At one point, blockchain, crypto, and tokens were all people were talking about. Of course, as bitcoin surpassed conventional fame and stabilized as a currency people have started to have a deeper understanding of what the capabilities of blockchain are. But the question of tokens still comes up.
Why do blockchains need tokens? While it may seem like some blockchains don’t need tokens, the truth is, tokens are an integral part of the blockchain framework as they represent ownership, incentivize growth and investment. They also have a number of other direct and indirect functions as well as capabilities.
Read below to find out more about why blockchains use tokens as well as the types and uses of tokens. We will also go into a few examples of frameworks that may not appear to need tokens but ultimately use them and for what purpose. Although the upcoming bitcoin halving has everyone’s attention, this is drawing in new crypto enthusiasts who need a baseline understanding of how the token economy could play out.
What Are Tokens
A lot of talk goes around these days in regards to tokens, token ownership, ICOs (Initial Coin Offering) and token exchange. However, many are still entirely unaware of what tokens are in relation to specific blockchain frameworks and the full extent of their use and importance.
At its most fundamental level, a token is a unit of value that is issued and defined by a specific organization that is both accepted by a certain group of buyers and sellers. Within the crypto framework, a token needs to be supported by an underlying blockchain network.
In this context, we can define a token as a cryptocurrency built onto an existing blockchain, one that is also supported and given value based on the support and market value of the specific blockchain frameworks capabilities.
This is where a lot of the questions arise in regard to the existence of tokens. With transactional blockchain networks like Bitcoin, it makes sense that there are coins or tokens. Bitcoin supports a blockchain that promises to conduct fast and almost entirely free financial exchanges on a decentralized network. A traditional bank, for instance, would take 3-7 business days to transfer funds internationally and charge a flat or percentage-based fee. The transaction would also be tracked by the bank and could be reported to governments and financial institutes if need be.
Bitcoin takes banks out of the equation and transfers funds in as little as 10 minutes with little to no fee. So, bitcoin is the cryptocurrency that runs on the bitcoin blockchain network. You transfer money by purchasing and transferring bitcoin across the blockchain framework. Similar coins arose from the success of bitcoin that either
- Transferred funds faster
- Were cheaper to buy
- Or used less energy
Still, bitcoin prevails as the top and most trusted cryptocurrency, currently comprising 66% of the total market value of all cryptocurrency.
So what about blockchain frameworks that aren’t necessarily financial and transactional in nature? Why do those have tokens that people can purchase and sell? To understand this, we first have to look at the different types of tokens and their use. For a primer on cryptocurrency overall, read our Cryptocurrency 101 post.
Types of Tokens
There are essentially two types of tokens:
- Security-Based Tokens
- Utility-Based Tokens
Let’s take a quick look at each!
1. Security Tokens
A security-based token or a crypto-security is the most traditional use of the token. It essentially represents proof of ownership. This framework is very much like the buying and selling of traditional stocks and bonds, with a few key differences of course.
Traditionally stocks and bonds are issued out to:
These act as proof of ownership and are regulated. In the United States for instance, they are regulated by the U.S. Securities and Exchange Commission or SEC. The stock market is also time-regulated, in other words, you can’t really purchase stocks before or after the allocated times. Weekends or national holidays are also off-limits. Furthermore, large transactions are often tracked to prevent:
Security tokens, also known as tokenized assets, are completely decentralized meaning
- no government entity regulates transactions
- there are no national or geographic boundaries
- you can buy and sell parts of assets.
You are also not restricted based on time or day so there are no “trading” hours and you can buy or sell tokens any day of the year. Yep, Christmas morning or 5 AM on a Sunday are all fair game.
Security tokens also make it easy for people and investors to access a wider portfolio revealing a number of transactions and investments. So that pretty much covers it for financial or proof of ownership based blockchain frameworks like Bitcoin and Ethereum but what about other uses for tokens in non-security tokens? Well, that brings us to the second type of token; the utility-based token.
2. Utility Tokens
Utility tokens are a bit less traditional and don’t deal so much with ownership and stake representation. Instead, utility tokens are a cryptocurrency with a purpose as it relates to a specific blockchain framework.
Take for instance data storage. Traditionally if you or an organization have to store large amounts of data you would have to rely on companies like Google, Amazon, or Dropbox. These companies offer small online storage for individual and large data storage for companies. Amazon’s Web Service, in particular, is used by websites and startups all over the world. These large companies have what can be referred to as a monopoly on data server storage so they are able to:
- Dictate the price
- Track and sell your data (this will vary from company to company)
- Access your information
This is where the decentralized blockchain comes in with its utility token. Coins like Filecoin promise to store data in similar cloud storage without using massive and environmentally harmful servers. Users will be able to simply store data in an encrypted form on the hard drives of other people also taking part in the network. Essentially, you would pay someone running a hosting node through the Filecoin utility token. The more data you store the more Filecoin will deduct from your token balance and allocate crypto to specific users whose hard drives are being used.
Similarly, render-based blockchain tokens and coins are allowing people to render videos and animations on other people’s computers while the computers are not being used. Again, the respective coin would deduct tokens from the users’ balance in order to increase usage of someone else’s computer power to render content.
Logistics tracking and product authenticity verification are already blockchains being used. VeChain focuses on product authenticity to prevent fake products, but there are other that focus on food and pharmaceutical safety. OriginTrail is focusing on food safety while Waltonchain combines RFID with a token for tracking and verifying potentially anything. Excepts watches right now, because you can’t fit a chip in a Rolex. But it will get there.
Are you starting to see the virtually endless uses of utility tokens? This is why the craze exists around blockchain. It’s not just the financial industry that would change, but almost all aspects of modern-day life could become decentralized. This has the potential to render large companies, middle men, and regulating bodies irrelevant, allowing individuals to
- Trade goods
- Provide services
This is all based on token exchange on a specific blockchain network. Now that we have a better understanding of the types of tokens, let’s go into more depth on how tokens are issued for security and utility values before looking at the various needs and uses of tokens within the blockchain framework.
Still fuzzy on things? Watch this video understand coins versus tokens versus securities. Don’t stress, even the US Securities and Exchange Commission and IRS haven’t figured it all out yet.
How Are Tokens Issued?
So you found a framework you are super interested in or you need to use the services provided by a blockchain and are wondering, “how do I get a hold of these tokens anyway?” Well, there are two ways that tokens are issued and they depend on whether the blockchain is based on a security token or a utility token.
For crypto-securities, the process of getting tokens is fairly simple. Like ownership in a company that issues stocks in an IPO (Initial Public Offering) security tokens are issued in an ICO. Tokens are distributed to:
This takes place during the ICO and the period of time that follows. Just like a stock, you can buy individual tokens. There are a few advantages to buying tokens over traditional stocks or bonds that we went over above.
Regulation on security tokens is virtually non-existent. However, the idea is that in the future many security tokens would become regulated and companies would go all out for ICOs and not IPOs. But the ICO flame-out of 2018 smacked the markets in face with the true reality. Many issued tokens but never actually built functioning products or networks that offered the user any value.
So what about utility tokens? Well, the way these values are issued is a bit different from how you can gain security-tokens. Utility tokens aren’t really intended to be traditional-style investments. They are more to sell people on the idea of a product or future. In other words, utility tokens sell people on a company’s potential.
This concept is very much like being an early investor in a startup but with just the idea in place, not the actual product. It’s like pre-ordering a book or t-shirt that hasn’t come out yet. So essentially, blockchain technologies are raising capital straight from customers or at least future customers instead of investors. This would also mean that utility tokens wouldn’t necessarily have the same restrictions and regulations as security tokens.
So far, however, utility tokens have not yet panned out in the ways many predicted they would. Furthermore, many tokens were issued to perform functions on blockchains for products or services that really didn’t need or would not benefit from a blockchain solution. For example, many gambling tokens were issued to use for betting on specific platforms. The idea is to use a token to place a bet on sports, election outcomes, eSports events and more, and the winnings would be paid out in more tokens.
The harsh market reality is that you can do all of that with a credit card or cash, and the winnings can be spent in traditional ways on products and services. Tokens cannot. They are blockchain platform specific. In other words, a token and chain was created to address a need that didn’t exist. Ironically one of the biggest failures in this was initially backed by Mark Cuban and Ashton Kutcher.
The eSports gambling platform Unikrn issued a token called UnikoinGold that is now worth 2% of its ICO price and lost 99.5% of its market peak price since January 2018. Unlike IPO’s the tokens offer no ownership stake in the company. The money was raised, the officers were paid, the platform was developed, and token buyers can sell at a huge loss or use them to bet on eSports. The project was then shut down in 2020 by the SEC as an illegal unregistered security offering.
Which is probably a better investment than the tokens themselves. I believe that fake and/or well-intentioned but failed ICO’s stained cryptocurrency’s reputation immensely in 2017-18, and it will take several years to unwind the damage caused.
But develooment continues on other tools and functions where a public immutable blockchain and token would provide a new service and great value. For example, logistics, authenticity, and tracking of food and pharmaceuticals for safety. Others are mentioned below.
It is this author’s opinion that very few cryptocurrency in the marke today has value. A handful will, likely including the logistics tokens. But I believe the next round of development will bring the truly useful blockchain products to market in traditional ways by using venture capital first.
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8 Reasons Why Blockchains Need and Should Have Tokens
So what’s all the fuss about? If tokens make sense from a security and utility standpoint why are people worried about tokens. Well, a number of investors are leary when it comes to tokens. This is mostly from a lack of understanding of the blockchain network and capabilities. However, their concerns do have some ground.
Many people want to know why non-financial, non-security and non-token reliant (supposedly) blockchains need tokens. In fact, investors become increasingly more leary of frameworks that don’t appear to need tokens but do an ICO. The doubt and concern is that these blockchains are fraudulent and only aim to raise capital for the founders without being invested in the technology behind the blockchain. While, there are a number of schemes out there, like the famous Bitconnect, some frameworks have valid reasoning behind issuing tokens.
We have gone through a few preliminarily reasons for why blockchains need tokens, but let’s go over them now in more detail. Here are the 8 reasons why blockchains need tokens:
- Tokens are needed to power blockchain
- Tokens are a currency
- Tokens can represent asset ownership
- Tokens can represent stake or equity ownership
- Tokens incentivize miners or nodes owners
- Tokens can be tracking devices
- Tokens allow for crowdfunding
- Tokenization of non-physical assets and documents
Many of these points are actually similar to one another and depend on one another; however, it’s important to form a complete image for each. Even though Mark Cuban backed Unikrn above, he makes money as a part owner of the platform. Here he discusses cryptocurrency and blockchains as Software as a Service (SaaS) tools that have some vague value.
1. Tokens Power Blockchain
The whole blockchain verification process is a little difficult to understand, and we won’t go into too much detail here but here’s the gist of it as it relates to bitcoin specifically. Miners find a solution to a complex math-computational problem and announce the solution to the other miners who then confirm the results. If enough miners on the network confirm then the “block” is added to the collection. The miner then receives a reward in the form of bitcoin, for instance. You can read more here.
The token in this instance acts as a reward for the miner; however, tokens can also fuel or power blockchain in a number of other ways. Ethereum network, for instance allows creation of tokens that can act as a form of escrow between two parties. In this instance, the Ethereum blockchain oversees the execution of smart contracts and the token completes the transaction.
At this point in blockchain development, most of these “smart contracts” will still end up converting to traditional fiat currency at the final step. That will gradually change as more vendors accept cryptocurrency for purchases and as developers solve the problems of cross-chain transactions.
2. Tokens Act as Currency
This one is a bit obvious but still worth pointing out. Currency tokens specifically can act as a payment method between two parties. You can buy:
You can do all this through blockchain. Bitcoin specifically is used for this purpose because it’s a staple in the industry and one of the most trusted cryptocurrencies. Litecoin, XRP, and NEM are other transactional currency examples.
Unfortunately, most tokens are still extremely volatile so their use hasn’t been widely adopted by:
Can you imagine paying for a piece of bread with bitcoin only to have the price shoot up the next day to where you could have bought a whole dinner? Or imagine selling a home and accepting bitcoin only to find out a week later you lost 20% of your property value.
Still, many companies, realtors, and small businesses do accept bitcoin and its token use as currency is growing by the day. But until a currency reaches a high market cap, establishes dominance and shows price stability, even those crypto transactions will end with conversion to fiat currency.
Where they do currently have advantages is in international transactions or cross-border payments. Right now, if a US citizen wishes to purchase something from India or Russia, there will be multiple parties involved, each taking a small fee. There will be several steps taken to ensure no fraud, and even then the deal can be reversed by a seller after receiving funds, leaving a buyer with no recourse.
But using a smart contract escrow payment, the money could be held in a contract until the buyer receives the goods, inspects them, and enters a code to complete the payment. All of this can occur without a single middle man or parties between buyer and seller. No PayPal chargeback schemes. But also no credit card company insurance. So it all depends on the Smart Contract reliability.
Cross-border international payments
Another example of the vast potential of cryptocurrency is the controversial token XRP, created by Ripple. Imagine a large corporate customer of a bank in New York City needs to transfer $20 million dollars to London, and the recipient needs that money in pounds sterling rather than USD. Right now, this type of deal requires both banks to have equal amounts of both USD and British pounds in their vaults before the transaction can be initiated.
Then, once the trade is started, it takes two days for the money to reach London, and another two days to be converted into pounds. And both banks will charge percentage based fees to enable the transaction. To address this, Ripple has created a lightning fast open blockchain network software and a currency called XRP.
To perform the same transaction using XRP, the individual would buy $20 million in XRP at the bank from Ripple or on the open market, send it to the bank in London, where it would be instantly sold for GBP. The whole process takes about 10 seconds. That’s right, 10 SECONDS! And the fees? As low as $10-20. Think about that. Right now banks can use XRP to send $20 million USD to London and convert it to pounds in 10 seconds for $10-20.
Cryptocurrency and blockchain are geographic and border agnostic. They work anywhere and everywhere. Even when banned.
3. Tokens As Proof of Asset Ownership
Using tokens you can claim ownership over tangible and physical assets like:
By recording a transaction on a blockchain using a token, the original owner and all subsequent owners of the asset can be tracked through the blockchain. This could potentially eliminate the need for paperwork and reduce the rate of theft and fraud. You can track the ownership history of assets and inherit assets through tokens.
In some countries where graft and politics are shady, land ownership is already being placed on blockchain networks to prevent fraud. It has a secondary benefit of eliminating fees from all the middle men; the bank, the lawyer, title insurance company for example, and it can take a few minutes to search the record of all previous owners of the property.
Who needs an expensive title search and title insurance when all of the information is available with a few clicks of a mouse on a public decentralized non-reversible blockchain record? A company called Factom has been working on this very problem and soothing for about 5 years. Their token, FCT, can also be used to store other types of permanent records, as well.
4. Tokens Are Proof of Stake or Equity Ownership
Like owning an asset you can also own equity in companies or crypto-coins through tokens. Investors in coins are granted tokens which solidify their stake in the network. You can break up tokens, dilute shares, and of course transfer them easily to other investors. At the moment token ownership is not regulated or tracked. However, there is a case to be made that all companies can do ICO’s instead of IPO’s in order to:
- Store more information through tokens
- Have faster transfer times
- Reduce exchange fees
For this to happen, the network would have to become decentralized which ironically goes against the blockchain philosophy. But this does prove how flexible tokens can potentially be. Of course, all this has not been put into practice yet and it will be sometime before companies avoid IPOs. Still, you can buy into coins and get issued tokens for specific blockchain networks.
5. Tokens Act as Incentives
This one is sort of a culmination of a number of points above but still an important factor to consider. While ideas are great and a vision can be inspiring, like a world with no fiat currency or bureaucracy, there almost always has to be some kind of motivation behind everything. That’s where tokens come in. Investors, miners, and crypto traders or buyers are all incentivized to participate in a specific network because they are rewarded with tokens of said blockchain. This trade volume, as well as the future potential of each coin, is what ultimately determines its price.
6. Tokens Can be Tracking Devices
Tokens can be combined with RFID and other tracking technologies to keep up with shipping and handling of products, or to verify a product from manufacturer source to the end user.
I believe logistics and anti-counterfeit blockchains will the the fastest growing segment in blockchain over the next 5 years as their potential is realized. Companies can do this internally with ledgers and databases, but those are exposed to hacks, fraud and even system failed. Public decentralized records are resistant to all of that.
7. Crowdfunding Can be Hosted via Tokens
Say you want to launch a startup that sells wine for cats… You’re going to need investors. Traditionally, this is a rather arduous task. Instead, you can bypass the investors and go straight to the people! Essentially people would pre order your product and own tokens that track what you bought into, how many you ordered, and in this case whether you want red wine or white. It’s basically crowdfunding gone blockchain!
8. Tokenization is the Future
This is probably the second most important reason, apart from tokens powering the blockchain, why networks need tokens. Many believe that Tokenization is the future and has virtually an endless number of uses. Take for instance a digital artwork or some other non-physical asset, you could own parts of the asset by owning tokens. It doesn’t stop there.
Imagine a world where all documents, paperwork, certificates, and data are tokenized. Every time you go to the doctor’s office you wouldn’t have to fill out a form, your medical record would simply be tokenized and nurses can easily access your information through your token. The same goes for health insurance. Ok so what if you want to buy a car? You can check the sellers token to find out how old the car is and if there have been any accidents on it.
Collectible assets can have serial numbers and embedded RFID tags to always verify that you aren’t buying counterfeit goods. The industries that could take a 180-degree turn because of tokenization are endless and most of it has nothing to do with money! This is why blockchains need tokens. It’s not just the financial aspect of things. There are countless uses for tokens both practically and theoretically.
Tokens are still very much in their early stages but already they show great potential. Of course, even in this early stage their use and importance are undeniable. If you enjoyed this article and wish to learn more about specific tokens and their uses, our coverage of logistics and authenticity tokens is a great resource. Imagine buying a Rolex or Coach purse and knowing for certain that it isn’t a knock-off. Imagine an outbreak of food-born disease can be tracked back to a specific supplier in minutes, potentially savings hundreds or thousands more from falling ill.
It’s all going to be possible with cryptocurrency tokens and blockchain. Unlike the buzz phrase of 2017 “crypto is worthless, blockchain has value,” people are now starting to realize there is “no blockchain without cryptocurrency.“ It takes a token to execute and support the blockchain functions.
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