A Primer on Blockchains, Protocols, and Token Sales
Blockchains are changing the foundation of the global economy, and everyone is freaking out.
Opinionated tribes are invoking civil wars and “forking” into new tribes. Multiple heated battles are happening simultaneously (mostly on social media) while only a few people on the outside understand what’s going on.
Even the terminology being thrown around is confusing; there’s been a rapid evolution of new technology that has resulted in a lack of lingo consensus. What is an ICO vs. a token sale vs. a TGE? Are coins, tokens, and cryptocurrencies the same thing? What exactly is a “protocol”, “DAO”, “dApp”, etc…
Still, a growing number of people are realizing that there is a way to transfer assets to each other securely, reliably, publicly, irreversibly, and globally — without the need for a central authority.
Marketplace corporations that profit from buyer/seller transactions (like Uber, AirBnB, eBay, Amazon, etc…) are paying especially close attention.
We’ve entered a world where “trust” is moving toward distributed networks of machines that no one person, group, corporation, or government owns. These networks have rock-solid data integrity, zero downtime, and financial incentives for anyone who participates.
The implications of this are enormous.
How we do business with currency, credit, contracts, real estate, computing, communications, fundraising, and pretty much anything else you can think of is changing.
It’s happening right now, and it’s happening fast.
What is a blockchain?
Simply put, a blockchain is a very long list of transactions stored on a network of computers (i.e. a distributed ledger).
As an illustration, imagine writing on a piece of paper that resulted in thousands of other pieces of paper around the world magically showing what you wrote. A blockchain is like that.
What is special about this distributed ledger is:
- It can smartly establish consensus of state (i.e. the transactions) even if huge swaths of computers on the network go down.
- The transactions are organized as a list of timestamped line items in the ledger inside blocks of data.
- Cryptography ensures that past transactions cannot be deleted or modified.
- Everyone can see the history of every transaction since the beginning of the chain’s creation.
- People are financially incentivized to spin up computers in the network, which secures the network’s ongoing existence.
Thus, math secures a blockchain’s past, and money secures a blockchain’s future.
What are protocols?
Most of us are used to entrusting a bank to maintain a proper ledger and ensure money is not “double spent.” But with blockchains, that trust is in the network of computers and their cryptographically secure protocol (i.e. the software that governs rules, operations, and communication between network nodes).
As an example, the Internet today runs on a relatively “thin” layer of protocols such as TCP/IP, SMTP, HTTP, and HTTPS. These protocols establish rules for computers across a network to follow in order to communicate effectively.
On top of these protocols, a relatively “fat” layer of applications like Google, Facebook, Twitter, etc.. have been built to interface between data and people. With this setup, centralized organizations own all the data and users are required to create new accounts and enter credit card info (and other sensitive data) in multiple places. This is annoying, especially when our identity and payment info gets hacked.
Blockchains are also operated and accessed via protocols, but the critical difference is that instead of a few “thin” protocols, a huge number of niche protocols are being built (i.e. “fat protocols”) that will support the next generation of applications. This setup allows users to “own” their data, and it allows developers to leverage a multitude of protocols and blockchains that will enable more powerful, secure, and inexpensive solutions for everything from payments and banking, to healthcare and telecommunications.
How can people transfer assets to each other on a blockchain?
Functionally, to create a transaction, applications like a “wallet” are used to create a “public address” (derived from a “public key”) on the network, which indicates identity. An associated “private key” — which is kept hidden from the network — grants ownership.
Importantly, each transaction sent into the blockchain must:
- be sent to a public address
- be “signed” by a private key
- include a transaction fee to be collected by the computers powering the network (or just “burned”, depending on how the blockchain is setup).
This process keeps the ledger growing in size indefinitely, and properly signals to the operators of the machines (i.e. “miners”) that transactions are worth processing. Without a sufficient fee sent with a transaction, miners won’t bother processing it (this helps prevent spam and denial-of-service attacks).
What happens if I lose my private keys or they get stolen?
Then unfortunately you are out of luck. By design there is no central authority to call and help you get it back. This is why various offline solutions for storing and securing private keys have become popular recently.
(As an amusing aside: while promising to disintermediate institutions like banks, ironically a growing number of people in the crypto world are storing some or all of their private keys within safe deposit boxes… in banks.)
What can blockchains do?
Blockchains have utility to disintermediate central authorities & disrupt corporations that silo data and hoard profit. With new protocols for things like payments, file storage, computing, lending, identity, reputation, etc… a boom in marketplace innovation is already happening:
- Bitcoin, Litecoin, Ripple, etc… record financial transactions (threatening traditional “fiat” currencies).
- Filecoin, Storj, Siacoin, etc… enable file storage (threatening cloud storage providers).
- Steem, Golos, Leeroy, etc… pay people to make & discover social media content (threatening Twitter, Facebook, Snapchat, Instagram, etc… ).
- And so on…
Of course, these are just examples of blockchains in each market. There are plenty of other currencies, file storage protocols, and social media platforms rising up as well (not to mention every other market vertical!).
Can blockchains be more complex than this?
Yes, they can. As an example, blockchains like Ethereum can store transactions that contain executable code. This means it is now possible to write a computer program on a decentralized network to move assets around based on pre-defined contract conditions.
In other words, anyone can now do things like make a will that distributes money over defined time intervals, create their own digital token to represent something (like an asset, part of an asset, or a club membership), or write a series of rules to govern a company (or even a whole country!).
Overall, my friend Conrad (@lisperati) recently wrote to me the following important observation:
“One of the things that makes blockchains different from databases (and makes ethereum different from a “computer”) is that blockchains are essentially nothing more than protocols: Anybody could write their own piece of software, connect it to the ethereum network, and it would process transactions exactly like ethereum, as long as the ethereum protocol is followed. Blockchains are a sort of ‘protocolization’ of computer software.”
What are coins?
Cryptocurrencies like Bitcoin, Litecoin, Ripple, etc.. that are recorded in transactions on blockchains indicating only a change in a numerical value (e.g. “X sends 1.34 to Y”) are “coins.”
What are tokens?
While it’s common to hear the word “coin” and “token” used interchangeably, the terms are importantly different. A coin is a relatively simple type of token, whereas a token can be — and often is — much more sophisticated than a coin.
Tokens are a complicated subject because not all of them are the same. The various types have different names being used currently, but — categorically:
- Asset tokens represent ownership of an asset (e.g. a company, a venture capital fund, an expensive piece of art, etc…). An example is BCAP, which represents ownership in Blockchain Capital’s third fund.
- Usage tokens (aka “Use”, “Protocol”, “Intrinsic”, or “Native” tokens) are used as transaction fees to write to a blockchain. Bitcoin is the most common example here.
- Work tokens give owners permission to contribute, govern, and/or “do work” on a blockchain. An example would be Maker (MKR), which gives owners the ability to govern an organization that manages the stability of an underlying coin (DAI).
- Hybrid tokens have properties of two or more of the above. Filecoin, for example, will be both a usage token (you need it to use the system), and a work token (you need to own some in order to provide file storage).
And to clarify some other potentially confusing terms regarding tokens and coins:
- ERC20 tokens can be any token (most commonly created on Ethereum) that adheres to the ERC20 token standard of how to access information, transfer assets, and fire off events. This makes it easier for developers to create applications such as wallets that work with a variety of tokens.
- App coin (or “appcoin”) is older term for a token used to fund a project. When you read articles from more than 6–12 months ago, you’ll often see this term. When you come across this term, just think “token.”
- Alt coin (or “altcoin”) is an appcoin that powers it’s own blockchain. Any coin that does so besides Bitcoin (e.g. Ethereum) is, by definition, an altcoin.
- Meta coin (or “metacoin”, or “colored coin” when using bitcoin) is a token that is built on top of a blockchain that already has an underlying coin. Nowadays, people just use the term token, which can be confusing when project owners generate and sell tokens in a self-described “Initial Coin Offering.”
- And a Cryptocurrency, by the way, is any token recorded on a blockchain that is traded on a market as money.
Are all protocols created with an associated token?
No. To make you even more confused (or enlightened), protocols can be created with or without an associated token.
An example is what’s going on over at Augur:
“Augur combines the magic of prediction markets with the power of a decentralized network to create a stunningly accurate forecasting tool — and the chance for real money trading profits”
You should read more about Augur via their white paper, but for our purposes here, it’s important to know that they run their network with a protocol token (REP), which is a work token that allows owners to report on the outcomes of events that the market is attempting to predict. REP itself is a token with a tradable market value.
In addition, Augur leverages another, separate protocol (which you can also read about in their white paper) to handle the token transactions between buyers and sellers. This protocol, by design, is not associated with a token.
Thus, protocols and tokens are extremely open-ended and flexible.
What is an Initial Coin Offering (ICO)?
This buzzword — though catchy since it sounds like Initial Public Offering (IPO) — is a misnomer. Most “ICOs” these days are more accurately described as Token Sales or “Token Generating Events” (TGEs).
Practically, token sales are fundraising events that can happen (1) before a company launches, (2) while a product is being built, or (3) after a product has been in the market for awhile. Most token sales these days are done via ERC20 tokens on top of Ethereum.
A big list of past and upcoming token sales can be found here.
Soon we’ll see token sales be the default fundraising mechanism for new and existing companies. This will offer investors a more liquid asset (i.e. the ability to quickly buy things with the tokens or sell them). And, in addition to the capital they raised, founders retain the liquidity of the tokens they kept. This essentially results in a double-fundraising event!
This is an extremely powerful change to the status quo.
What are dApps?
Having discussed blockchains, protocols, and tokens, the final layer to the tech stack in the crypto-universe are consumer-facing platforms and applications. The term “dApp” refers to a “decentralized application”, which — long story short — means it’s built on top of one or more decentralized blockchains, protocols, and tokens.
A huge list of 645+ dApps can be found at https://dapps.ethercasts.com
What are Smart Contracts?
Made popular by the folks behind Ethereum, Smart Contracts (SCs) are executable code contained within transactions on a blockchain that execute predefined rules based on a set of conditions (i.e. “contracts”). SCs, therefore, are transaction protocols by definition; they move assets between parties reliably based on programmed instructions.
Indeed, new protocols in the form of smart contracts written to the Ethereum blockchain are created often. Examples are SCs baked into tokens that define the who, what, where, and when between token purchasers and generators. Many token sales these days are an agreement to deliver a token that has not yet been created (e.g. Filecoin’s recent token sale); the associated SC is programmed to distribute the new tokens appropriately once they become available.
What are DAOs?
DAOs are “Decentralized Autonomous Organizations” that are governed by Smart Contracts. DAOs should not be confused with “The DAO”, which did a token sale in May 2016 to raise ~$150m, of which ~$50m was hacked and stolen a few weeks later. This resulted in the shutdown of the organization and a fork of the Ethereum community after leaders decided to rollback the code and give the money back to the victims.
An example of an active DAO today is Maker, which — as mentioned above — grants MKR token holders the right to govern an underlying currency (DAI). The job of MKR token holders is to minimize the price volatility DAI against the IMF’s reserve asset, SDR. You can learn more about MKR and DAI in depth by reading their white paper here.
Big picture, the future of DAOs could be in autonomous organizations like, for example, a global fleet of self-driving cars using programmed rules to operate. Instead of being owned by a central authority, they could own themselves and use profits to add to their fleet, drive themselves to repair shops and pay for services, etc…
So yes, Uber & Lyft, be prepared for disruption by one or more robotic, AI-driven DAOs.
Author’s note: thanks in advance for any/all feedback, corrections, and comments to this article. Overall, it’s an amazing time to ponder new protocols and solve interesting problems with decentralized infrastructure. Subscribe to my newsletter and I’ll let you know when I write more about blockchains, protocols, token sales, startups, and the occasional underlying science of health & fitness topics. Special thanks to Andrew, Dave, Mike, Tony, JC, Shay, and Conrad for reviewing this article and providing feedback! And last but not least, remember to comment below, hit the clap button, and/or share this primer article with a friend if you’ve found it helpful. Thanks!