitcoin is also known as altcoin or just “coins”. They are frequently used interchangeably. Altcoins only refers to coins which are an option to Bitcoin. Nearly all altcoins are a version (fork) of Bitcoin, constructed using Bitcoin’s open-sourced, first protocol with modifications to its inherent codes, thereby simplifying a totally new coin with another set of attributes. A fundamental notion of changing open source codes to make new coins is known as hardforks. To understand better what a hardfork means, you can study Bitcoin Cash which is a hard fork from Bitcoin.
This normally results in the introduction of a new coin. There are various sorts of forks like hard fork, soft fork or casual fork.
You will find different altcoins which are not derived from Bitcoin’s open source protocol. Instead, they’ve established their very own blockchain and protocol which affirms their native currency.
Interesting fact: The very first Altcoin has been Namecoin, that was made in April 2011. It’s a decentralized open source data registration and transport system.
Tokens
Tokens are a representation of a specific utility or asset, that generally resides on a blockchain. Tokens can signify essentially any resources which are fungible and tradeable, from commodities to loyalty factors to other cryptocurrencies!
Creating tokens is a far simpler process since you don’t need to change the codes from a specific protocol or design a blockchain from scratch. All you need to do is follow a standard template around your blockchain (e.g. Ethereum, Waves system), which permits you to produce your own tokens. This performance of producing your personal tokens is made possible via the usage of smart contracts.
What is a smart contract? A smart contract is a self-executing programmed computer codes which don’t require some third-parties to function.
This is how the process works:
Tokens are made and distributed to the general public via an Initial Coin Offering (ICO), which is a method of crowdfunding, through the launch of a newly created cryptocurrency or token to finance o project development. It’s very similar to an Initial Public Offering (IPO) for shares, but there are some crucial distinctions. Many eagerly participate in ICOs, and see it as a fantastic method to invest in projects which may offer excellent returns of investment.
Interesting fact: A template for token creation is fantastic since it provides a standard interface for interoperability between tokens. This makes it much easier for you to save different sort of coins inside one wallet. An illustration is that the ERC-20 standard on the Ethereum blockchain, which is utilized by over 40 tokens.
What is a Security Token?
Security tokens are synonymous with an investment contract. Security tokens could represent shares in a business, earnings flows, an entitlement to dividends or interest obligations. From a financial view, they’re similar to stocks, bonds or derivatives.
The national laws apply to ICOs, and they are different from country to country. This means that securities, asset tokens fall under these laws. That’s why it’s important to know the country in which the ICO is launched, to know the regulations which apply to a token.
How to know if a token is a security token?
Usually, If the answer to the question “Is the token increasing in value over time, and is that increase connected to the company’s performance?” is Yes, then that is a security token.
A Security Token is an electronic token that represents debt, equity, an investment contract, or other security in an enterprise.
It isn’t a coin nor is it meant to be money. The four conditions that have to be fulfilled in order for the tool to be considered a security are:
- It’s an investment of cash;
- There’s an expectation of gains from the investment;
- The expense of cash is in a frequent venture; and
- Any gain comes from promoters or third party.
This is called the Howey test, which was a Supreme Court case, between the Securities and Exchange Commission (SEC) and Howey. They determined that if a digital token fulfils the four requirements of this test (such as other securities) it’ll be controlled by the SEC. So these digital tokens are securities, not commodities or currencies, and therefore they’re not governed by the Commodity Futures Trading Commission (CFTC).
Summary
- Regulatory framework, depending on the country
- Expectation of return
- Similar to a stock
What is a Utility Token?
Utility tokens are much like the tokens you would purchase at an arcade, and grant you access to an organization’s services or products. They are not regulated, and therefore utility tokens are not investments.
From time to time, the lines between a security and a utility token may become confusing, especially once you add in unclear regulations, which are added in the absence of a globally-accepted frame. But when a utility token is correctly structured and functions as a “voucher” for the organization’s services, it stays a utility and usually exempt from rigorous regulatory oversight.
A Utility Token is an electronic token created for utilization only, not for investment.
It’s not a coin.
If a person is buying a utility token for investment purposes, it’s very likely to be regarded as a security token, ( the SEC stands by this view). A utility token is a token which can only be utilized on the 1 platform or network (where it is issued) and can’t be converted into fiat or electronic money.
It’s somehow similar to loyalty points and gift cards. Gift cards or loyalty points can only be used on a single platform or community and are often representative of a prepayment for services.
In discussing the gap between utility tokens and security tokens, SEC chairman Jay Clayton said: “A token that represents a participation interest in a book-of-the-month club” shouldn’t be a security token.
On the flip side, tokens in “a yet-to-be-built publishing house with the authors, books and distribution networks all to come” will probably be a security token since “prospective purchasers are being sold on the potential for tokens to increase in value — with the ability to lock in those increases by reselling the tokens on a secondary market — or to otherwise profit from the tokens based on the efforts of others.”
Summary
- Not, or less, regulated
- Aren’t investments
- Give Accessibility to a product/service
Security Tokens vs Utility Tokens: Why It Matters
Knowing the distinction between a utility token along with a security token is an essential aspect.
Whether you are holding tokens or are arranging a crowdsale, then you want to be aware of the difference.
To begin with, you do not wish to purchase something without understanding exactly what it is, and secondly, you have to understand what legislation the token should be compliant with pre-launch of a token crowdsale.
Prior to picking what coin to start your own ICO with, you will need to ask yourself a question: “Which are the requirements of my ICO?”. And make sure you don’t fall into these common traps:
Avoiding Security Tokens
Even if you intend to avoid regulations and call you token a utility token because that doesn’t make it a utility token. By calling a token a “utility” token or structuring it to supply a utility doesn’t stop the token out of being a safety.
In case a security token gets the features that your ICO needs, then pick a security. When there’s absolutely no demand for a security token, then do not make one unnecessarily.
Underutilizing Utility Tokens
Utility tokens are of numerous types and with different attributes and can cover the needs of an ICO. Utility tokens are dynamic. Many overlook their features, however, it is crucial that you do your homework before ignoring the choice completely. By exploring all the features, one can get a better understanding of the capabilities of a token, have a better chance to successfully launch their own token or invest in a profitable project.
Altcoins vs Tokens
The most important difference between altcoins and tokens lies within their construction. While altcoins are different currencies using their ow blockchain, tokens function within a blockchain that eases the introduction of decentralized software. Nearly all coins in (near to 80%) are tokens because they are much simpler to make.
Cryptocurrency vs Digital Tokens
Can you answer the question “What are the common for a dollar bill, the stocks of a company and a prepaid gift card?”
They don’t have a lot of things in common. Now let’s take this analogy to cryptocurrency (or virtual currency), security tokens and utility tokens. Again, they don’t have that many things in common.
But if you comply with that the world of digital translators from the media and popular media, you’d believe virtual currencies, security tokens, and utility tokens are very similar as they’re often simultaneously and discussed under the subject of “cryptocurrency.”
Many online publications and even investment guides use the term “cryptocurrency” to describe virtual currencies, security tokens, and utility tokens. But these three terms describe extremely different concepts, each of which can be subject to various legal frameworks and regulations.
While every one of the items is made on distributed ledgers using the blockchain technology, from both a legal and a practical standpoint, the similarity ends there. We should rethink using the term”cryptocurrency,” and instead use the phrases that are particular to the classes that have grown: virtual currency, security tokens, and utility tokens. Within our descriptions below we supply more details about the significance of each one of those classes.
Initial Coin Offerings (ICOs) and Digital Tokens
ICO is the abbreviation for Initial Coin Offering. This is similar to crowdfunding or IPO. The essence of this process is that cryptocurrency projects are inviting anyone to become an investor in their project. The majority of these crypto projects launch a new cryptocurrency.
Let us clarify the usage and term of “ICO”
ICO stands for First Coin Offering. The normal ICO denotes the offering of electronic tokens that are generally either safety tokens or utility tokens. Furthermore, an ICO is generally not the first offering of the issuer. While ICO rhymes with IPO and is still a tricky term, it shouldn’t be confused with the public offering of securities.
As the marketplace rises, the terminology used in the field of cryptocurrency will hopefully get a wider spread and be understood properly. The differences between the different kinds of tokens are important. By understand their purposes, we can better apply the laws on their sale, use and the way they are created.
By ‘participating’ in an ICO, an investor is actually funding the project developers with more famous cryptocurrency, such as Bitcoin or Ethereum. With these funds, the project owners will be able to develop the project, and the investors are holding the digital tokens similar to stocks.
If a trader holds an electronic token, he then owns those shares from the project.
Digital Tokens Plays Important role in ICO:
The importance of digital tokens is revealed when we started learning about the fundraising which many startups need and acquire through ICOs. The creation of a crypto token requires some particular features and need to fulfil a certain task, while registered on the blockchain. Nowadays, there are websites willing to help with any part of the creation of a blockchain project.
Cryptocurrencies can be hard to understand, particularly because of their inherent blockchain technologies, which it’s all about complex math calculations and terminology you haven’t heard before. But we have you covered. Here are some resources to help you get started in the crypto world:
- What is the blockchain technology?
- What is Bitcoin and how does Bitcoin work?
- The Beginner’s Guide to Cryptocurrency
- The best cryptocurrency exchanges in 2019 for beginners
The concept of Tokenization
Tokenless Blockchain
As in Tim Swanson’s excellent report on permissioned ledgers, there is the concept of tokenless blockchains. This might imply a blockchain or decentralized distributed ledger that lacks an intrinsic token (eg Ripple with no XRP), nevertheless, asset-backed tokens are most likely to still be utilized. ‘Tokenless’ doesn’t refer to the lack of the asset-backed token, but to the lack of intrinsic token.
We do not always require a token. Based on the blockchain system, you might or might not require an inherent token.
Generally, permissionless ledgers where anybody may add a block, want some type of incentivisation scheme for block validators to perform their job. But in distributed ledger systems in which you control both the validators and block-creators, they then might do their task for a number of motives (perhaps the task is part of a contract). , such as since they’re contractually bound to do so. There is a bit more about it here.
Dematerialization and Tokenising legal constructs
Presently there’s a great deal of buzz in the blockchain circles and all sorts of things are tied to a blockchain: stocks, gold, debt, businesses, IPOs, diamonds, artwork, decentralized organisations, wine, music, countries and so forth.
Sometimes the objective is to have the ability to transfer resources (or IOUs) fast and easily while maintaining the physical thing secure (in a warehouse).
Other times, it is to get a digital token whose electronic possession matches the physical travel thing. For instance, once I offer you an actual diamond, I send you the electronic diamond-token, so you can control it now, and thus that the blockchain recordings the provenance of this diamond, such as a supercharged certificate-of-origin that contains a complete listing of possession.
Seeing legal constructs, notably stocks and companies, I think there’s a gap between monitoring claims to inherent objects onto a ledger, and really lawfully dematerialising the thing.
Dematerialising
Dematerialising something is the process in which we replace a material item with an electronic one. For instance, paper share certificates have mostly been replaced by possession entries in databases. Some paper contracts are replaced with pdf documents.
Even though you’re able to declare “this digital token represents a share of a company”, and you’ll be able to send this to somebody else, this does not have any legal position. The token is not the share, even in the event that you possess the share in actual life, and you issue the token on the rear of it. The token is something beyond the law that you’ve created.
Sure, since the owner of stocks, you might devote to others that should they own that token, you then are going to pass the privileges (such as if you have this token, I’ll pass any dividends I purchase (from actually possessing the shares ) to you.
But if the shares are registered on your name in the shares registry, the authentic and legal shares registry, not the blockchain ledger that you’re using to monitor the electronic token you’ve created, then you own them.
That is why it’s untruthful when people say they’re generating *insert legal construct here* on the/a/some blockchain. They are not, It’s just as someone would create a business by writing “I create a business with 100 stocks” on a napkin, without doing all of the actual work of lawful firm creation and registering the business to a national authority of the country he lives in.
Sure, even if the legislation changed and a particular blockchain becomes part of the system or has been deemed equal to the country’s register of organizations, then yes, on this statutory blockchain, you might create a business. This is something all blockchain enthusiasts are looking forward to seeing: how legislation will gradually adapt to the blockchain technology.
Crypto Resources To Get You Started
If you are beginning your journey into the world of cryptocurrencies, then here is a list of useful guides and resources which can get you started: