The emergence of blockchain technology and cryptoassets like Bitcoin has given rise to a new form of digital asset known as tokens. Tokens represent programmable assets that can enable new economic models and incentivize network effects. In this article, we’ll explore what exactly tokens are, the different types of token models, and how tokens are being used to build new tokenized economies.
What are Tokens?
Tokens are digital assets that are programmable and can represent anything from financial assets to identity or access rights. Tokens differ from cryptocurrencies like Bitcoin and Ethereum because they are created on top of an existing blockchain protocol like Ethereum, rather than having their own standalone blockchain.
Some key characteristics of tokens include:
- Programmable: Tokens have embedded logic and rules that dictate their behavior. This allows for more complex functionality than simple cryptocurrencies.
- Flexible: Tokens can represent assets like fiat money, commodities, securities, reputation, rewards points, votes etc.
- Tradeable: Tokens are designed to be freely traded on exchanges just like any other cryptocurrency.
- Fractional: Tokens can divide into smaller sub-units, enabling fractional ownership.
- Fungible: Each token unit is interchangeable with other tokens of the same type.
There are several different token models that are being used to build new crypto-economic systems:
Utility tokens represent future access to a product or service. They are similar to API keys and grant holders the right to access the network and use its functionalities. Examples include Filecoin, which will allow holders to access decentralized file storage, or Golem, which will let users access distributed computing resources.
The value of utility tokens comes from speculative demand around the success of the network. If the network grows popular, demand for its utility tokens will rise. This incentivizes early adopters to invest in the tokens and evangelize the network.
Work tokens represent computational resources spent to perform tasks that support a network. For example, in Golem’s decentralized computing network, providers stake Golem Network Tokens (GNT) to get chosen to complete computing tasks for requestors. The more GNT staked, the greater the chance of being selected for jobs.
Work tokens align incentives between providers and the network by rewarding useful work that contributes resources. This is an effective tokenized model for building out distributed networks powered by crowd-sourcing.
Governance tokens allow holders to vote on decisions for protocols and DAOs (decentralized autonomous organizations). By locking up governance tokens in a smart contract, voters can participate in decision making and collectively determine things like development direction, resource allocation, and protocol changes.
For example, MakerDAO’s MKR token allows holders to vote on risk management and other parameters for the stablecoin protocol. Governance tokens better align incentives around managing common resources and driving long-term value.
Financial Return Tokens
Financial return tokens entitle holders to financial rewards like dividends, revenue shares, staking rewards, and more. For example, the KNC token for Kyber Network allows holders to receive a cut of the network’s trading fees as a reward for maintaining liquidity.
Financial return tokens incentivize investors to lock up assets long-term and support the growth of the network by sharing in the success. New projects can bootstrap networks by rewarding early believers.
Some tokens use hybrid models that incorporate utility, governance, financial rewards to create a circular, synergistic token economy. For example, staking tokens allows holders to earn staking rewards (financial return) while securing the network with greater decentralization (utility).
Compound merges utility, governance and revenue share models. Lenders and borrowers access money markets via the COMP utility token while earning governance rights to steer development. Interest payments are channeled back into the community via COMP token rewards.
Non-Fungible Tokens (NFTs)
Non-fungible tokens are unique, indivisible assets with identifying information encoded into smart contracts. While fungible tokens act like currency (interchangeable), NFTs are differentiated collectibles like artwork,game items, memorabilia etc.
NFTs prevent duplicability and allow provable digital scarcity, turning digital assets into verifiable collectibles tracked on blockchain. NFTs can transform ownership models for digital goods of all kinds.
How Tokens Incentivize Network Effects
Well-designed token models align incentives between different network participants to grow engagement and activity. Crypto-networks need tokens to bootstrap the chicken and egg problem between suppliers and consumers of resources. Some examples:
- Filecoin miners receive block rewards and transaction fees paid in FIL tokens for providing data storage on the network. This incentivizes more miners to join and supply storage capacity.
- Compound lenders supply crypto capital to lending pools in exchange for cTokens which let them earn COMP governance/reward tokens. This attracts more lenders with assets to lend.
- Uniswap liquidity providers add tokens into liquidity pools to enable decentralized trading. In exchange they earn swap fees from trades, incentivizing more liquidity provisioning.
In each case, tokens allow the networks to attract the supply-side resources needed to then attract demand. This bootstrapping effect kicks off a self-reinforcing cycle that grows the network.
Additionally, financial return models share back value creation with token holders, incentivizing additional participation and capital commitment. Aligning supply and demand with token rewards is crucial to overcoming the chicken and egg dilemma for decentralized networks.
Real World Examples of Token Models
Let’s look at some real world examples that demonstrate different token models in action:
Filecoin – Decentralized Cloud Storage
Filecoin is building a decentralized cloud storage network to challenge centralized incumbents like AWS, Google Cloud and Microsoft Azure. Its utility token FIL represents access to storage capacity while also incentivizing participants to maintain the network as miners and verifiers.
Miners stake FIL tokens as collateral to provide storage and earn block rewards and fees from clients. The more tokens staked, the more storage can be provided. Verifiers with FIL tokens can also earn tokens by auditing the correctness of storage. This circulation of FIL tokens aligns incentives between usage and maintenance of the Filecoin storage network.
Numeraire – Hedge Fund Management
Numeraire has created the NMR token to coordinate data scientists competing to build machine learning models for an automated hedge fund. Data scientists stake NMR tokens on model performance. Better models are rewarded with more NMR.
This work token model incentivizes data scientists to build the best models to maximize financial gains from both hedge fund profits and NMR token rewards. It introduces a crypto economic model to coordinate decentralized collaboration for hedge fund management.
Livepeer – Distributed Video Encoding
Livepeer lets anyone become a broadcast node for real-time video encoding and streaming by staking its LPT governance token. Stakers earn fees from video broadcasters and can vote on protocol changes like fee structures, staking parameters, inflation rates and more.
The LPT token aligns incentives between maintaining the network infrastructure and governing the protocol evolution via staking for economic rewards and voting rights.
Rally – Creator Coins
The Rally platform allows content creators like influencers, streamers, and artists to launch their own branded social tokens for followers. These ERC-20 creator coins unlock special benefits like exclusive content, community access, discounts and more.
Fans can buy coins like PAZ for Paige Abendroth or LD for Lindsay Davis to get membership perks and show support. This transforms the dynamic between creators and followers via crypto monetization and activates direct support.
The Evolution of Economic Models
Tokenization enables new community owned networks with built-in incentives that can challenge traditional corporate structures. Participants are rewarded for contributing resources that benefit the communal network.
New models emerge such as:
- Crowd-Based Capital Markets: tokenized asset classes democratize investing through fractional ownership and 24/7 liquid markets.
- Decentralized Organizations: protocols owned and managed by token holders who capture the value created rather than remote shareholders.
- User-Owned Networks: users earn tokens for boosting network effects, aligning incentives with network growth and benefit.
- Token-Curated Registries: communities self-curate whitelists (e.g. ad quality) via applicant staking and token holder votes, eliminating centralized gatekeepers.
- Social Tokens: creators mint tokens with embedded access and governance to monetize their brand and deepen ties with followers.
These models leverage the coordination and incentive properties of tokens to restructure network ownership, governance, participation and reward.
Benefits and Impacts of Token-Based Economies
Token-based models have profound economic benefits and impacts:
- Accessibility – nearly anyone can participate by purchasing tokens and help shape nascent networks as an early adopter.
- Value Capture – tokens allow contributors to capture a portion of the value they create through embedded incentive models.
- Global Reach – blockchain protocols are inherently global which unlocks new international economic opportunities.
- Efficiency – crypto networks with public ledgers and peer-to-peer exchange cut out rent-seeking intermediaries and drive down costs.
- Transparency – financial flows and incentives are programmatically enforced on-chain for anyone to audit and analyze.
- Composability – tokens are interoperable between protocols, allowing novel combinations and mashups.
- User Empowerment – end users can collectively steward protocols and build grassroots capital structures via tokens and DeFi.
However, there are also risks and challenges to consider:
- Volatility – speculative trading can cause boom and bust cycles and destabilize new networks.
- Scams – bad actors can exploit hype cycles to launch scam tokens and Ponzi schemes.
- Regulatory Uncertainty – uncertainties around taxation, securities law, AML rules and more still exist.
- Concentrated Wealth – critics argue tokens may simply recreate plutocratic models and micro-economies of scale.
Overall though, tokenized crypto-economies usher in a more participatory, open and transparent model for exchanging value. They expand opportunities for billions locked out of legacy systems to coordinate, innovate and capture value together via programmable trust and incentives.
Tokenization allows the design of new economic models optimized for the internet era. Protocol governed networks can bootstrap participation, resources and value generation via programmable incentive models. While regulatory challenges remain, the token economy offers a more equitable economic future compared to closed corporate and government systems.
Here are 5 frequently asked questions about the token economy and how tokens are creating new economic models:
What are tokens in the context of blockchain technology?
Tokens are digital assets that exist on a blockchain. They can represent anything from financial assets to identity and access rights. Tokens allow for programmable logic and rules that enable new kinds of incentives and economic models.
How do tokens differ from cryptocurrencies like Bitcoin?
Cryptocurrencies like Bitcoin have their own standalone blockchain network. Tokens are created on top of an existing blockchain protocol like Ethereum and rely on it for security and distribution. Tokens also allow more complex functionality as programmable assets.
What are some examples of popular token models?
Some common token models include utility tokens which provide network access, work tokens for incentivizing labor, governance tokens for voting rights, financial return tokens for dividends/revenue share, and non-fungible tokens (NFTs) for unique digital assets.
How do tokens help bootstrap new networks and economies?
Tokens help align incentives between different network participants to provide resources, governance, and value creation. This helps overcome the chicken and egg problem for new networks to reach critical mass adoption.
What are some benefits and risks of token-based economies?
Benefits include accessibility, value capture for contributors, transparency, and user empowerment. Risks include volatility, scams, regulatory uncertainty, and wealth concentration. Overall tokens expand economic opportunities but thoughtfully managing downsides is critical.