Tokens

Digital assets you can control with your wallet

To start, what's a token? In the physical world, a token is a jeton that has value within a circuit that recognizes it and that is accepted by its users. Vintage public telephone tokens, company's loyalty cards, and carbon credits are all examples of tokens.

A cryptographic token is a quantified and tradable unit of social or economic value recorded on the blockchain.

Tokens can be fungible, non-fungible, and soulbound.

Fungible

Fungible tokens represent coins much like cryptocurrencies bitcoin and ether. They are:

• interchangeable with tokens of the same type: I can exchange one coin for another coin, since they are fungible assets

• divisible into smaller pieces whose sum makes the whole

• transferable from one wallet to another

Technically, a native cryptocurrency for a blockchain like bitcoin and ether is different from a fungible token, like DAI and UNI, which lives on a blockchain but is not its native coin.

Non-Fungible

Soulbound

Programmatically, tokens are defined in token standards for smart contracts. A token standard is a minimum interface a smart contract belonging to the standard must implement to allow tokens to be managed, owned, and traded.

• the most common standard for fungible tokens on Ethereum is ERC-20

• the most common standard for non-fungible tokens on Ethereum is ERC-721

• there is still no commonly accepted token standard for soulbound tokens.

There is also the concept of multi-token standard, ERC-1155, for what are also called semi-fungible tokens. A semi-fungible token is a non-fungible token that has a supply, that is a number of identical (fungible) digital assets associated with the token. If the supply is 1, we boil down to a non-fungible token. If the supply is greater that 1, then there are many identical copies on a unique asset, like the very same editions of a unique artwork. In this way, the ERC-1155 token can do the same functions as an ERC-20 and ERC-721 token, and even both at the same time.

Tokenization or real world assets

To tokenize a real world asset (RWA) means to create a digital twin (a token) of the real asset. The digital twin is stored and exchanged on a blockchain.

Examples of RWAs that are being tokenized are fiat currencies, equities, government bonds, and real estate. The primary example is the tokenization of USD using stablecoins like USDT and USDC.

For instance, there are 3 key main benefits of tokenizing real estate on-chain:

1. Allowing real estate to be purchased by investors from all across the globe

2. Reduce the purchasing time from days to minutes

3. Lower cost of entry

Token applications

So far, blockchain token applications are mainly driven by finance, gaming and art.

Fungible tokens

The principal application of fungible tokens on programmable blockchains like Ethereum is Decentralized Finance or DeFi.

DeFi refers to the ecosystem comprised of financial applications that are being developed on top of blockchain systems. It aims to create a financial system that's open to everyone and minimizes one's need to trust and rely on central authorities.

Popular DeFi applications include:

• stablecoins: cryptocurrencies that attempt to peg their market value to some external reference, typically the U.S. dollar

• decentralized exchanges: applications in which you can provide liquidity to a pool of coins (market making) earning an interest or swap coins of a liquidity pool (market taking) paying a swap fee that goes to the liquidity providers

• lending and borrowing: services to lend your coins and earn an interest or borrow cryptocurrencies paying an interest and depositing a collateral as a guarantee

• staking: tools to stake your coins on a blockchain using the Proof-of-Stake consensus mechanism, like Ethereum and Solana, and get a reward interest or the possibility to become a validator of the chain, competing for the block rewards

DeFi vs TradFi. Image from Ethereum.org

Non-fungible tokens

These are notable use cases of non-fungible tokens (NFTs):

• profile pictures (PFPs), the most popular and traded are CryptoPunks and Bored Ape Yacht Club. PFPs are used as status symbol and profile pictures on social media accounts and metaverses

• digital art, with iconic projects Autoglyphs and Fidenza, and marketplaces SuperRare and ArtBlocks, where artists mint their artworks and collectors can bid and buy them

• decentralized metaverses, where many assets are tokenized as NFTs. Two notable examples are:

  • Sandbox, a metaverse where users can build, own, and monetize gaming experiences

  • Decentraland, a metaverse where users can buy and trade virtual lands; on a piece of land one can build things, for instance a digital art museum

Let's focus on the pipeline of operations that are necessary to mint and sell an NFT on a marketplace like SuperRare. We consider the case of the artwork Andy-Machine-Portrait-2020 by hex6c:

1. the artwork (an digital image in this case) and its metadata (title, description and keywords) are created by the artist

2. the artist interacts with the gallery's smart contract in a minting transaction in which an ERC721 NFT associated with the artwork is generated and transferred from the contract into the artist's wallet

3. the NFT is saved onchain and contains the address of the creation contract (contract address) and a progressive numeric identifier of the artwork within that contract (token id);

4. the metadata and the artwork file are instead stored offchain on decentralized file system like IPFS or Arweave. The minting transaction contains a link to a JSON file on IPFS that contains the metadata of the artwork and a further link to the artwork file also on IPFS (see the input data field and click on decode input data)

5. the artwork is now available on the primary market of the gallery. Collectors can bid by participating in an auction, signing transactions that interact with the gallery's smart contract, committing the funds offered in the contract. Any funds previously committed in lower bids are released

6. when deemed appropriate, the artist may accept the last bid made by signing a transaction interacting with the gallery's smart contract. In this case the NFT transfers from the artist's wallet to the collector's wallet and the offered cryptocurrency (net of the gallery commission of 18% on primary market) moves the other way round.

7. the artwork remains on the gallery's secondary market, where it can possibly change hands from collector to collector. In the case of a sale on the secondary market, the sale transaction transfers an artist royalty of 10% of the sale price to the original artist of the artwork, who therefore always retains a share in the ownership of the work even after it has been sold. Notice also a 3% gallery commission on secondary market.

Is the NFT idea new?

The NFT idea is not new in the art world: conceptually, it is precisely what Sol LeWitt did with his Wall drawings project.

LeWitt writes up (generative) instructions in a numbered certificate, and then different assistants might draw different renderings of the same instructions in different places at different times.

The certificate contains the following statement: this certification is a signature for the wall drawing and must accompany the wall drawing if it is sold or otherwise transferred.

Right-click-save

Why should I buy an NFT if I can right-click-save it?

First, what the collector buys is not the digital artwork itself, but the non-fungible certificate (NFT) associated with it. The buyer acquires the right to resell the token. The digital artwork is always visible and can be downloaded by everyone.

The artist retains the corpus mysticum (the intellectual property) and gives away the corpus mechanicum (the medium on which the idea rests), which in the context of crypto art is the NFT and in fact is immaterial.

A first reason to buy an NFT is to make an investment in order to resell the artwork at a higher price making a profit (financial speculation). A second reason is to support art and artists (patronage).

Soulbound tokens

Some possible use cases of soulbound tokens are illustrated below:

Soulbound token use cases. Image from NFTNow

• Verifiable credentials: SBTs can be used to create verifiable credentials that can be used to prove a person's identity, education, or other qualifications. For example, a student could earn an SBT to prove that they have graduated from a university.

• Governance rights: SBTs can be used to distribute governance rights to members of a community or organization. For example, a DAO could use SBTs to give members voting rights.

• Know Your Customer (KYC): SBTs can be used to verify a person's identity and KYC status. This could be useful for businesses that need to comply with KYC regulations.

• Credit scoring: SBTs can be used to create decentralized credit scoring systems. This could help people who have difficulty accessing traditional credit systems.

• Anti-spam and bot prevention: SBTs can be used to prevent spam and bots on social media platforms and other online communities. For example, a social media platform could require users to hold an SBT in order to post messages.

• Gaming: SBTs can be used to create new types of in-game items and rewards that are non-transferable and account-bound. This could create a more immersive and engaging gaming experience for players. In fact, the origin of the term soulbound comes from the popular online game World of Warcraft, where soulbinding is a game mechanism that prevents higher-level characters to lend their equipment to their friends and guild mates.