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Re-Classifying Blockchain Tokens for Simplicity

I’ve already written on Tokenomics and related token classifications in this June 2017 article that quickly became a reference point throughout the industry, Tokenomics – A Business Guide to Token Usage, Utility and Value.

In light of the evolution of the blockchain market, I hope we can re-classify tokens in a way that is simpler, and takes into account the recent developments in what has been commonly labelled as “security tokens”.

For background, let’s define a cryptographically-enabled token as a cryptocurrency with a purpose. No matter what its purpose is, the token has the same properties as cryptocurrency. It can be exchanged and its ownership can be transferred on a blockchain, from one peer to another, without the involvement of a central party. The token holder or owner can be a person, an organization, or an autonomous computer program, also referred to as a smart contract.

I’m a big fan of simplicity. With that mind, I think we should settle on the following simple classification for tokens.

Utility Tokens

They include all types of work-related tokens (passive or active; by computers or humans), i.e. ones where there is an earning and spending equivalent to some valuable activity. It also includes the payment function in cases where that’s all what the token does. My previous article on Tokenomics provides a good depth of coverage on the utilitarian aspect of tokens, except for the “earnings” role which could be interpreted as an asset token that yields a dividend.

Asset Tokens

This is where the commonly named “security tokens” fall. I’m not a big fan of the term “security tokens” because it is a legal classification, and doesn’t say much about the inherent functionality that is represented by such tokens. Plus, for some tokens, it has been an escape route from the SEC’s grips for seeing everything as a security token. In the asset token case, the owner of the token is certainly a human or organization, and the token represents an ownership of sorts in something that is valuable at the time of the transaction. In most cases, the token represents something that already exists in the real world, eg. a physical property, or a share in a company. What the blockchain adds is a new form of liquidity and ownership exchange, mostly centered on efficiency of transfer.

Crypto Property

CryptoKitties are the best example of this new class of digital property that is non-fungible, unlike the previous two above which are fungible. You don’t need a particular token to represent this new form of asset, but you might need one if the creator decides to associate one with it. For example, a given crypto property might be worth 2 ETH or 1 NEWTOKEN if NEWTOKEN is the currency of choice for this specific asset. This NEWTOKEN is different from an Asset Token because it represents an asset that is stored on a blockchain the minute it is born or created. A crypto property has no physical or digital equivalent without a blockchain. It is not something you can take out of a drawer or pull out of your pocket. It is new and therefore native to blockchains.

This isn’t a regulatory framework, nor was I discussing the legal implications for complying with the issuance and operations of these types of tokens. That is beyond the scope of this post.

However, I’d like to emphasize that the Utility Token and Crypto Property aspects are the most innovative concepts that are newest to us. Therefore, we should continue to question whether existing security laws should be squarely applied to them without an updating of sorts.

When technology and markets evolve, regulators need to figure out when to rigidly enforce adoption of old rules, and when to evolve themselves, especially if existing regulation hasn’t been updated for decades. Otherwise, regulation could stand in the way of continued innovation, wealth creation, talent development, and industry growth.]]>

Utility vs. Security Tokens: Why Not Both?

I’m seeing increased activity in the “token airdrop” model, and this topic deserves some thoughts.

In the most primitive scenario, companies declare that a certain percentage of their tokens are designated for users, and they send them randomly to wallet addresses with the hope that these wallet recipients become actual users.

The problem with these early scenarios is that most often the network is not ready, so there is no real token utility, in essence defeating (or considerably delaying) the purpose and effect of that air drop. Furthermore, these users weren’t pre-qualified as real potential users, so there is no market awareness about the products behind these companies. As a result, token usage remains a mirage. In this scenario, users are buying into a lotto, because a large number of token-based companies will not make it, compared to the ones that will be lucky enough to enjoy market value appreciation that is commensurate (to a degree) with actual token utility.

In some of these cases, the airdrops are part of a previous token offering, but a more recent scenario that appears to be popular with the EOS ecosystem is to just issue air dropped tokens (e.g. 20% of total distribution), keep a significant percentage as reserves (60-80%), wait until the token starts trading upwards (assuming there is some speculative hype or real usage that drive it), then start selling your reserve tokens into the public markets to fill your treasury. In essence, it’s like getting the effects of an ICO without raising money from anyone, and flying under the suspicious radars of regulators. This, in my opinion is a current loophole in the regulatory ICO landscape that may or may not last.

Moving to more advanced scenarios (Air Drop 2.0), token-generating projects are purposely introducing a delay in token issuance, and labeling their ICO as a “Usage Token Purchase”. In this case, users buy into the token, just as they would in a normal ICO, but they are required to take specific product actions with a determined number of their purchased tokens, in order to “unlock” their token ownership and resulting liquidity. If they don’t use them, they risk losing them. This form of token activity could range from end-user activity to a form of computational staking into the network itself.

Air Drop 2.0 is interesting, but that may not be enough. One of the primary reasons is that if the delays introduced are short, (e.g. 45 days), once these tokens are public, then we’re back to the scenario where the speculators can still overwhelm the market way ahead of full and sustainable token utility because the delay period may not give enough time to generate sufficient token usage at the network effect level.

As Mike Maples Jr. says in his post, Slow Money Crypto, Liquidity can be more of a “bug” than a “feature.”, to which I would add that “premature liquidity” as being the issue.

In the absence of real traction metrics, the current token-based appreciation model of happenstance gains of 10-30x over a period of a few months is not sustainable. Luck is not a business model. I don’t mind seeing 10x or even 100x on investments over a longer period of time. Many ICOs have already given 20x on their initial token prices, and they can still fail.

When there is profit to be taken, investors will take it. Most institutional ICO investors are momentum chasers who need to make their next trade as soon as it yields a profit they can register.

We need to disconnect user behavior/usage from speculative investor behaviors, but introducing a short delay between these two periods may not be enough.

Reality is,- token holders never become instant users, although the white papers expectations assume they would. You need to give time for user acquisition to play out, just like any other user acquisition unravels without a token. The token is not a carrot. In the best of cases, it is an organic incentive that is properly engineered into the product to enable a native and natural user behavior that cannot be gamed, although it might be gamified. I’ve already written about the dilemma of Token Users vs. Token Traders.

So, what if we had hybrid tokens, where one is a distinct usage token, and the other a speculative one?

What if there was a new scenario with two different classes of tokens where the company sells a “security token” to investors (and they will need to hold it for real), and sell (or give) a utility token to real users. Under this scenario, there would be a delay of at least a year to allow not just the network to be open, but for it to start proving its utility with at least some real usage. Or, the company could choose to not even issue the security token until much later, at a time of its own choosing.

In the above scenario, investors would be required to hold their tokens much longer.

What remains to be worked on is the interaction and relationships between the speculative token and the work token, both from a technical and legal perspective.

I’m watching some companies that are trying to figure this out, and planning to have 2 types of tokens, and not by using stable coins.

Air drops are a very interesting model, and I expect they will evolve into something real, if properly executed. I also see having different classes of tokens for the same project as a real path forward that could smoothly bridge the token utility aspect into its security characteristics.


Two Videos and a Podcast on Blockchains, Tokens and Decentralization

Tokens Usage. “The most important token is the one being actually used”. I’ve been saying that for the past few months, and recently 2 important stats came out to vindicate this claim: 53% of Ethereum transaction types are related to smart contracts, and Crypto Kitties has already done 2.8M transactions in the past 6 months. I’d like to see more such usage related metrics. 2) Tokens Classification. The regulatory environment (especially in the US) is casting a shadow on the future of token-based models. Currently, entrepreneurs and their lawyers are leading the way in classifying tokens as they see fit, but the jury is still out as to bona fide realities. The default trend today is that every token is a security, but I’m not sure this trend will remain that way. Here they are… Oslo Blockchain Day Edcon 2018, Toronto Podcast with Georgian Partners And here’s where the YouTube channel with some of my other videos.]]>

State of the Token Market (with PDF)

StateofTokenI’m sharing the following pdf’ed powerpoint presentation, depicting where I see the status of the token market today. I have been delivering a version of this presentation in the past 3-4 months at various keynotes across North America and Europe. This version  is updated and more comprehensive than what I ever presented publicly. It is further augmented by the following analysis points: It is worthy to note that the regulatory landscape is divided roughly into 3 buckets: 1) alternative jurisdictions who are innovating and seeing this activity as a market share opportunity, 2) traditional Western regulators who are trying to apply (or interpret) existing regulation to what they see, in essence exacerbating the proverbial attempt of fitting a square peg into a round hole, 3) the “rest” of the world who is doing little to nothing, while observing others, and eventually planning to follow. Entrepreneurs are still attempting to use the token as a fund raising mechanism, with a varying spectrum of strength on actual Token models, and even less attempts at real governance and accountability towards investors or the market. I see continued lukewarm innovation in the middleware sector of blockchain technology. We need more standards, because standards increase adoption, and we need more integrated tools and development frameworks, because they spur activity in applications development. Two potential blockchain usage models are emerging with some initial promising  tractions: a) the token as a participation incentive for adding value to the network (I’ve described this here and here), b) the native digital asset as a free-moving instrument that can be traded on the blockchain or made part of a new interaction experience (eg CryptoKitties-like assets and others, including the nascent form of digital art). Classification of tokens will continue to be a slippery slope. Attempts to intelligently classify them is challenging, because their role is evolving like a moving target: a given token’s usage lifecycle will take many forms of evolution, as most tokens espouse multi-functional properties. Assigning a deterministic label on a token might be a futile exercise. Tokens as an in-market payment instrument is the most un-imaginative model out there. Sure you can take any existing business, slap a token to pay for this and that, and claim a token-based model. But that’s not nearly enough innovation to move the needle on value creation and attracting new users. Projects based on the token-as-payment model are dead-on-arrival, and will fail in my opinion…unless there’s a lot more to the token than being another currency. DApp Apps are emerging as the mobile cousins of a Metamask-enabled browser. Early DApp browsers such as Toshi, Cipher (acquired by Toshi) and Trust Wallet are still in their early 1.0 manifestation, and mostly aggregate access to other DApps more than innovate over new ground. Going forward, their future might be uncertain as standalone native DApp Apps will also become popular, perhaps not requiring crutch support from these DApp browsers. In this category, I foresee OpenBazaar and CryptoKitties to lead the way in showing us what a real standalone Peer to Peer Mobile DApp can do. [disclosure: I’m an investor in both companies and a Board member at OpenBazaar] There is a continued disconnect between cryptocurrencies value and valuations (ref: The Other Flippening: Token Users vs. Token Traders). Despite many attempts to quantity the metrics behind cryptocurrency valuations, the markets have not yet assimilated any form of analysis rationales behind the trading patterns. Most cryptocurrencies go up or down together, with little regard to differentiation between the better vs. more questionable ones. Stablecoins continue to fascinate more than deliver or assert themselves as a long term answer to isolating users from the vagaeries of external market volatility. Finally, a word about “the crash“. A real crash could only happen when investors suffer real losses and incur pains that cause them to massively exit the playground. Currently, there is sufficient built-in performance gains that have accrued to early investors such that prospective losses are only time-relative, but not absolute.


13 Questions for the Blockchain as We Enter 2018

“The wise man doesn’t give the right answers, he poses the right questions.” — Claude Levi-Strauss

As we enter 2018, here are some questions on my mind, relating to the state of blockchain and where we may be going.question-questions_answers_5

I like asking questions, and have followed that format last year in my CoinDesk end-of-year article titled “Blockchain in 2017: Do We Know What We Don’t Know?” These questions are still relevant a year later, as many of them were strategic, so I encourage you to re-read it.

Today, there are newer questions I have been asking during some recent talks I gave, such as at my opening remarks at the Token Summit II in San Francisco on December 5th 2017, in this video:

1. What makes a “Good” Token?

At the heart of this question is the specific token functionality that is being concocted or delivered. I have written at length about it in Tokenomics, stressing the importance of the token role in a given project, protocol or application. Beyond having figured that out, what makes a good token is undoubtedly the team behind it, because they need to execute, iterate and deliver.

2. Will the success rate of ICOs be better or worse than tech startups?

Worse than startups. Why? Because most ICOs aren’t being surrounded by the right advisors and mentors. Yes, ICOs have lowered the fund raising bar, but they have also raised the ensuing success risks. Many ICO projects include first-time entrepreneurs who are freewheeling on their own, zigzagging their way into uncertainty. There is no escaping typical startup evolution laws and dynamics, even if the blockchain project is open source, decentralized and includes smart contract autonomy. The flip side is that, having lots of money allows an ICO project to stay alive longer, giving the illusion of progress, but that’s not a measure of success necessarily.

3. Are open source, decentralized protocols going to be more significant than their web equivalent?

The fat protocols theory has plenty of believers and critics (here and here). Regardless of the nature of this debate, there are real blockchain protocols that are emerging. Some are horizontal and general-purpose (eg. IPFS for file sharing across any applications), while others are vertical or industry specific (eg. Etherisc for insurance, or OpenBazaar for P2P commerce). With the Web and Internet, the suite of common protocols included: TCP/IP, HTTP, HTML, DNS, FTP, IMAP, and SMTP, to just name a few of the more popular ones. With the blockchain, we are still waiting to clearly see which major new protocols will emerge and sweep armies of developers with them.

4. Will decentralization deliver?

Decentralization has several dimensions: political, philosophical and technical. Some blockchain purists would like to immediately decentralize everything, but the reality is that decentralization will be achieved step by step. It is not a sudden state that you just turn on just because there is an underlying blockchain somewhere.

5. Will there be a crash?

If you have been following the crazy volatility underlying the price of cryptocurrency, you wouldn’t be asking this question. Truth is,- there have been many crashes along the way. Market caps are routinely swinging 40% up or down on a given week, and that’s enough variation to crush anyone who is on the wrong side of the trend. A better question might be: when will we see the “Big Crash” (with a capital C), the one that will be the equivalent of a hurricane or tsunami in terms of proportion and damage incurred. In my opinion, we still need to see much higher total market caps that are even more vertiginous and sky-reaching, probably in the $1.5-2 Trillion range before a spectacular Crash would likely occur.

6. Will countries or central banks create their own cryptocurrency?

A few countries and central banks have been talking about “digital currency”, and most of them are carefully ignoring the term “crypto”. Fact is- digital currency is not the same as cryptocurrency. These countries/central banks are recognizing the benefits of the digital currency features of cryptocurrency, but they don’t want any of the decentralized uncertainties that come with blockchain-based currencies. That said, I believe we might witness two phases of evolution. First, we will see an initial rolling of some “national digital currencies”, inspired by cryptocurrency. Then, there will be a second phase with more daring implementations that are closer to the true decentralized ethos of cryptocurrency, once we gain more experience in learning about crypto-economic monetary policy mechanics. Likely, these experiments will emerge in countries that don’t have stable currencies, as this allows them to leapfrog into the world of cryptocurrency, just as many underdeveloped countries leapfrogged into cellular networks and didn’t build better landlines.

7. Is Crypto Valley ahead of Silicon Valley?

The area around the small town of Zug in Switzerland is commonly referred as Crypto Valley, due to its local government openness to, and acceptance of blockchain-related jurisdictional peculiarities. The Ethereum Foundation is credited with having swung the door open for Zug’s emergence as a “crypto valley”. Since then, the canton of Zug has seen rapid development of a healthy ecosystem related to everything crypto, from technology startups, developers, legal services, accelerators, experts, and financial resources. It is worthy to note that the Zug phenomenon has spilled into neighboring Zurich, given the 23 minute-train ride proximity to the financial capital of Switzerland.

8. What will the SEC do?

When it comes to cryptocurrency related regulation, the SEC is the big elephant in the room that everyone is watching. Their actions (or inactions) have a direct effect on the mood and environment pertaining to cryptocurrencies, especially since ICOs have been so popular in 2017. So far, their actions have been of a punitive nature, having picked on a handful of clear scam cases, in addition to a steady dose of cautionary warnings. However, it is possible that the SEC might start to provide more specificity pertaining to some form of regulatory compliance around token generation events. My bet is that they will be asking for some transparency and reporting requirements, somewhat similar to what currently exists on the securities side.

9. Will Wall Street adopt the blockchain?

Here lies the dichotomy. The blockchain is an alternative financial system that challenges the de-facto traditional financial system. Yet, the traditional financial sector is poised to gradually embrace and adopt blockchain technology in a variety of levels. Although Wall Street will not shoot itself in the head by obsoleting itself, it will shoot itself in the foot by taking baby steps towards implementing blockchain technology as part of its partial infrastructure, then gradually will introduce new products that are solely focused on the blockchain.

10. What will be the effect of new crypto funds entering the space?

To-date, more than 170 funds totalling $2.5B have been announced in this space, including from newcomers, traditional VCs and Wall Street veterans. I have joked that, soon we will have more funds than tokens. Most of these funds will start to deploy their capital in 2018, fueling more frenzy indiscriminately on immature blockchain models and technologies. On the positive side, this will continue to fund innovation. On the other hand, this could have a precipitating effect on eventually inflating valuations even further, getting us closer to a big Crash tipping point.

11. Is every asset destined to become liquid on the blockchain?

Without a doubt. From native assets (e.g. CryptoKitties), to new financial instruments, to non-native assets that can have a blockchain representation (e.g. via fractional ownerships), the liquidity of assets is going to get a boost. 2018 may well be the year where we see billions of non-currency assets begin to trade on blockchain networks.

12. When will we see more blockchain standards?

In the technology world, standards have a magical effect on user adoption. We need more blockchain standards of the middleware kind (read: The Blockchain is Still Waiting for its Web, Here is a Blueprint for Getting us There), because they lower the difficulty bar for common developers who want to interact with blockchains without worrying about the vagaries of its infrastructure. Look at the effect of the ERC-20 standard on the proliferation of tokens issuance, and the emerging ERC-721 non-fungible token standard’s impact on the development of native assets, and these are only the tip of the iceberg.

13. Do we fully understand the economic models behind tokens?

The alphabet soup on metrics, analytics and quantitative assumptions is growing: stablecoins, monetary policy, inflation rate, tokens supply, velocity of assets, asset base, transactions volume, etc…to name a few. But do we really know how to model the theory of blockchain economies based on the relationship between these variables? Does each cryptocurrency issuer need to become like a Federal Reserve Chairman, who is constantly tweaking the various economic knobs and dials? What experience can we point to, so we can decisively say “this is the theory”, or “these are the best practices”? Our field of knowledge is definitely embryonic at this point.

There you have it. Of course, there was clarity in some answers and uncertainty in others.

Let 2018 usher a new chapter in the evolution of the blockchain. It is only pushing the limits of its implementation that we will discover its real potential.


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