What is the token economy?

To put it into layman’s terms, the ‘token economy’ feels a bit like what kids did for fun at primary school in Britain in the 1970s: hanging out in the playground trading in stickers for our sticker albums. If you were starting a new album you would happily trade a whole unopened packet of stickers just to fill up a few more pages.

By the time you got close to completing your book, if someone else had the coveted sticker you needed to fill in an important gap, it might trade for up to several unopened packets. Who knew that football stickers as a form of currency was an early introduction to the laws of supply and demand and the tactics of peer-to-peer trading with digital tokens?

The humble kids’ sticker craze is not that dissimilar to the current trend for buying into Initial Coin Offerings or token sales. Such sales are a form of crowdfunding facilitated by the rise in popularity of peerto-peer exchanged cryptocurrencies and blockchain-based applications. Imagine buying a token in an ICO as a bit like trading an unopened packet of those football stickers –it’s essentially a bet on the future.

So what is a digital token? To borrow from a primer created by Coinbase: “A blockchain token is a digital token created on a blockchain as part of a decentralized software protocol. There are many different types of blockchain tokens, each with varying characteristics and uses. Some blockchain tokens, like Bitcoin, function as a digital currency. Others can represent a right to tangible assets like gold or real estate. Blockchain tokens can also be used in new protocols and networks to create distributed applications. These tokens are sometimes also referred to as App Coins or Protocol Tokens”.

When you purchase the latter form of tokens you are buying them on the promise that they may be useful to you in the future or else on the assumption you can trade those tokens for some other digital asset of value. Due to a statement from the US Securities and Exchange Commission issued in late July 2017, and various more recent statements by other government agencies, there remains some uncertainty about which types of tokens will be classed as securities and which will not. Nevertheless, enthusiasm for token sales continues seemingly unabated.

So what happens once we have large numbers of such tokens being bought and exchanged online? ICOs have already exceeded projected expectations. Earlier this year, industry commentator William Mougayar suggested ICOs would raise at least $1 billion by the end of 2017 – at the time of writing (Oct 2017) the figure stood at over $2.3bn and rising. These massive numbers are attracting attention – even from ICO sceptics – and raising questions about the impact such volumes is having on fees, transaction speed and scalability of the Ethereum blockchain where these ICOs take place.

ICOs are also raising questions about the ‘democratisation of investing’. Just as the internet suddenly allowed anyone to start a blog and become a journalist, so tokens will allow many ordinary people all over the world to become investors. This comes with both great advantages and potentially also with huge risks for the uninitiated (or even for so-called experts in what remains a very volatile and rapidly-evolving marketplace).

So what happens when there are many different types of tokens all being issued and traded on different platforms? The number of digital assets on the Ethereum blockchain is increasing rapidly due to the growth in implementation of smart contract-based use cases. As this trend is only likely to continue, demand is likely to grow for users wanting to exchange assets or balance a portfolio consisting of many different tokens. Decentralised order books have sprung up to meet this demand but there are also options for peer-to-peer trading on a decentralised asset exchange. In their whitepaper, Michael Oved and Don Mosites , the c0-founders of AirSwap, the implementation of the peer-to-peer Swap protocol for trading Ethereum (ERC20) tokens, argue that such a system would increase liquidity, as well as improving scalability and privacy.

Centralised cryptocurrency exchanges essentially came into existence due to the need to exchange cryptocurrencies like bitcoin into local currencies – since these currencies are still not widely in use by merchants and consumers. You still can’t easily pay your mortgage or your bills with cryptocurrencies, for example. The early exchanges like Mt Gox have become infamous for what went wrong. Yet those were the early days and many established centralised exchanges continue to operate successfully.

Their survival tends to rest on the quality of management and consumer service, on whether they can establish good relationships with the traditional banking system and on how much liquidity they can offer. And it is not always easy for users to know, however, whether an exchange can be trusted and how much risk they are being exposed to – be it credit risk, security (for example, when an exchange is vulnerable to hacking, as in Mt Gox’s case) or lack of protection in case of disputes.

Decentralized exchanges are exciting great interest because they promise to potentially address some of these limitations. Examples include 0x, which uses a decentralised order book; AirSwap, which allows users to trade peer-to-peer; and KyberNetwork, to name just a few. Some of these exchanges facilitate the exchange of digital tokens to traditional (fiat) currencies while some are only designed to exchange different types of digital tokens. They also divide up into platforms which operate on the blockchain and those which operate socalled ‘off-chain’ systems.
The future of the token economy will see a dizzying array of digital assets trading on a variety of platforms, revolutionising the way we trade in the future. And these waves of new funding pouring in to the start-up community are already spawning a new form of ‘Blockchain Silicon Valley’ with decentralized innovations of every kind springing up – what Laura Shin of Forbes has called “cloud computing meets the sharing economy meets the Fed”.
If you’re interested in the future of investing and the future of business, it’s time to take more than a token interest in what’s happening in the token economy.

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ICO Crowd is the world’s first and foremost publication on Initial Coin Offerings (ICO).