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Tokens 101: How they work and where they provide value

Cryptocurrencies and crypto tokens (simply tokens) have now become household names.

Although these two digital products have gained a lot of popularity lately, few people understand the difference between the two, and they mistakenly use them interchangeably.

For the record, cryptocurrency is a digital or virtual currency designed to work as a medium of exchange. It uses cryptography to secure and verify transactions as well as to control the creation of new units of a particular cryptocurrency.

Tokens, on the other hand, are a special kind of virtual currency tokens that reside on their own blockchains and represent an asset or utility, according to Investopedia. Tokens are usually defined for use on top of a particular blockchain like Ethereum.

Tokens are what we talk about nowadays in the context of ICOs, and the idea is that the platform itself provides the launchpad for all these tokens, without needing them to create their own individual blockchains.

Tokens can provide certain utility, as if they were the “currency” inside that particular platform or economy, and these are called “utility tokens”. In any such case, tokens are the fuel (the “gas”) or the price to access the protocols or perform an action.

They can also in some way be equity-linked or even debt-linked. Most tokens today are built on top of the Ethereum blockchain and comply with what’s called the ERC20 standard. Owning a token is equal to holding something which could potentially be very valuable over time in that ecosystem.

Also Read: Saison Capital rolls out new token fund to accelerate Web3 investments

The era of tokenisation

We are experiencing the movement of #TokenizeEverything and finding digital twins for any item that exists in the real world. In the real world, not all things are commodities that have fungibility (interchangeability). Although all items belong to a category, they are not homogeneous and can be very different.

Non-fungibility and the uniqueness of each token then has an impact on its desirability — perceived or real-valued. Therefore it’s a logical consequence that the blockchain space started with fungible assets, and it now is extending into non-fungible tokens (NFTs) or tokens that are not interchangeable/replaceable.

To understand the concept of NFTs, we need to first understand the difference between the words ‘fungible’ and ‘non-fungible’.

“Fungibility” in a traditional sense means that any asset or item is equal and exchangeable to any other item or asset. The classic case is fiat currencies, wherein any denomination of, suppose USD, is exchangeable to any other denomination of USD. In the case of blockchain tokens, the classic ERC20 tokens are considered to be fungible, i.e. they can be exchanged with each other freely.

‘Non-fungible’, on the other hand, means ‘that cannot be replaced’ or ‘not interchangeable’. Two items may look identical, but each has its own unique information or attributes that make them irreplaceable or impossible to swap.

Also Read: National University of Singapore is partnering with Microsoft to boost AI capability in the region

A real-life example is a flight ticket. While two plane tickets look identical, they cannot be exchanged with another similar ticket. Each has different passenger names, destinations, departure times and seat numbers. Interchanging them will have serious consequences.

Both the ERC20 and ERC721 tokens represent different use cases and hence one of them cannot replace the other, in fact, they will complement each other in the long term.

Importance and relevance of NFTs

NFTs are an important development in the blockchain space. As mentioned above, NFTs are markers or tokens for unique assets that can’t be duplicated. When NFTs are used, the control is in the hands of the owner, not the software developer.

Their applications are endless. As we’ve entered a hyper-digital age, blockchain-based NFTs offer a solution for cryptographically creating a unique digital item, e.g. a football card of Cristiano Ronaldo, with only 100 of them being produced. The NFT guarantees that the “card” can’t be copied and shared unless the NFT itself is traded. It enables the verification of authenticity and ownership of an asset without requiring a central authority. They can be used to move ownership of diamonds, gemstones, limited edition gold coins or bars, and art pieces instantly on the blockchain network.

NFTs are also transformational in the gaming world. Imagine games like Pokemon Go, that took the world by storm. In a non-fungible token sense, each Pokemon would have a unique ID to it, and would be stored on the blockchain.

The most popular use case is CryptoKitties. It is a game centred around ‘breedable’ and collectible creatures, called CryptoKitties. Each cat is one-of-a-kind and 100 per cent owned by you; it cannot be replicated, taken away, or destroyed.

Decentraland is another success story in the NFT space. Decentraland is a virtual platform owned by users, who can grab a VR headset or use their web browser and become completely immersed in a 3D, interactive world. Here, the user can purchase land through the Ethereum blockchain, creating an immutable record of ownership. With full control over their land, users can create unique experiences; they can go to a casino, watch live music, attend a workshop, shop with friends, start a business, test drive a car, or visit an underwater resort — all within a 360-degree, virtual world.

Also Read: Building a diverse and inclusive workplace sidestepping tokenism

Non-fungible tokens potentially have a lot more applications. For example, they could  store the authenticity of real world assets like art. A non-fungible token could be created and tied to a real-world asset, such as a priceless piece of art.

In this way, the authenticity of the artwork would be immutable and infinitely more secure. There would be no way for forgers to counterfeit the art. In the same way, non-fungible tokens could be used to store birth certificates, identities and other unique information.

Manufacturing and supply chain are the other important industry verticals where NFTs can be used. If products are assigned an NFT at the point of manufacturing, their tracking and ownership can be easily carried out, during the supply-chain cycle and beyond.

Incorporating NFTs in some identity management solutions can also be quite useful. For instance, issuing tokens for entrance into sensitive facilities/institutions can be facilitated with NFTs.

All in all, the issuance, tracking, and storing of securities can be very easily managed using NFTs. Presently, large and highly ‘available’ databases are used to track issued securities that are connected to a number of other institutions like banks that need that information. Even the process of data collation and auditing of these assets can be made more efficient by using NFTs.

Having said that, NFTs are not meant to replace fungible cryptocurrencies like Bitcoin or Ethereum. Fungible tokens will continue to stay and people will continue to use them as a transaction token. However, what will drive a NFT in the coming years is the fact that real world assets and its unique digital representation and identity can now be on the blockchain.

How NFTs will impact various industries

Although NTFs will simply be a different digital asset class category, its impact on the application infrastructure will be wide reaching. NFTs have already taken the crypto world by storm. Several ICOs have already considered, or are considering to use NFTs, to supplement their tradeable ERC20 tokens.

Also Read: How to find a good investment with new crypto tokens

Similarly to how security tokens are impacting change, NFTs will have an impact on the workflow and value assessments across the industry — from exchanges to wallets to marketplaces.

As usability improves, the idea of a deed to a real-estate property could become passé. The deed will be the NFT.

Of course, losing the private keys to access that NFT is a problem, so workarounds still need to be figured out, but the opportunities for bringing offline verification into the blockchain realm opens up endless possibilities, e.g. vehicle sales via NFTs, real-estate, rare pieces of digital art (paintings, photographs, music), etc.

NFTs will also open up the realm of asset tokenisation even further.

There is a nascent but growing field of activity around NFTs in financing. In the case of raising funds (via security tokens or utility tokens) for ICOs where the underlying assets have some uniqueness, NFTs make sense.

There is also talk about Initial Debt Offerings (IDOs), whereby the projects can crowdfund via unique debt-contracts represented by NFTs. Each layer of debt or each slug of equity in a stack may be better traded and recorded with NFTs.

Limitations of NFTs

NFTs are still a nascent technology standard, and the adoption is not widespread. In addition, the ability to “marry” an NFT to a physical object —  for example a QR code sticker or a wrapper like a smart container — is still too simple and prone to failure. Until better solutions are mature, the NFT market will be limited to more digitally native assets.

Another key challenge is the extra effort and understanding needed to create its adoption. However, one good news is also the emergence of platforms like 0xcert which allow for plug-and-play creation of NFTs, making experimentation easier.

Also Read: Singapore’s facial recognition, video analytics startup XRVision gets investment from Boundary Holding

Moving Forward

Last two years have seen the fungible token standards raise billions of dollars of capital and trade these tokens are crypto currencies.

The way the crypto markets are questioned right now and dropped in value will demand crypto assets that represent tangible value to keep the market interested and prove the blockchain applications.

This will be the next wave in crypto markets as people see NFTs as something of unique and tangible value which can be brought onto and traded in the blockchain. There will definitely be a lot more ICOs adapting NFT standards vs fungible tokens standards.

NFTs need the right environment to be deployed. While gaming is a different industry altogether, real-world assets often function in mission-critical environments and cannot compromise on security, scalability, and immutability.

NFTs are an extension of the token economy that has the potential not only to achieve mass adoption of blockchain and cryptocurrency but also significantly expand the market from utility tokens and payment tokens to object-oriented.

e27 talked to several cryptocurrency and blockchain experts, including Pankaj Jain (formerly with 500 Startups), Shaun Djie (Co-founder of Digix), Gaurang Torvekar (Co-founder and CEO of Indorse), Philipp Pieper (Partner at Swarm Fund), Atul Khekade (Co-founder of XinFin), Karan Bharadwaj (former CTO at XinFin), Jehan Chu (Co-founder of Kenetic Capital), Nitin Sharma (angel investor), and Sandeep Phogat (Founder and CEO of Panaesha Capital) for this article. We would like to thank them for their expertise.

This article was first published on June 30, 2019.

The post Tokens 101: How they work and where they provide value appeared first on e27.

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