What is a blockchain-based ‘token’? It can be tricky to wrap one’s mind around concepts such as the tokenisation of financial assets, token fractionalisation, and how smart contracts behave in certain scenarios, even for seasoned DeFi (decentralised finance which does not use intermediaries) industry practitioners.
Chances are you haven’t been interrogated on blockchain concepts by a crypto-obsessed six-year-old, but as Albert Einstein once said, ‘If you can’t explain it to a six-year-old, you probably don’t understand it yourself.’ With that in mind, I have taken a stab at explaining the tokenisation process by using an analogy to something all six-year-olds know: marbles.
Despite the diversity of tokens, most of them can be generalised into three main categories as defined in the Token Taxonomy Framework:
Fungible tokens are all identical and cannot be distinguished from each other. Each individual token is essentially interchangeable, like US dollars, company shares, or ounces of gold. This is probably the simplest and most common category of tokens, and basic use cases for fungible tokens are quite straightforward − the most common one being cryptocurrencies (such as Bitcoin or Ether).
Non-fungible tokens (NFT) are like a collection of different, unique marbles: they represent something unique or finite and therefore are not mutually interchangeable. NFTs are used to create verifiable digital scarcity, as well as representing asset ownership of things like real estate, luxury goods, works of art, or collectable objects in video games (CryptoKitties is an early example). The football club Barca issued tokens to the fans to be used as a discount for games or memorabilia. Essentially, NFTs are used for items which require a unique digital fingerprint. NFTs make possible a whole new variety of powerful opportunities for using blockchain technology.
Hybrid tokens are a mix of both and are therefore a bit more complex. Each token belongs to a class (sometimes also called category/partition/tranche). Inside a given class, all tokens are the same: they are fungible. But tokens from different classes can be distinguished from each other: they are non-fungible. Using the marble analogy, hybrid tokens are like groups of different-coloured marbles, identical to all and only those marbles of the same colour group. Hybrid token classes can for instance represent a fund share, a container on a ship, etc.
For any token, there are a set of pre-defined axioms or ‘rules’ dictating its behaviour in certain scenarios. For more common uses of tokens, such as financial asset tokens, a set of generalised Ethereum token standards have been built in order to ensure more seamless interoperability and integration with existing platforms and decentralised applications.
Blockchain solutions will operate on the Internet of Value without wall gardens. Therefore interoperability of tokens will be essential.
Ownership of ‘something’
A token digitally represents the ownership of something in a secure way, using cryptographic methods. ‘Something’ can be anything: a crypto asset, yes, but also a company share, a fund share, a syndicated loan, a corporate bond, a derivative, a real estate asset, a piece of art, or a luxury good.
The properties and requirements of a certain token differ depending on the use case. Choosing the right token from among the numerous options depends on the given use case.
In France, Mata Capita, a real estate management company, issued security tokens worth €350 million for three different funds.