Tokens are everywhere
The world is flooded with a wide variety of tokens, each with different characteristics. In fact, tokens are everywhere in our daily lives.
- The license to practice a profession is a token, which represents the fact that the holder has the necessary knowledge and experience to practice this profession.
- The membership card for a club is a token, which represents the fact that the holder is registered in this club.
- The key to a house is also a token as it certifies that the owner has paid the price for his stay in it.
In essence, a token is the means of trading or proof of a right to use a function.
In today’s world but also in the future, all tokens will tend to become digitally embedded in an ecosystem. An ecosystem is the whole structure of a project, which starts and develops a team. A blockchain ecosystem is a group of different technological elements capable of interacting to create a system that performs a specific function. The ecosystem includes the idea, the mode of operation, the operating system, and the token that it will use. Tokens fulfil many roles in an ecosystem. So, a token can represent an asset, or it can represent an auxiliary tool that an ecosystem has.
With the term token we can describe cryptocurrencies, but we can also describe digital assets that operate over the blockchain of another cryptocurrency, as many decentralized financing tokens (DeFi) do. Tokens help decentralized applications do everything from automating interest rates to selling virtual assets. They can also be held or exchanged like any other cryptocurrency. In the crypto world, the token holder can bet on the financial markets, vote on decisions within the token ecosystem, use pools that will yield interest, and many more.
The Crucial Factors
Token valuation is of the utmost importance and requires intensive analysis. Based on this analysis, an investor can choose to adopt and use a token, thus helping the evolution of the ecosystem in which the token operates. There are several critical factors that affect the value of an ecosystem and tokens. Critical factors are the following:
THE TEAM BEHIND THE ECOSYSTEM
An ecosystem is the whole structure of a project. The people behind the project are a key factor in the widespread adoption of the ecosystem and therefore the token within it. Α reliable ecosystem must be supported by a reliable team. Indeed, one of the most important reasons some ecosystems and tokens are highly trusted is their team. By checking LinkedIn and other sources of information, we can check the quality of the team that created the ecosystem and token and whether those in the team are trustworthy so that one can invest in their idea and the token they created.
INITIAL COIN OFFERING [ICO] & LOCK-UP PERIOD
How the token will be distributed after the Initial Coin Offering [ICO] is an important factor, which can be found in the white paper. What is important is to check the lock-up period of the tokens given to the team and the consultants. A positive sign is that the founders and the rest of the team will have a long lock-up period, which shows that they are interested in the long-term potential of their ecosystem and tokens.
Ecosystems often tend to focus on the technical side of the project, neglecting their community. It is obvious that emphasis should be placed on the technical nature of the project. However, what matters most is someone in the team interacts regularly with the community, thus giving users, due importance.
Without an active community, an ecosystem will not be successful. For the community to be active, the ecosystem must take care of and respect the community, because if it does not do so, no matter how good all the other fundamental and technical elements are, in the end, the ecosystem will fail. An ecosystem that gives due importance to the community makes the community active by creating strong branding. An active community operating in an ecosystem with strong branding is one that provides stability and value to a token.
THE MISSION AND USEFULNESS OF THE ECOSYSTEM
One of the most critical valuation factors concerns the mission that the ecosystem represents and how it will use the token in it. An ecosystem needs to perform a mission that should be clear to users. If tokens are used in an ecosystem only as a means of trading, then their mission is clear, and they do not need complex business models in their ecosystem. But if one uses the token, to be able to trade in the ecosystem by paying for example transaction fees (gas fee) or to access the platform functions or run Dapps (Decentralized Apps) then this variety of missions requires a complex business model.
In addition, what needs to be at the centre is the real usefulness of the ecosystem. The crucial question is: does the ecosystem bring real value to the user’s daily life?
THE REGULATORY FRAMEWORK
The expansion of the initial coin offering created the need for legal controls through various government bodies. An ecosystem must comply with all the regulations of the country in which it is based. It is of great importance for every ecosystem to have a strong legal team to ensure its legal compliance.
THE STRUCTURE OF A TOKEN
Perhaps the most difficult but also very important is to examine in depth the structure of the token in terms of how well it fits into the ecosystem as this will give the incentive for its adoption.
The analysis we need to do for this purpose has multiple parameters which are presented below.
The first thing we need to do is understand the type of token we are dealing with. There are many differentiation classes for tokens, some of which relate to their Layers.
- Tokens that operate on a blockchain basis are Layer 1 tokens
- Tokens that are built on the main blockchain such as Dapps are tokens that are at Layer 2.
The proper functioning of an ecosystem that is Layer 2, depends entirely on the proper functioning of the ecosystem that is in Layer 1. This means that if there are any problems with the blockchain in Layer 1, these problems will affect the prosperity of Layer 2. Although there is an attempt for the independence of the Layers, their interdependence remains high. So, if an application running at Layer 2 works well, then this good operation will be reflected positively at Layer 1 as well. Therefore, if the quality of applications at Layer 2 is high, this will give high value to the Layer 1 ecosystem.
In conclusion, we will need to know in which layer the token works and how it connects with the other layers.
Security Token or Utility Token
The term Security Token refers to an easy-to-use, negotiable financial instrument that holds some kind of monetary value. Represents a property position in an ecosystem held by the token holder.
Most tokens are classified as security tokens; however, a token, in order to acquire a financial nature (security token), must meet the following conditions:
- To have the form of investment.
- There should be an expected return related to the investment
- Profit should come from the efforts of the ecosystem and not from investors.
Security tokens are subject to state laws and regulations and are required to comply with these regulations. Their non-compliance leads to serious consequences, such as sanctions and possible termination of ecosystem development. Security tokens are assets that present profits and are entitled to interest or dividends.
If a token does not meet the above conditions, then it is classified as a Utility Token.
Utility tokens give their holders:
- right to use the ecosystem.
- voting rights in the ecosystem.
When a team creates a utility token, it means it is essentially creating a form of digital coupon that can be redeemed in the future. A digital coupon can be for reduced charges or special access to a product or service. Bitcoin, for example, is a utility token.
Utility Tokens are not legally an investment; therefore, they can be exempted from the provisions governing securities.
How Tokens enhance the Ecosystem
Tokens enhance their ecosystems in two ways:
- The first way is to create incentives for participation, from the users of the ecosystem.
- The second way is to be a tool for application development (Dapps) on the ecosystem platform.
A. Incentives For Participation
In cryptocurrencies such as Bitcoin, which is a layer 1 token, the participation incentive is based on the proof of work protocol. Proof Of Work [POW] protocol works as follows: Miners using computers with multiple graphics cards (GPUs) try to solve cryptographic puzzles to “extract” a block and add it to the block. Chain (process) is a process that requires a huge amount of energy and computing power.
When a miner manages to solve the puzzle, he presents his block to the network for verification. If approved, the block is added to the chain.
So, what encourages miners to get involved in this whole process? By finding a valid block, the miner gets a block as a reward.
Ethereum, on the other hand, is moving toward a Proof of Stake Mechanism (POS). In this protocol, users take on the role of “validator” as they will be required to lock some of their tokens as collateral. They will then start validating the blocks as follows: when they discover a block that they believe can be added to the chain, they will present it to the other validators for validation. If the block is added to the chain, then the validators will receive a reward. In case an Ethereum validator tries to act maliciously, in other words, if it acts against the system, then a penalty mechanism is activated. Under this mechanism, tokens entered into the system as collateral will be removed immediately. This ensures that the participants in the system act in accordance with the regulations.
B. Application Development
Creating reliable and reputable Dapps in an ecosystem is of great importance as it generates value in the ecosystem. Creating value in the ecosystem is done according to Metcalfe’s law.
Metcalfe’s law is a theory of the effect of the network, according to which the result of a telecommunication network is proportional to the square of the number of connected users of the system [n2].
Let’s look at an example with telephone devices.
If only one person had a phone (app), then it would not be valuable at all. However, if two or more people own a phone (app), then it immediately becomes more valuable because it helps these people connect with each other and share information.
The following diagram helps us to understand it:
According to the diagram above, if we have three telephones (apps) on the network, then three connections can be made. However, the remarkable thing is that if there are five telephones, then ten connections can be made, while if there are seven telephones in the network, then we have twenty-one connections, and with nine telephones, thirty-six connections. In other words, increasing the number of phones (apps) works exponentially on these connections. The more people using the network, the more users they will attract. The network is an ecosystem that can enjoy exponential growth when individuals use it according to Metcalfe’s law. The more people are involved in an ecosystem, the more valuable it becomes.
Increasing Ecosystem Value
The goal of an ecosystem is to utilize Metcalfe’s law to increase its value. To achieve this, an internal economy will need to be created in the ecosystem using tokens that will allow developers to create efficient projects. To achieve this goal there are two methodologies that can be followed.
- The first methodology concerns the integration of costs in the form of transaction fees (gas fees).
- The second methodology concerns the process of active participation in the validation of transactions, Stacking.
- Integration of “gas” costs
In terms of the form of commissions, a successful transaction or execution of a contract on the Ethereum platform requires a fee. This fee is referred to as “gas” and is priced in small portions of Ethereum, called gwei (or nanoeth). Additionally, “gas” is used to allocate resources for the Ethereum Virtual Machine (EVM) so that Dapps can run automatically in a secure, decentralized environment.
The “gas” price is determined by the volume of transactions currently observed for a product and the miners of the network, who may refuse to process a transaction if the price of gas does not meet their threshold.
The crucial issue is the integration of gas costs so as not to deplete the ecosystem’s resources. Smart contracts must be able to terminate within a specific time frame. To ensure that the contract is terminated and not entered into an endless loop, smart contract platforms such as Ethereum use an inherent fee meter called a “gas cost”. Each piece of an order in a smart contract is associated with a gas cost. Before running, the developer attaches a little gas to the contract. As soon as the gas is exhausted, the contract immediately ceases to be performed. The users of the smart contract pay the gas cost through the Ether token.
Stacking is the process of actively participating in the validation of transactions as an alternative way of mining. It is a form of investment, and all you need to do is keep a certain number of tokens unchanged, in a crypto wallet or in a central account (Staking Pool). This is made possible by the way blockchain technology works. As every blockchain transaction requires verification, this reward system uses users’ tokens, through their placement, to verify transactions and thus support the network. Essentially a user ” lock-up ” or “freeze”, tokens in a digital wallet (Smart Wallet) or in a “smart contract” (Smart Contract) to support the security and functions of a specific blockchain network. So, by locking or freezing tokens, users receive “rewards”.
In summary, focus on the way in which an ecosystem has been structured, if it creates incentives to reward the community in order that it is expanded, thus making the use of token more widespread and therefore more valuable. Take the time to research the team behind an ecosystem, the intentions of the founders and the team regarding the lock-up period of the tokens given to the team and advisors, the frequency and level of interaction with the community, what is the mission of the ecosystem and what kind of additional power does it give to the users. Last and not least, focus on the legal team if it can ensure legal compliance.