At first glance, tokens can appear complicated. The oldest and perhaps simplest example of a digital token is Bitcoin. It’s often referred to as digital cash or digital gold — but which is it? And what gives it value? And how does it work? Going down this rabbit hole is fun, but time consuming, and ultimately not required to obtain a high-level understanding of the different types of tokens.
Tokens have many nuanced differentiators such as use case, structure, governance rights, fungibility, and others, and therefore fall into different classifications similar to how you might think of taxonomies in biology. Just like biologists classified the world into domains, kingdoms, phylums, etc., token designers are now discovering and classifying emerging tokens in the blockchain ecosystem.
By and large, tokens fall into two broad categories: fungible and non-fungible.
Fungible tokens are essentially interchangeable for one another and are most often compared to dollar bills. You don’t really care about the serial number or date of creation for the dollar bill a clerk gives you because the one printed in 1998 has the same nominal value and is accepted by the same people as the one printed yesterday.
Non-fungible tokens (NFTs) means that each one is unique. Plane tickets, for example, are unique in that each is tagged to a specific individual, time, flight, and destination. You can trade plane tickets with a random person at the airport, but it’s unlikely you’ll be able to use theirs to get to your desired destination.
So how are these fungible and non-fungible tokens used?
Fungible tokens are really great for regular transactions and standardized exchanges of value. We want one bitcoin from Alice to be equal in value and accepted by the same people as one bitcoin from Bob. All ERC-20 tokens on Ethereum, such as Augur or 0x, are also fungible, as are most other cryptocurrencies. You can use them to:
- Transact with other individuals and companies
- Stake on certain outcomes (e.g., outcomes of an Augur prediction market)
- Stake to provide a service (think taxi medallions)
- Use as collateral for crypto-backed loans
- Make loans
- … And most other things that you can also do with dollars
Non-fungible tokens, often represented by ERC-721’s on Ethereum, get quite a bit more interesting because they can essentially represent just about anything in the world. These can be broken up into two primary categories: digitally native and digital representations. They either exist on their own for their own sake or are tied to another object (whether physical or digital).
Cryptokitties is the most famous example of a digitally native non-fungible token. They were created as a blockchain-based game and reside within the Ethereum ecosystem. There weren’t physical plushies previously on which the kitties were based or a previous version of the game that didn’t use blockchain.
Land registries and home ownership “on the blockchain” is a common example of a digital representation non-fungible token. The land or the house itself is not on the blockchain, of course, but a record of it is. And if you create non-fungible tokens that represent land deeds on the blockchain so that whoever owns that token is the one that owns the land, then you’ve effectively created a blockchain-based digital representation of a real world asset.
What about consumer and security tokens?
This is yet another classification that’s important to understand, but on which token designers are still working out the kinks. Consumer tokens are not a legally-recognized distinction because nothing like it existed before and it doesn’t fit neatly into any established precedent.
For now, consumer tokens are viewed as giving access to a protocol’s or company’s products or service without implicating the securities laws.
When selling consumer tokens, projects should ensure that people are buying and using the token so that they can interact with that protocol or company– not so that they can speculate. This is really good for several reasons:
- If many speculators hold the token, its price will be artificially high, making it expensive for regular individuals to interact with the protocol or company
- Speculators increase the volatility of your token because they buy/sell it based on its future price, not its current utility
- Having real users, not speculators, in possession of these tokens creates a community of people interacting with your product, providing feedback, recommending it to their friends, and generally helping the network grow
Token Foundry takes this distinction seriously and has created the Token Foundry Standards, a framework for selling consumer tokens and launching decentralized networks in a way that directs the tokens offered in the sale to actual users of these networks.
Security tokens, on the other hand, are tradable blockchain-based assets that fall under traditional definitions of securities (i.e., debt or equity). They are subject to all the same regulations as regular non-blockchain based securities. There’s two really exciting areas in security tokens that hold a lot of promise:
- Securitizing more things
- Increasing liquidity, efficiency, speed of execution, and security
Securitizing is the process of “converting (an asset, especially a loan) into marketable securities, typically for the purpose of raising cash by selling them to other investors.” It can often be an expensive proposition, as there are numerous legal and financial restraints and requirements and third party costs involved in the issuance, management, tracking, securing, trade execution, settlement, etc. of these securities.
Blockchain and, more specifically, smart contracts offer the possibility of making those costs plummet while making these securities more liquid, cutting out middlemen to increase efficiency and speed of execution, and making them more secure (code is law). For example, you would be able to securitize many new assets like fine art that were previously cost-prohibitive, allowing for fractional ownership. You could also structure auditable collateralized debt obligations with programmatically defined payments to owners of various tranches that auto-execute, eliminating enormous inefficiencies in reconciliation.
The interesting bit is that fungible vs non-fungible and consumer vs security classifications actually interact. You can have:
- Fungible consumer tokens such as Augur tokens
- Non-fungible consumer tokens such as Cryptokitties
- Fungible securities such as blockchain-based equities
- Non-fungible securities such as blockchain-based land deeds
But aside from the classifications we have already discovered, the truth remains that we are more excited about ones that are still a mystery. No one could have predicted the incredible advances in the internet and how it would fundamentally change our social structures, networks, work styles, and many more things. This is the potential of tokens now — we don’t know what will come, but we know it will be incredible.