What Is the Token Economy?

Chapter 4. Outlook

Just as the World Wide Web made it easy to publish a web page with a few lines of code, blockchain has made it easy to issue your own token in a few lines of code to represent any type of value or access right. It took us more than a decade to learn what we can really do with websites, but when we did, the Web2 took off. It might therefore take a while before the power of this new token economy ahead of us can be unleashed, and best practices manifested. At the time of writing this report, many important network effects have not yet kicked in—such as, for example, a widespread blockchain market adoption, scalability, usability, and the fact that the Web3 stack is still in development. There are also many regulatory uncertainties that need to be addressed before network effects can kick in. Although it is difficult to foresee when all of this could happen, it is likely that it will take less than 10 years. Furthermore, it is important to understand that no meaningful token application will run on blockchain only. Many use cases that are attributed to blockchain only—for example, transparency along the supply chain of goods and services—will be possible only in interaction with big data applications, artificial intelligence, and the Internet of Things. The convergence of these emergent technologies, which are all interdependent, will be more powerful than any single technology alone.

Many economists are skeptical that cryptographic tokens can permanently replace conventional currencies for the following reasons:

• There are strong network externalities that favor existing conventional currencies.

• There is currently a lack of sophisticated monetary policy rules leading to socially desirable stability and liquidity supply to the economy.

• From a classic economic perspective, it seems impossible to prespecify socially optimal “lender of last resort”¹ rules in a smart contract. The lack of such a lender of last resort makes a financial system prone to financial crises and systemic panics.

However, I would like to argue that we are in the very early stages of a potential token economy. I am confident that economic methods and practices will find their way into the smart contracts and token governance rules of future tokens. We can already see this happening in the cases of certain algorithmic stable tokens. Furthermore, it is important to note that many central banks are currently looking into or have already started to create what the International Monetary Fund refers to as a CBDC (Central Bank Digital Currency). CBDCs tokenize central bank money and make it crypto/DLT compatible, which might, at least in the short and medium term, resolve the stable token issue stated in the preceding chapters. While I am also skeptical that tokens will eradicate the role of classic monetary systems and central bank money, it is likely that tokenizing the economy, from real assets to digital assets and a series of access rights, will affect the role of central bank money as a geographical monopolist providing a medium of exchange. Cryptographic tokens represent a new, heterogenous asset class, potentially fulfilling a diverse range of economic functions, and might create a lot of competition to central bank money, if and when the network effects of mass adoption of that technology manifest. The speed at which these tokens are being issued is an indicator that a new tokenized economic system is emerging, and blockchain networks and similar distributed ledgers are the settlement layer of it. New legal frameworks and additional taxonomies will be needed in an ongoing fashion as these new structures transition from an early innovation phase to a more mature infrastructure phase.

One important bottleneck will be the emergence of multitoken capability of wallets and better key recovery solutions. Another bottleneck will be overcoming the challenge of token trading through the inefficiency of centralized exchanges. When P2P swapping of tokens matures and is adopted by wallet software, anyone will be able to exchange any token P2P, wallet to wallet, without any intermediary. In such a future scenario, powered by AI and blockchain, atomic swaps² could potentially introduce a tokenized barter economy powered by global trading platforms, without the coincidence-of-wants problem of the analog world.

Further Reading

This chapter is an abstract of the book Token Economy by Shermin Voshmgir (BlockchainHub, 2019). Many concepts referred to in this chapter, such as the “inefficiency of centralized exchanges” and “atomic swaps,” as well as different types of token use cases, are explained in detail in the full version of the book. The book also gives a general introduction to the technology and its applications as well as discussing its socioeconomic implications.

¹ The concept of lender of last resort goes back to Henry Thornton in the nineteenth century and refers to a mechanism for a safety net aimed at limiting the risk of disruption in the financial system, as a result of financial panics and bank runs spreading from one bank to the next due to a lack of liquidity in one. It was developed as a tool for crisis prevention. A lender of last resort is an institution that acts as a provider of liquidity to financial institutions that find themselves unable to obtain sufficient liquidity otherwise. It is a government guarantee of liquidity to financial institutions.

² Atomic swaps allow for P2P cross-chain trading and can be directly executed between separate blockchains, wallet to wallet, without a trusted intermediary such as an online exchange. They use a type of smart contract called a hash time-locked contract (HTLC) to secure the transaction, making sure that both parties to the trade fulfill the requirements of the trade. Unlike when trading on an online exchange, users have full control and ownership over their private keys when conducting such trades.