If you keep a close eye on the tech news, you couldn’t help but notice the terms “token”, “ICO” and “Tokenization” spreading like wildfire from one publisher to another.

Previously, I tried to lay down in plain language what is ICO and why you might care, to later realize that to understand the rising popularity of ICOs, you need to understand the concept of tokenization first.

So What is Tokenization?

The concept isn’t new. You are probably familiar with tokenization already. Think about casino chips or subway tokens you use to “pay” your fare. Or when you are asked to exchange your cash for branded tokens to pay for drinks or entertainment at a certain event. All these tokens replace physical money and reduce the cash handling risks such as theft or fraud for instance.

Basically, “tokenization” stands for the process of substituting a sensitive data element (your cash) with a non-sensitive equivalent (token), that has no extrinsic meaning or value – you can’t pay with a subway token for anything else than the subway.

Sounds simple?

Now, let’s take a step further and apply the concept to the digital world.

Tokenization, Blockchain, and Cryptocurrencies

The particular appeal of tokenization is that it reduces the friction and cost of conducting a certain transaction. Again, think about a subway token – it’s priced exactly to match the fare amount and is not prone to volatility.

Now think about your typical financial transaction – a card payment for a fare:

  • The transaction occurs at a lower speed (not instantly). Your card is actually billed a couple of days later.
  • There’s a need to trust the chain of intermediates – the POS terminal should work with your card.
  • It relies on a single party. If your bank software is down, you can’t conduct the payment.
  • Limited interoperability. Paying in other currencies means additional conversion fees and so on.

Tokenizing an asset can reduce this friction and when it comes to financial operations – blockchain-based tokenization has proven to be the best solution so far.

To remind, here’s a great explanation of blockchain from Autonomous Research:

So the blockchain enabled the creation of tokens that could be transferred between two (or more) parties over the Internet without requiring the consent of any other party (e.g. a central authority such as a bank). All these transfers and changes are recorded in a public ledger (“Excel spreadsheet”).

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All the bitcoin transactions are recorded in the Bitcoin blockchain. Other tokens keep the records related to transfers and changes to their monetary base in their own blockchains respectively.

This is an important point as a token’s codebase is different from its blockchain databases.

Here’s a quick example to illustrate this point.

Someone decides to repurpose the US banking infrastructure to operate Canadian dollars. After all, both the US and Canada use “dollars” and they have a shared cultural origin. Yet, their monetary base is entirely different.

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The idea is similar with the tokens – the two token types can use similar codebases, but have different blockchain databases.

Where Do Tokens Come From?

Bakaj Srinivasan has proposed the next broad classification of tokens to explain how tokens are typically generated.

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Tokens based on new chains and forked Bitcoin code. Some enthusiasts started experimenting with the Bitcoin codebase and as a result came up with the so-called alt currencies as ZCash (boasting even higher privacy then Bitcoin) or Litecoin (a faster mind alternative to Bitcoin that uses another type of algorithm for mining). These tokens spur off the bitcoin blockchain and initiated their own blockchains.

Tokens based on new chains and new code. The next step of tokenization was the creation of a whole new breed of tokens based on new codebases. The most common example is Ethereum. Its codebase was built from scratch with new capabilities introduced through advanced programming.

Tokens based on forked chains and forked code. At some point, Ethereum faced a security crisis and part of the initial adopters decided to split and introduce their own “monetary policy”, which is now known as Ethereum Classic.

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Next, the new token needs to be adopted by a larger majority to retain its value. Typically either of the following scenarios takes place:

The new token is pre-mined – a portion of that tokens are allocated for the creators and related parties.

It goes on “crowdsale” – anyone interested on the web is invited to purchase the tokens.

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The token is used in an ICO – A company launches new digital currency using either of the ways described above and sells the tokens to the crowd of investors. Those, who chip in, don’t get an equity share in the company or receive dividends as it happens in traditional investment schemes – yet, they own the currency tokens and assume that those tokens will increase in value for a future sale.

Mining Tokens

You probably know that bitcoin and similar cryptocurrencies are obtained by “mining” – aka conducting complex calculations to redeem the reward.

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The incentive for miners to participate in creating hashes for blocks is the reward of “coins.” For example, an early miner of Bitcoin was paid 25 coins for successfully creating a hash. If he had held onto those 25 coins, even if he had never mined anything else successfully, he would now have a U.S. dollar value of $100,000.

It is no wonder that many tech-savvy individuals have decided to become miners and compete with one another to be the first one to create a successful hash for a block and collect the coins, using software that has specifically been written to mine blocks. And the more a miner is willing to spend on hardware and software, the greater the potential for “winning” and getting those coins.

The problem is this: It’s very easy for software to create a hash from a collection of data, in this case, financial transactions. So, there are protocols put in place that establish criteria for how a hash must look.

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This makes mining much more difficult, and more sophisticated hardware and software are required for miners to be successful. For this reason, a lot of would-be miners have dropped out of the “race,” usually because they cannot afford the sophistication now required to be competitive. So the more people get on the mining bandwagon – the scares the rewards become.

As Sebastian Quinn-Watson, a consultant with Blockchain Global, a bitcoin mining firm, pointed out:

“Today, about 1,700 bitcoins are generated a day. Basically, we are all fighting over one coin every 10 minutes.”

Basically, that why mining alt tokens has become more promising for professionals. For instance, Neuromation, a deep learning startup generating synthetic data for training neural networks, has developed a new reward system for miners.

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For executing certain services (such as generating labeled data), miners are rewarded with the platforms currency – neurotoken. The price for each action directly correlates with the price per unit of computation, meaning there’s a minimum token price floor setting. By optimizing computational resources and balancing the supply/demand in the marketplace, this startup plans to achieve a more fair reward system and avoid the scenario, where everyone is fighting for a single coin with little reward.

So basically, the miners are among the first to benefit from pursuing alternative tokens that are tied to a product-related token.

Tokenization At Large

The creation of tokens, however, isn’t limited to financial transactions only.

Considering its convenient, decentralized and secure nature, tokens have now become an attractive way to represent a certain business asset on the blockchain.

Here’s one curious example:

SingularDTV is pioneering in the decentralized entertainment industry. Their main idea is to give content creators full control over their content and provide a new monetization method – SNGLS token that represents the intellectual rights for the product.

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Content creators will get paid instantly when their content is consumed, instead of waiting for a monopolistic payout from some third-party mediator (e.g. YouTube or Netflix that takes a hefty cut out of profits too).

Each viewer will make a direct smart contract with an artist, choose appropriate usage policy to pay the artist for the specific content they want to access. Meaning, you are paying only for what you want to watch, rather than a bundle of all available/suggested content as it is now with most live streaming platforms.

The same approach could be applied to govern and manage relationships in multiple centralized industries such as stock trading, precious metal trading and basically any procedure assuming a paper certification process.

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Your asset (stock, diamond, real estate) becomes a token and it’s placed on blockchain to confirm the transaction, trace ownership and any other changes that happened along the way with no centralized authority to rely on as a mediator.

Specifically, that is why tokenization has become such a “hot” area across different industries lately.