Original title: Defining tokens

Original authors: Miles Jennings, Scott Duke Kominers, Eddy Lazzarin

Compiled by: Shenchao TechFlow

As activity and innovation in token-based network models continues to increase, builders want to know how to distinguish between different types of tokens-and which token may be the best choice for their business. At the same time, consumers and policymakers are working to better understand the role and risks of blockchain tokens in applications.

To help organize the conversation, we provide definitions, examples, and frameworks to help you understand the seven types of tokens most commonly used by entrepreneurs: network tokens, securities tokens, company support tokens, functional tokens, collectible tokens, asset-backed tokens, and Memecoin. We outline them in more detail below.

Quick review: Tokens and their characteristics

Fundamentally speaking,Tokens achieve true digital ownership.

More accurately, a blockchain is a decentralized computer made up of a network of individual computers that maintain shared ledgers-actually an “air computer.” Tokens are data records on these ledgers that track quantities, permissions and other metadata. Crucially, these data records can only be changed based on rules encoded on the blockchain that can be used to grant enforceable rights.

Beneath this precision, there are many details that have an impact on design, functionality, value and risk: Because tokens are embedded in software, they can be programmed to represent almost anything-any digital form or property record. This means that tokens can be designed as digital stores of value such as Bitcoin, productive and consumer assets such as Ethereum, collectibles such as digital transaction cards and game items, payment stablecoins such as USDC, and even digital stocks.

Some tokens provide the holder with various rights (such as voting rights or economic rights), while others only allow the use of products or network services. Some tokens can be transferred between users, while some cannot. Some tokens are interchangeable, meaning that all units are equivalent (e.g., U.S. dollar bills), while others are non-interchangeable, meaning that they represent unique personal assets (unique, e.g., transaction cards, or even Mona Lisa).

These design choices are important because they determine whether a token is a good store or medium of exchange of value; whether it is a productive asset with intrinsic functionality and/or economic value; or whether it is inherently worthless. The characteristics of a particular token also determine how it will be treated under applicable laws.

So whether you are building blockchain-based projects, investing in tokens, or simply using tokens as a consumer, it is crucial to understand what to look for. It is important not to confuse Memecoin with web tokens. The rest of this article is designed to help eliminate this confusion.

token type

Network Token

Internet tokens are essentially linked to the programmatic functions of blockchain or smart contract protocols, and their value also derives from this.

Network tokens often have built-in utility; they can be used to operate the network, reach consensus, coordinate protocol upgrades, or stimulate network action. The networks to which these tokens are associated usually (and in most cases should) contain economic mechanisms that drive the value of the tokens. These include programmatic buybacks, dividends, and other changes to the total supply of tokens through token creation (“taps”) or destruction (“sinks”) to introduce inflationary and deflationary pressures to serve the network.

Internet tokens can have trust dependencies similar to commodities and securities. In recognition of this, both the SEC’s 2019 framework and FIT21 stipulate that when these trust dependencies are alleviated through decentralization of the underlying network, network tokens will be excluded from U.S. securities law. The core essence of decentralization is that systems can operate without human control (individuals, companies, or management teams).

Network tokens are best suited to guide the creation of new networks, assign ownership or control of the network to its users, and/or ensure that the network can self-fund continuous and secure operations. Examples of network tokens include DOGE, Bitcoin’s BTC, Ethereum’s ETH, Solana’s SOL, and Uniswap’s UNI. In the context of smart contract protocols such as Uniswap and Aave, network tokens are sometimes called“Agreement token” or “application token”.

security tokens

Securities tokens represent the digital form of securities, which can be in traditional forms (such as corporate shares or corporate bonds) or can have special characteristics, such as providing interest in the profits of a limited liability company, a share of athletes ‘future income, or even future litigation settlement payments. Securitization rights.

Securities usually confer certain rights, ownership or interests on the holder, and their issuer usually has the unilateral power to affect or build asset risk. As the U.S. Securities and Exchange Commission is expected to modernize securities laws to allow on-chain trading, the number and types of securities that will be tokenized may increase, which could increase the efficiency and liquidity of securities markets. But even as categories continue to grow, digital securities will still be subject to U.S. securities laws

Securities tokens have been used to raise funds for commercial enterprises. Examples of security-based tokens include Etherfuse Stablebonds and Aspen Coin, which is a part-ownership interest in Aspen Regis Resort.

Company-backed tokens

Company-backed tokens are intrinsically linked to and derive value from off-chain applications, products or services operated by the company (or other centralized organization).

Like network tokens, company-backed tokens may use blockchain and smart contracts (for example, to facilitate payments). But because they are mainly related to off-chain operations rather than network ownership, companies can unilaterally control their issuance, utility and value. Like functional tokens (described below), company-backed tokens often have their own embedded utility. Unlike functional tokens, company-backed tokens are speculative.

Given these characteristics-although corporate-backed tokens do not confer clear rights, ownership, or benefits on the holder like traditional securities-they have a similar trust dependence as securities: their value essentially depends on the system controlled by the individual, company, or management team. Therefore, although company-backed tokens are not securities themselves, when company-backed tokens attract investment, their trading may be subject to U.S. securities laws.

Company-backed tokens may become a legal category. However, they have historically been used primarily to illegally circumvent securities laws-attracting investment in applications, products or services controlled by the company, and may serve as a proxy for the company’s equity or profit interest. Examples of company-backed tokens include FTT, which serves as a profit interest on the FTX exchange, or hypothetical cloud service providers issuing tokens that allow holders to access cloud services and receive a portion of the on-chain revenue from such services. At the same time, BNB is an example of a company-backed token that evolved into a network token with the launch of Binance Smart Chain. Company-backed tokens are sometimes referred to as ““, or, given their links to off-chain applications, they are called”Application Tokens」。

For more information on the differences between network tokens and company-backed tokens (including FTTs), please read “Network Tokens and Company-backed Tokens”.

Functional tokens

Functional tokens provide practicality within the system and are not used for investment purposes. Functional tokens are often used as currency in the digital economy. Examples include digital gold in games, loyalty points in membership programs, or points that can be redeemed for digital products and services.

Importantly, functional tokens are different from securities tokens, Internet tokens, and corporate-backed tokens because they are specifically designed to deter speculation. For example, these tokens may have no supply cap (meaning unlimited quantities can be minted) and/or limited transferability; if not used, they may expire or depreciate, or they may have monetary value and utility only in the system in which they were issued. Most importantly, they do not provide, promise or imply financial returns. Given that they are not suitable as investment products, functional tokens are generally not subject to U.S. securities laws.

Functional tokens are most suitable for use as currency in a digital economy, where issuers gain economic benefits by controlling the monetary policy of the digital economy (i.e., acting as a central bank) and maintaining a stable token value, rather than benefiting from the appreciation of token value. Examples include FLY, which is a loyalty and payment token for the Blackbird restaurant network. Another example is Pocketful of Quarters, an in-game asset that did not receive action relief from the Securities and Exchange Commission in 2019. Robux and Start Alliance Points have not yet been tokenized, but otherwise they embody the concept of functional tokens well. Functional tokens are sometimes called“Utility Tokens”,”Loyalty Tokens” or “Points”.

Collect tokens

The value, utility or meaning of a collectible token is derived from a record of ownership of tangible or intangible goods. For example, collectible tokens can be digital simulations or representations of art, musical works, or literary works; collectibles or merchandise, such as ticket stubs for concerts; membership in clubs or communities; or assets in games or metaverse, such as digital swords or plots of metaverse land.

These tokens are often irreplaceable and are often of practical use. For example, collectible tokens can serve as event licenses or tickets; can be used in video games (such as the sword); or can provide ownership related to intellectual property. Because collectible tokens are typically associated with finished products or products and do not rely on the efforts of third parties, they are generally not subject to U.S. securities laws.

Collectibles tokens are best used to convey ownership of tangible or intangible goods. Many (although not all)”NFT” products fall into this category. Examples include NFTs that convey ownership of digital art or other media; profile images (“pfps”) like CryptoPunks and Bored Apes, as well as other virtual fashion and branded goods; game items; and account records or identifiers (such as the ENS domain).

Some collectible tokens are directly associated with physical products, either providing a digital extension of the physical product experience, such as Pudgy Penguins toys and Generative Goods collectible cards, or providing a digital representation of physical goods for easy tracking and/or exchange, such as NFT event tickets and BAXUS’s vault alcohol NFT.

Asset-backed tokens

The value of asset-backed tokens stems from claims or economic risk on one or more underlying assets. These underlying assets may include real-world assets (such as commodities, fiat currencies, or securities) or digital assets (such as cryptocurrencies or equity in a liquidity pool).

Asset-backed tokens can be fully or partially collateralized and can be used for different purposes: as a store of value, hedging instruments, or on-chain financial primitives. Unlike collectibles tokens, which derive value from ownership of unique goods such as digital art, in-game items, or event tickets, asset-backed tokens function more like financial instruments, deriving value from their collateral, price-linked mechanisms, or redemption rights. However, the regulatory treatment of asset-backed tokens depends on their structure and use. Some tokens, such as legally backed stablecoins, are generally not subject to U.S. securities laws. Other tokens, such as certain derivative tokens, may be subject to securities or commodity regulation if they represent investment contracts or future-like instruments.

There are many use cases for asset-backed tokens, including:

·Stable coins,pegged to currency or assets;

·Derivative tokens,Provide synthetic exposure to underlying assets or financial positions;

·Liquidity Provider (LP) tokens,Claims representing pooled assets in the decentralized finance (DeFi) agreement;

·Deposit receipt tokens,Represents assets pledged or in custody.

Examples include USDC (a stablecoin backed by fiat currency), Compound’s C token (an LP token), Lido’s stETH (a liquidity pledge token), and OPYN’s Squeeth (a derivative token that tracks the price of ETH).

Memecoins

Memecoin is a token with no intrinsic utility or value, is usually associated with Internet memes or community-driven movements, and has no fundamental connection to the network, company or application.

Memecoin’s price is driven entirely by speculation and related market forces, making it highly susceptible to manipulation. Its main characteristics are the lack of intrinsic purpose (if there were, they would no longer be Memecoin), the lack of practicality, and the resulting zero-sum nature and volatility. Memecoin is generally not subject to U.S. securities laws, but remains subject to anti-fraud and market manipulation laws.

Examples include PEPE, SHIB and TRUMP.

Not all tokens fall into one of these categories perfectly-entrepreneurs regularly iterate and test new models. For example, social and reputation tokens may be more like functional tokens if they are not investable, and more like company-backed tokens if they are controlled by a centralized issuer. Tokens can also evolve from one category to another as token characteristics change or new functions are added, making classification difficult.

But the decisive feature of classifying these categories is the expected source of value accumulation. Flowcharts help illustrate this:

(Note: The picture is an AI translation, which is inconsistent with the original token definition)

Acknowledgements: We would like to thank Chris Dixon, Tim Roughgarden, and Bill Hinman for their helpful comments; as well as Tim Sullivan’s editors.

Miles Jennings is general counsel for a16z crypto, advising the company and its portfolio companies on decentralization, DAO, governance, NFT, and state and federal securities law.

Scott Duke Kominers is the Sarofim-Rock Professor of Business Administration at Harvard Business School, associate professor in the Department of Economics at Harvard University, and research partner at a16z crypto. He also advises companies on web3 strategy and marketing and incentive design; please see his website for further disclosures. He is also co-author of “Tokens for Everything: How NFT and Web3 will change the way we buy, sell, and create.”

Eddy Lazzarin is the chief technology officer of a16z crypto. He manages the engineering, research and security teams that support the investment process and work with portfolio companies to shape the future of the Internet.

original link