Introduction to Digital Tokens

Digital tokens have become a hot topic lately, and the first exciting cryptocurrency was Bitcoin. So what are they? How do you digitize a token? Why is it important?

When I hear the word ‘token’ I think of casino chips, or something we can exchange for beer in a certain market.

We’ll explore the original purpose of ‘digital tokens’ and then take a look at the world of cryptocurrency tokens, distinguishing between blockchain-native tokens (such as Bitcoin’s BTC), and asset-backed tokens (such as Ripple’s IOUs).

The beginning of digital tokens

When you enter an email address when joining a website mailing list, it will usually ask you to check your email, and then you will be asked to click a link. It will look something like this:

https://www.website.com/confirm_email?token=4bdebebc-135b-4748-b7ab-25b31a285df8

In this case, this "token" is the string it sends you. It's unique, and when you click on it, it tells the server, "Yes, this guy verified the email, and this email account is definitely his."

So the website sends you a token, and you send it back, proving that you control that email address.

However, ‘token’ in the cryptocurrency world is used in a completely different way, let’s explore it below.

Cryptocurrency Tokens

Unlike what we have seen above, cryptocurrency tokens do not exist as strings of characters (if they did, they could be easily copied), conceptually, they are a record on a ledger (the blockchain). You own these 'tokens' just like you own a key that allows you to create a new entry on the ledger and redistribute ownership to someone else. You do not store these tokens on your computer, you store these keys, which allow you to redistribute the number.

I prefer to think of these 'tokens' as specific amounts of digital resources that you control, which you can redistribute to others.

We will introduce two types of tokens:

1. “Built-in” or “native” blockchain tokens

2. An "asset-backed token" issued by one party on the blockchain for later redemption.

1. Built-in tokens <br />Built-in tokens are fictitious resources that have certain utility.

Some of the more famous built-in tokens are:

1. BTC of the Bitcoin blockchain

2. XRP (Ripple) of the Ripple network

3. NXT (Future Coin) on the NXT platform

4. Ethereum’s ETH

For more information, please refer to: coinmarketcap.com

These 'tokens' are the real heart of the blockchain, without them, the blockchain cannot function. They are usually part of an incentive scheme to encourage people to help the system verify transactions and create blocks. Or as in the case of Ripple, each transaction costs a little token, which helps prevent spam transactions from happening.

How are these built-in tokens generated?

Since these tokens are not backed by anything, they can be generated by software, which is as easy as writing on a piece of paper "I want to create 1 billion toy coins". In fact, if you do this, and you and your friends can keep a good record, you can also record the transaction records between your friends and their friends, then the toy coins you create are the same as these digital ledgers.

For the example above:

In Bitcoin, BTC is calculated by miners through tedious calculations according to a schedule. Newly created tokens are randomly assigned to block makers. Over time, the total amount of Bitcoin produced will increase (but there will be an upper limit of 21 million).

In the case of Ripple, the token XRP was initially pre-mined and distributed to major participants (several founders). Each transaction consumes a small amount of XRP, which will be destroyed over time instead of being redistributed to transaction verification. The total number of XRP in circulation will decrease over time.

In the case of NXT, NXT is 100% pre-mined. Every transaction on the NXT network will have NXT fees. These fees go to the block makers (called "forgers" instead of "miners" in NXT). The total amount of NXT remains constant over time.

In the case of Ethereum, ETH ('Ether') is partially pre-mined. Transactions and smart contracts require ETH to create and run, and ETH is used as a reward for block makers. Block makers (miners) can also receive block rewards (mining).

Purpose . The main purposes of the built-in tokens appear to be:

1. Block verification rewards (“miner rewards”)

2. Prevent spam (if all transactions consume some tokens, it will limit spam)

While these tokens have extrinsic value (you can buy and sell them on exchanges, and exchange them for other cryptocurrencies or fiat currencies), they still don’t represent anything.

2. Asset-backed tokens

Asset-backed tokens are certificates of rights to an underlying asset issued by a specific issuer.

The history of money on Wikipedia shows that asset-backed tokens have actually existed for a long time. You can put some gold in a gold dealer and then get a receipt or an "I Owe You" (IOU) note. This note can be used for trading, and anyone can take these notes to the gold dealer to get back the corresponding amount of gold.

Asset-backed tokens are digital equivalents. They are certificates of rights to an underlying asset (similar to gold). Transactions between tokens are recorded on the blockchain. If you want the underlying asset back, you send these asset-backed tokens to the issuer, and the issuer will return the underlying asset to you.

Popular underlying assets include fiat currencies (US dollars, euros, etc.) and precious metals (gold and silver), but if you pay attention to the news, you will find that people are beginning to record various assets on the ledger by creating digital tokens, including diamonds, artworks, music...

How do asset-backed tokens work?

For example, Coins-R-Us, a fictional Bitcoin exchange, issued digital tokens backed by the euro.

You can log into your online bank and send Coins-R-Us money, through normal Euro banking, to the Coins-R-Us bank account for 100 Euros. When they log in and see the money, they then give you 100 digital asset collateral tokens, called Coins-R-Us Euros.

The creation of these tokens is recorded on the blockchain (it could be colored coins on the Bitcoin blockchain, assets on the Ripple or NXT networks, or smart contracts on Ethereum). You can send these tokens to your friends (in exchange for something or as a gift), and then these tokens will continue to be tracked on the same blockchain.

One day, a friend wants to exchange this asset-collateralized token for something real, and then she needs to go back to the Coins-R-Us exchange, create an account, tell the exchange her bank account, and then send the Coins-R-Us euros to the exchange. Finally, the exchange will transfer the euros to her bank account.

“Token-less” blockchain

In some discussions, including Tim Swanson's excellent presentation on permissioned ledgers, the concept of tokenless blockchains has been mentioned. I think what this means is that blockchains or distributed ledgers will lack a built-in token (e.g. Ripple without XRP), however, asset-backed tokens can still be used. This "tokenless" also means no built-in token, not asset-backed tokens.

You don’t always need a token, depending on how your blockchain system is set up, you may or may not need a built-in token.

In a normal, permissionless ledger, where anyone can add a block, it requires some sort of incentive scheme to get block validators to do their job. However, in a distributed ledger system, you control these validators and block makers, so they may do their job for different reasons, such as they are obligated to do so by agreement. More on this here.

Dematerializing and tokenizing legal contracts

Currently, the media has reported extensively on blockchain, saying that all kinds of things can be placed on the blockchain: stocks, bonds, gold, companies, listings, diamonds, art, distributed organizations, red wine, music, countries, etc.

Sometimes the goal is to be able to transfer assets (or the equivalent of an IOU) quickly and easily while keeping the physical object safely in a warehouse.

Other times, it’s about having a digital token that matches the digital ownership of a physical world object. For example, if I sell you a physical diamond, I can send you a digital diamond token that I control, and you control it. The blockchain records the origin of the diamond, the complete ownership record, and so on.

As for legal structures, especially companies and stocks, I think it's not just a question of general ledger, it also involves the issue of dematerialized law.

Dematerializing something means replacing something physical with a digital token. For example, paper stock certificates have mostly been replaced by database ownership registries. Some paper contracts have also been replaced with PDF files.

Although you can declare that "this digital token represents a company's stock" and you can send them to others, it has no legal effect. Even if you own these stocks in real life and then use the stocks to endorse these tokens, these tokens are not actually stocks. These tokens are actually something invented by you outside the law.

Of course, as a shareholder, you can transfer certain privileges to someone who holds a token issued by you, e.g. if you own this token, I will give you the dividends I get (real shares).

However, you own those shares because your name is on the share registry (the actual legal share registry), not because you created the blockchain ledger that tracks the tokens.

So, this is why I cringe when I hear people say they are creating *subtle legal structures* on the blockchain. They don’t, it’s like I can create a company by writing on a napkin “I will create a 100-share company”, but I haven’t gone to the industry and commerce bureau to do the relevant legal registration.

Of course, if the law is amended to stipulate that a specific blockchain can be, or is equivalent to an agency like the Industry and Commerce Bureau, then, ok, on this legal blockchain, you can create a company. If the law eventually accepts this technology, I think it will be a very interesting thing.