Why tokens matter, and how to clarify the path to tokenization

Why tokens matter, and how to clarify the path to tokenization

Organizations have several options for choosing the type of crypto token. The token economy they choose affects the probability of success for the organization. Tokens are the fuel of a decentralized economy.

The use of tokens, and technologies such as blockchain, can significantly reduce the cost of safe and reliable token exchange. The potential for tokenization to disrupt existing interactions is huge, offering more effective solutions for existing paradigms (for example, crowdfunding, fractional ownership), as well as opening up completely new models of financing and cooperation. One of the most striking examples of the use of tokens is financing. Although crowdfunding has helped democratize funding, too often worthwhile businesses are left without funding. Tokens can potentially reduce the gap between organizations that need funding and investors who have available funds.

General understanding

Tokenization, tokenomics and token development are new concepts that are difficult for many to understand. Moreover, these terms are often used differently in different contexts. What do these concepts mean and how can the ecosystem benefit from this? Without a common understanding among all stakeholders involved in the ecosystem, it becomes difficult to allow people from different disciplines to collaborate effectively and build a tokenized ecosystem.

A common understanding is relevant not only for the creation of tokenized ecosystems, but also will allow regulators and policy makers to correctly solve regulatory problems. Thus, it will contribute to a healthy public discussion of tokenization.

A common understanding consists of precise terminology and taxonomy, international standards, useful metaphors that can be shared with a wider audience, and a clear legal and regulatory framework. Since the field of tokenization is very lively, constant coordination, training and interaction between all stakeholders is important.

The terminology is defined as follows:

Tokens: digital representation of the value (for example, an asset) in the blockchain.

Tokenization: the process of converting a value (for example, an asset) into its digital representative.

Tokenomics: The study of the emerging field of design of crypto-tokens and related digital assets using economic incentives, game theory, cryptography and computer science.

Token development: The practice of using tokens as a basis for designing value streams and, ultimately, economic systems.

Targeted tokenization: Using the exchange of values to control the behavior of the ecosystem to achieve a specific goal.

3 types of tokens

Although according to Coinmarketrate.com there are more than 7000 different tokens, there are three types of tokens: currency tokens, service tokens and security tokens.

Currency tokens

Currency tokens are the most well-known tokens simply because the first crypto token, Bitcoin, is a currency token. The value of the token is determined by supply and demand. Unlike paper money, which is backed by gold, currency tokens are supported only by demand and trust in the market.

Therefore, the new currency token faces a chicken-and-egg problem: in order for a currency token to be used by a large number of people, a currency token must have a value and high liquidity. However, to have high liquidity and value, there must be a lot of users. Therefore, Bitcoin and Ethereum took a long time for them to grow in price.

The more currency tokens there are, the more difficult it will be to overcome this problem. As a result, there will be only a few tokens with a dominant currency in the future. In this regard, it is likely that in the future, currency tokens will be mainly state-created tokens (CBDC), such as the now existing digital yuan of China.

Service tokens

The second type of token is a service token. This is a token supported by some kind of digital asset. This is a token that has a use case, and it was not developed as an investment. Most modern blockchain startups strive to develop their own token as a service token. Although these tokens are not intended for investment, they can still increase in price if the demand for the associated platform or service increases.

Thus, a service token offers future access to a product or service, and it is best compared to a gift card or bonus points. An example of a service token is ETH, which is used in the Ethereum blockchain and allows you to launch smart contracts and transactions.

Security Tokens

A security token is a token that allows its owner to receive a (future) share in a company or other asset, such as a painting, car or building, whether in the form of dividends, a share of income or a price. It is an investment contract and, therefore, attracts the attention of regulators.

In November 2018, the US Securities and Exchange Commission (SEC) shocked the crypto community by announcing that it had accused two blockchain startups of illegal sales of digital tokens. Two companies, Airfox and Paragon, did not commit fraud, they simply did not register their tokens with the SEC (as was the case with the vast majority of token sales in 2015-2018). According to the SEC, most tokens can be considered securities and, therefore, are subject to regulation. And the epic with Ripple continues to this day.

Security tokens provide the buyer with certain rights and obligations.

Most crypto startups tend not to deal with a security token, as this requires additional verification by regulators. However, most startups sell their tokens before they have a product. These tokens can be considered as an investment contract, which can be replaced with a service token in the future.

Tokens are the fuel of tomorrow’s economy

Tokens are the fuel for a decentralized economy. Without tokens, decentralized organizations cannot launch their platforms and offer their services and products. They will become an important characteristic of the organization of tomorrow. However, it is vital that the token has a sense of existence, otherwise it can be perceived as a fraud. Only when there is a real option for using the token, and it complies with the existing rules and laws of the token economy, it will have a real chance of success.

However, in many countries, the regulation of tokens is still a problem. Different rules are currently being developed in many countries. The problem is that tokens do not adhere to borders, and, therefore, the world will benefit from global, and not regional (for example, European) rules for the use of tokens. This is confirmed by the European Central Bank, stating that:

“Disparate regulatory initiatives at the national level can cause regulatory arbitration and, ultimately, hinder the stability of the financial system to shocks in the crypto-asset market.”

Currently, we see that in small countries there are favorable rules for attracting crypto startups, while in large countries there are stricter rules, which makes it difficult to attract token startups. Some of the different rules for using tokens in the world include:

France: crypto companies must voluntarily comply with existing rules in order to obtain a business permit.

Germany: very strict regulation, requiring startups to obtain a banking license from the German regulator (BaFin).

Switzerland: cryptocurrency is not considered as money, but some category of tokens is considered as securities, but requires a license.

Estonia: Clear regulation of cryptocurrencies, cryptocurrency exchanges and custodial wallet service providers for AML/CFT purposes, through the adoption of AMLD into national legislation.

Malta: clear regulation, service tokens do not require a license. Although it seems that Malta is losing the title of the cryptocurrency capital.

Singapore: Cryptocurrency is not regulated in Singapore, however, the activities associated with it, or its characteristics arising from its activities, determine whether it will be regulated as securities or other legislation.

Liechtenstein: This tiny country recently adopted a blockchain law, which consists of very clear token rules. Within these rules, tokenization means that any right or asset can be “packaged” into a token according to the token model. This offers clear guidelines for companies.

Last thoughts

Tokens are programmable, and they offer new opportunities for companies to be more flexible in terms of ownership, voting rights, dividends and financing. This will greatly affect the essence of the legal entity, and will have a strong impact on liquidity in the global economy. However, clear regulation is required, and since tokens do not adhere to borders, countries, or even entire regions, can attract a lot of investments and companies with favorable rules.

Favorable-does not necessarily mean turning into a tax haven. This means having clear and easy-to-understand / follow rules, as well as having a token-friendly environment. An example of this would be that it means that it is easy to open a bank account as a crypto company.

There is still a very long way to go, simply because regulation takes time. However, regulators should also see that cryptocurrencies are not going anywhere, and tokenomics will radically change the global economy.