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The Periodic Table of Blockchain: How to Classify Tokens

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Dr. Pavel Kravchenko holds a Ph.D. in Technical Science and is the founder of Distributed Lab.


For many years, people believed that the Earth consisted of an amalgam of four elements: earth, fire, water, and air. It was not until nearly 1750 that scientists realized that fire is not an element, but the result of a process.

Later, in 1869, Dmitri Mendeleev unveiled her periodic table of elements, which showed what chemical elements might actually exist, including those that are not present here on Earth. Mendeleev's work has led to targeted research and a synthesis of elements, which has led to breakthroughs in many industries.

There is the impression that today's people do the same with digital resources – naming them as traditional crypto-currencies, ICO tokens, utility tokens etc. This leads to confusion for the media and the crowd.

They begin to believe that everything that contains crypto – or token – is magical and has new features and a new monetary model. Regulators are the last to catch up, sometimes allowing everything that seems innovative, without a thorough analysis of the issue.

The definition of certain numerical asset classification criteria will advance the entire industry and simplify the work of investors and regulators.

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Definitions and Preconditions

A digital asset is everything that exists in binary format, and it has the right to use it.

Digital resources are scarce – which means that at any given time, there can only be one owner (or group of owners) set of assets.

A token is a unit of account that represents the balance of its owner in a designated asset.

Classification principles

There are five processes in a digital accounting system, which can have at least three states (centralized, decentralized, impossible) and can be managed by one or more roles:

  • Governance
  • Guard
  • Issuance and Distribution
  • Treatment of Transactions
  • Verification

Different combinations of the ways these processes are managed lead to different types of digital assets (which we call the distributed periodic table).

Examples

These are the most common for terms now or established.

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Cryptocurrencies

A network that performs the issuance and initial distribution of a currency, in addition to processing transactions in a decentralized manner, using a secure and provable mathematical algorithm.

The five processes are managed by this algorithm, which is executed independently by each participant. The key property of a cryptocurrency is the level of decentralization (the number of participants and the correlation between their decisions).

Another important property is participation without permission, which requires a system without censorship.

The extreme conditions for cryptocurrency are:

  • Undetermined number of participants-validators:
    • who are completely anonymous
    • who have no reputation
    • and whose transactions are entirely private.
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Good examples are currencies based on proof of work, such as bitcoin and monero.

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currency of the central bank

A centralized and centrally managed five-process system in which digital currency is pegged to a national currency on a 1: 1 ratio.

Digital Currency

In some systems, processes such as transaction validation, setting up fees and updates can be managed by the decentralized network of users – while the issuance of currency and the initial distribution is managed by a centralized organization.

The guard is not applicable because there is no guarantee.

Good examples are Ripple, Stellar, IOTA.

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Tokens protected by commodities

A commodity is an article produced to satisfy wants or needs. Tokens backed by commodities represent property rights over a given amount of a product. Tokens are managed in a centralized system of governance, custody and issuance. These processes are performed by a service provider or by the custodian of a physical commodity.

A token is always supported by a fixed amount of the commodity, and the ratio of 1: 1 is guaranteed by a designated party.

Examples are the US dollar before 1971, a token that represented gold, or warehouse receipts – in these cases, processing and auditing are also centralized.

An example of the crypto world would be Tether, whose processing is decentralized.

Equity Tokens

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A security is a fungible financial instrument that represents a certain type of financial value.

The shares represent the property of a company or the participation in its sources of income. Security tokens represent the property of an underlying security or a portion of a cash flow generated by the system.

Tokens are managed in a system of centralized governance, custody and issuance. These processes are done by a custodian or by a company itself. A token always represents a certain number of shares, or a percentage of cash flow. The processing can be done centrally by a custodian.

DAO tokens, whose processing is decentralized, are an example of the world of encryption.

Accounting Tokens

Accounting tokens represent something that makes sense to report, but that makes no sense for the transfer.

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Governance, issuance, custody and audit are centralized. Identity, reputation and ratings are examples of such assets.

Identities of trusted sites belong to this category, although in this case the transmission, custody, and audit are decentralized.

Digital Collectors Items

A collector's item is an item considered to be valuable or of interest to a collector.

These objects are unique and non-fungible. The token represents the property of a particular object. Governance and issuance are centralized.

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CryptoKitties are examples of such assets.

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Utility Tokens

The utility is a quality of the utility of an object. The utility tokens represent the right to use the functionality of the system. The role of utility tokens is to make the use of the system simpler than it was without them, which is true under certain conditions.

Utility tokens provide several functions – such as internal currency, system value accumulation or accounting. In the long run, utility tokens must break into divisions – digital currency, security chips, accounting tokens. Governance and issuance are centralized.

How to determine the type of digital asset

Here are some questions to ask about which category a token belongs to:

  • Is the token representing a designated asset?
    1. Is the asset fungible?
    2. is provenance important?
  • Is the issue of the token predefined by a mathematical algorithm (constitution)?
    1. Is there a process of change of constitution by users?
  • Is it logical to transfer tokens between owners?
  • Does symbolic possession represent profit-sharing (the value or economic model) generated by the system?
  • Does the system have a specific owner who provides the service or guarantees the custody of an underlying asset?
  • Does a transaction with the token affect all participants in the system?
  • Is Token Ownership a Share in a Given Enterprise?
  • Is it logical that the price of the token increases indefinitely?
    1. How would the costs in the system be affected?
    2. If the system provides a service, would it become too expensive?
  • Can the system run without a token?
    1. Can I use other tokens (cryptocurrencies, etc.) for payments and rewards?
    2. Does the system need its own monetary policy (balance between supply and demand)?
    3. If the token is used for the prevention of DDoS attacks, are there other means of protection?

Analysis

Before the emergence of bitcoin, it was believed that all five processes could only be handled centrally.

Bitcoin, however, showed that it was perfectly possible to set up decentralized financial systems.

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When we said that each process can be run in three ways (centralized, decentralized or that the process is not possible), the result is that there are hundreds of possible combinations.

Let's explore some of them:

  • All processes are centralized – that's fine, and that gives us a central bank currency.
  • All processes are decentralized – an option that gives us bitcoin.
  • The first four processes are decentralized, but auditing is impossible – such systems exist, like cryptocurrency monero (or zcash).
  • The first four processes are decentralized, but the audit is centralized. This is possible – for example, if the initial secure settings for zcash had not been destroyed (which some suspect is the case).
  • Governance and issuance are centralized, but custody, processing, and auditing are decentralized – a case we see in Ripple or Stellar.
  • All processes are centralized, but transactions are not possible – it is PKI (Centralized Public Key Infrastructure).
  • Governance is centralized, custody, issuance, audit are decentralized, but transactions are impossible – this corresponds to identity on blockchain.
  • Transactions are impossible, everything else is decentralized (the audit may not be possible) – the identities of the web-of-trust.
  • The guard is impossible, the issue and the other processes are centralized – land register.
  • The guard is impossible. the issue and governance are centralized; processing and audit are decentralized – land register on a blockchain.
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Strange New Worlds

We are on the eve of a major breakthrough when we will see new new business models and the application of tokenization. They will become possible thanks to the technological improvements of the cryptographic tools (efficient homomorphic encryption, short and fast null knowledge proofs, secure multi-part computation, quantum computation), mesh networks, network infrastructure, etc.

These new business models will largely rely on new types of synthesized assets and lead to significant economic and social changes. It is important to have a precise vocabulary to make sense of it all.

Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which owns an interest in Ripple and Zcash Company, the for-profit entity that develops the zcash protocol.

Periodical image of the painting by Shutterstock

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