Preface: I first wrote the “Intro to Cryptoassets” the night before the inaugural issue of Distributed went to press in late 2016. My tardiness was less the consequence of procrastination, rather than a sudden realization that we had a gaping hole in a text that was supposed to introduce newcomers to this quickly emerging innovation. The term “cryptoassets” had not yet been popularized, and texts such as Chris Burniske and Jack Tatar’s (who helped with this updated version) Cryptoassets hadn’t been published. Yet I sensed the tidal wave of new asset issuance that was coming. That wave came crashing down upon this nascent industry in 2017 with the onslaught of ICOs, and this year with the rise of tokenized securities and non-fungible tokens. With the newest issue of Distributed ready to hit the press, I realized I had to update my original introduction to account for the emergence of crypto-tokens as a bonafide asset class, with a broader range of more defined characteristics. I hope this short piece can be used to help entrants to this revolutionary technology more easily understand the scale of its ramifications. —JG
It is unlikely that Satoshi Nakamoto, Bitcoin’s pseudonymous creator(s) initially realized they had invented more than just the world’s first modern cryptocurrency, a cryptographically secure, internet-based money with a provable supply, which incentivizes the security of a decentralized financial network. However, nearly a decade later, it’s clear Nakamato introduced an entirely new paradigm for value creation and exchange through his innovation — what we now call cryptoassets, or “tokens.”
The following iteration of cryptoassets after Bitcoin were other protocol tokens, which are the native cryptoassets of any blockchain or distributed ledger — database networks with no central server, often used as a reward to incentivize validation of transactions in the network. The creation of the second cryptoasset at the encouragement of Nakamoto, Namecoin, a decentralized domain naming service (DNS) using Bitcoin’s source codel was released in 2011. The subsequent cryptoassets to be introduced were less novel than Namecoin — typically attempts to create new cryptocurrencies, a subset of protocol tokens that attempt sovereign, digital money (like bitcoin.) Litecoin, Darkcoin, and countless others, copied Bitcoin’s open-source code, added new features such as speed or privacy, or tweaked the cryptography, earning this type of protocol token the disparaging term “alt-coins.” Between 2011 and 2014 hundreds of these cryptoassets emerged, and many gained market capitalizations that extended to the hundreds of millions of dollars.
Most of the attempts at cryptocurrency disappeared in the “cryptowinter” of 2014 and 2016, when the market capitalization of all cryptoassets collapsed. The small handful that survived, however, have since exploded in value. That being said, it should be noted that not even bitcoin has yet been adopted so broadly that it can be truly considered a “currency.” This partly explains the adoption of the term “protocol” or “network token,” which is also used to describe the native cryptoassets of blockchain and distributed ledger protocols that do not attempt to create digital money, per se (such as Ethereum’s ether, explained below.)
The third iteration of cryptoassets were Mastercoin and colored coins, first introduced in 2012 and 2013, respectively. Mastercoin’s mission was to become a standardized protocol and token built as a second layer of the Bitcoin network for secure, decentralized “smart properties” and “virtual currencies.” Colored coins are methods for associating physical world assets with addresses on the Bitcoin network. These can be seen as the initial attempts to develop tokenized real world assets — cryptoassets issued atop a pre-existing blockchain but tied to the value of offline assets such as currencies or property.
While neither of the aforementioned technologies failed to receive meaningful traction, Mastercoin did lead to the launch of Tether, an early stablecoin — a tokenized real world asset backed by fiat, or government-issued money, deposited in a bank account. This was designed to minimize the price volatility that is characteristic of most other, floating, cryptoassets. Other attempts at stablecoins have since been introduced to create similar cryptoassets but pegged to fiat in a more distributed manner. Using external economic incentives, both MakerDAI, which uses collateralized debt positions (CDPs,) and Basis, which is designed like a decentralized central bank, are prime examples.
It would be Ethereum, a new blockchain and protocol token (ether), first proposed in 2013 and released in 2015, which realized the potential outlined by previous technologies, and turned crypto-tokens into a bonafide, new, asset class. The major innovation that Ethereum brought forward was the concept of a programming language for smart contracts — effectively self-executing contracts with the terms of an agreement between parties directly written into lines of code. Not dissimilar to Mastercoin, this allowed the issuance of new cryptoassets without a new blockchain. But unlike Mastercoin, which was a slow, second-layer protocol and token, the faster Ethereum blockchain and its native smart contracts enables developers to create new cryptoassets with ease and, in theory, to build decentralized applications, or dapps — software with zero server downtime and censorship resistance.
One of the first dapps to be built atop of Ethereum was Augur, a decentralized prediction (betting) market platform. In 2014, Augur created one of the first utility tokens, which is a cryptoasset, similar to a tokenized real world asset in that it is issued atop a pre-existing blockchain with its own protocol token, but that enables an application to operate in a decentralized manner. Augur’s REP token allows its holders to stake their tokens in order to report on the outcome of bets, which earns them part of the application’s transaction fees, and creates a decentralized event resolution system. Utility tokens have since been created to facilitate computing power (Golem), advertising (Basic Attention Token), and a decentralized asset exchange protocol (0x.)
Utility tokens, and their growing popularity amongst startups as a fundraising mechanism, led to a surge of Initial Coin Offerings (ICOs) in 2017 — a form of crowdfunding first pioneered by Mastercoin, Ethereum, and Augur, which gives individuals the opportunity receive a portion of a new cryptoasset’s issuance and to bootstrap its network effects in return for investment.
Concerns about cryptoasset issuance and potential securities laws violations, buttressed by this technology’s capacity for more frictionless, liquid, and transparent forms of value exchange, led to a new subset of tokenized real world assets: the tokenized security or “security token.” These cryptoassets derive their value from an external, tradable investment asset, and are thus subject to securities regulations.The first tokenized security was created by a venture firm, Blockchain Capital, who created the BCAP token in early 2017. This token represented a limited partner interest in a venture fund, with each BCAP being a single share ($1 USD at the time of issuance.) Tokenized securities have since been issued for equity by companies like Documo, which provides document workflow solutions, cashflow by Spin, a scooter sharing startup, bonds by Neighborly, and image rights management via KODAKcoin. They’ve also been proposed for assets such real estate and intellectual property. Ethereum also spawned new tokenized real world assets that are not securities, such as DigixDAO, a gold-backed cryptoasset, and the newer stablecoins (above.)
The most recent cryptoasset to arise is the non-fungible token (or NFT.) An NFT is similar to security and utility tokens in its issuance, but is different in that each token is unique and cannot be used interchangeably (non-fungible.) The foremost example of NFTs is Cryptokitties, a dynamic, virtual collectible game, similar to baseball trading cards or Neopets in decades past. Non-fungible tokens draw on the provable digital scarcity and supply that Satoshi Nakamoto first invented with Bitcoin, and have been proposed for in-game items in video games, virtual memorabilia, and creating verifiably scarce digital art, in addition to tracking rare items in the physical world.
Bitcoin alone was a revolutionary concept — a math-based money and store of value, controlled by neither banks nor governments. But if the past decade of innovation in crypassets is any indication, Satoshi Nakamoto’s invention will be remembered as the spark that ignited a reinvention of finance and beyond, giving new meaning to our conception of “value” in the digital age.