A Taxonomy of Tokens

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A Taxonomy of Tokens

There has been a phenomenal increase in the number of tokens in the cryptocurrency world over the past two years. Initial Coin Offerings (ICOs) became a popular way of fundraising where project teams issued tokens in exchange for funds. Decentralized application (DApp) development also increased with many of these requiring their own unique type of tokens.

It can be easy to get confused when the token ecosystem is expanding at such a rapid pace and so much token terminology is being spread around. This guide breaks down tokens to their simplest format with clear examples of what tokens are and what their roles are. Different examples from the main blockchains which operate the largest tokens will also be provided.

What is a token?

A token essentially boils down to being a digital currency, good, or service which is native to a blockchain or DApp. While standard cryptocurrencies are used as a form of digital money, tokens can have a variety of different functions depending on how they are developed but they typically serve a function within whatever DApp or blockchain they operate in.

What are they used for?

The most common use case for tokens is to raise funds. Three major cryptocurrencies: Ethereum, EOS, and Tron all raised funds by issuing tokens. Ethereum issued Ether which is used to incentivise miners to keep the Ethereum network secure and also used to transfer to Gas which is used to pay transaction fees on the Ethereum network. The Ethereum ICO took place over the course of 42 days in 2014, over which Ether was sold in a price range of 1,337 to 2,000 Ether per Bitcoin contributed.

Many projects which are launching their own blockchain issue tokens on an existing blockchain prior to launching their own mainnet blockchain. Both EOS and Tron completed their ICOs on the Ethereum network. Tron and EOS were tokens on the Ethereum blockchain and effectively acted as placeholders until the Tron and EOS main blockchains were launched. A transfer could then take place whereby every holder of a token on the Ethereum blockchain sets up an account on the launched blockchain and is issued an EOS or Tron cryptocurrency.

Another common use for a token is as a digital good or service within a DApp or blockchain. One of the most notorious examples of this is CryptoKitties. CryptoKitties is a DApp built on top of the Ethereum network whereby users trade their Ether for unique digital cats. Once users own two cats, they can breed them with each other to create a new unique cat by paying a fee to the network.

Each of the unique cats represents a token within the DApp and there is also a marketplace for the tokens where users can buy and sell different digital cats. CryptoKitties skyrocketed in popularity in December 2017 and severely slowed the Ethereum network due to the high demand for transactions. The highest CryptoKittie purchased was valued at $172,000 at the time of sale.

Ethereum Tokens

Ethereum tokens are by far the most popular. Many large-scale projects have used the Ethereum blockchain to conduct their ICO. They also have the most developed DApp environment. There are over 1750 DApps operating on the Ethereum blockchain.

Tokens that operate on the Ethereum blockchain comply with a technical standard known as ERC. There are two types of tokens which can operate on the blockchain. These are ERC-20 and ERC721. These are both smart contracts enabling developers to deploy them after coding in their own specifications.

ERC-20

ERC-20 tokens are by far the most popular type of token issued. These are the tokens which are used when an ICO is taking place. They are also the kind which are used if the token is going to act as the native currency within the DApp.

The key point to note about an ERC-20 token is that they are fungible. A fungible token means that every token is equivalent to each other. Every token should have the same value when priced against Ether, USD, or otherwise.

Imagine creating a game as a DApp on the Ethereum blockchain called the HODLympics, whereby users participate in competitive games to compete for tokens and have to partake in activities to try and increase their token balances.

The HODLcoin is the ERC20 token which is going to operate as the currency for our game. Every HODLcoin needs to be equivalent to every other HODLcoin and that is where fungibility comes into play. If the first issued HODLcoin was more valuable than the later issued ones, it would not match the goals of the game.

It is the same with ICOs. When tokens are issued in exchange for funds, it would undermine the objective if some tokens had different values than others. It would make the fundraising process a mess and it is unlikely for investors to participate.

ERC721

That brings us to the second type of Ethereum token. An ERC721 token is a non-fungible token. Every token is unique. CryptoKitties is a game which operates with ERC721 tokens. Each token represents a unique digital cat. For that reason, tokens will have different values. In the CryptoKitties games, the digital cats which were created in the first ten sold for extraordinarily large amounts with the first and fourth created digital cats selling for approximately 250 Ether each.

Other Tokens

EOS Tokens

After conducting a year-long ICO on the Ethereum blockchain which raised approximately $4 Billion worth of Ether by the time the ICO wrapped up, EOS launched their mainnet blockchain in mid-June 2018. EOS designed their architecture to tackle some of the scalability limitations of Ethereum. EOS used a different algorithm to reach consensus over the system but there have been many concerns over the security tradeoffs of this algorithm.

Many dubbed EOS to be the Ethereum killer but it has yet to see a mass transfer of developers moving to EOS from Ethereum to build DApps. Data shows that there are about 200 DApps on EOS as of December 2018, with some of these being inactive. While Ethereum has ERC-20 and ERC721 smart contracts for developers to deploy tokens, EOS has the eosio.token smart contract.

Developers code in specifications such as the supply and can deploy their token in the DApp they have built on the EOS blockchain or directly on the blockchain itself. The most popular DApps so far on the EOS blockchain have been betting games by a large extent.

Tron Tokens

Tron is another platform which launched as a competitor to Ethereum and to tackle some of the scalability issues. Tron also adapts the architecture of the system to achieve scalability. Similar to Tron, it adapts the consensus algorithm resulting in security concerns also being raised for this project.

One of the ways Tron has facilitated the migration of developers and DApps from Ethereum to their platform is to make the underlying decentralized computing infrastructure of Tron, the Tron virtual machine, compatible with the underlying decentralized computing structure of Ethereum, the Ethereum virtual machine.

Another way they have competed with Ethereum is by making the fees far less to operate a smart contract on Tron compared to Etheruem. There have been over 1600 tokens generated on the Tron blockchain but the state of DApps is still far behind Ethereum. Many tokens generated are not being used.

Tethered Assets

Earlier this year, Interstellar launched the decentralized exchange StellarX on the Stellar blockchain. Interstellar is an organization that develops products for the Stellar blockchain. One of the key issues with decentralized exchanges has been that users could only speculate on assets native to the blockchain the exchange is launched on. For example, a decentralized exchange launched on Ethereum such as Ethfinex would only allow users to speculate on Ethereum and Ethereum-based tokens.

StellarX used tokens to provide a way for users to trade assets that were not native to the blockchain. Users of StellarX could trade and speculate on the price of other cryptocurrencies and even physical assets such as gold. StellarX achieved this through using tokens to represent the assets.

For example, if users were to exchange to gold on the StellarX exchange they would be converting to a token which represents gold. This is known as a tethered asset. Different issuers offer different tokens and the tokens are redeemable to the issuer.

The key problem with this is it poses an extra risk to the user of the exchange. The system functions well provided that there is an actual asset behind each token and that the asset is redeemable on the user’s request. Issuers may also only be holding a fraction of the assets in proportion to tokens and using the other funds to make risky investments or putting towards other uses.

Bitcoin Tokens

There are also tokens on the Bitcoin blockchain. Ethereum, EOS, and Tron use Turing-complete programming languages which makes it far easier for developers building DApps, smart contracts, and deploying tokens. The Bitcoin Script programming language makes even the simplest smart contracts and DApps highly complex to code.

The Omni layer which is a software layer built on top of the Bitcoin blockchain provides a solution to this making smart contracts, DApps, and tokens possible on the Bitcoin blockchain. This software layer enables users to far more easily build tokens which use the Bitcoin blockchain as the final settlement layer.

The largest market cap token built on top of the Omni Layer is USD Tether (USDT), USD-pegged stablecoin. This token is a highly controversial one. The token maintains its value pegged to the USD through backing the token in a 1:1 ratio with the USD. The token has the same key problem as the tokens listed on StellarX.

There has never been a confirmation that the token actually has the USD to back the tokens. Many speculate that there isn’t sufficient USD backing the tokens and that the company behind USDT simply print more USDT to use to purchase actual cryptocurrency assets. A breakdown of the relationship with auditor Friedman LLP served to spark further suspicion.

Key Token Takeaways

While cryptocurrencies are a digital store of value or medium of exchange, tokens encompass an even wider role and often represent a digital good or service. The token economy has been booming over the past two years. Many DApps and smart contracts have a token central to how they operate.

Tokens have found their biggest use case so far in fundraising with over $20 Billion raised in 2018 and over $6.5 Billion raised in 2017. As the token economy continues to develop, models for valuing them and assessing their role in the ecosystem will continue to be refined.

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