Week 42- How To Design A Token System
So you’ve decided that you need to use tokens for your project.
What’s next then? How do I get down to the brass tacks of token systems without getting too technical?
As the business owner, it would be foolish to just decide that you want to represent something with tokens because tokenisation is “on trend” and everyone is promising you that you can tokenise anything from your house to your underwear.
Tokenisation is not for every industry and asset class. It might be the case that traditional methods work much better and faster than modern methods.
You do however, have to consider whether you want to stomach these initial growing pains to position your business better for the moment when the adoption of tokenisation “crosses the chasm”.
Left Behind Like Domino’s?
During the advent of the internet, one of the first few use cases was the transaction of goods and services in the pizza industry. The first pizza joint to allow customers to go online and pay for their pizza was Pizza Hut, the foresight that was shown in 1994 was truly revolutionary because it proved that almost-instant faceless transactions were indeed possible, which was unheard of during the early days of the internet.
As they continued to see value in facilitating such a method to reach their customers, they began to invest and improve on their online capabilities. This allowed them to pull ahead of their rivals Domino’s that lagged behind in significantly. Domino’s relied almost all of their sales via the phone or store interactions. Pizza Hut was technologically far superior compared to any other pizza chain in the US.
By the time Domino’s had finally caught on to the internet, it was already too late. Pizza Hut had amassed $1 billion dollars of online transactions globally by 2008. They already had their foundations well cemented and was leaps and bounds ahead of Domino’s. It would take Domino’s a long time to catch up with Pizza Hut.
I see the same thing happening with the Tokenisation. I don’t mean this in an “internet-hype-messianic” way but I do believe that the finance and property industry in particular need to start looking into Tokenisation very seriously, for fear that they might end up in the junkyard 10 years down the line.
Of course I say this with the Great Financial Crisis firmly planted in my rear-view mirror, where many financial pundits had said it was the end of the finance industry in which the truth was far from that.
So, if businesses want to embark on the journey of engineering a token system, what kind of thinking should guide them through the decision process and design thinking?
There are 4 engineering lenses that businesses need to look through to find more clarity in their decision making.
- Technical Engineering
- Legal Engineering
- Economic Engineering
- Ethical Engineering
Lens #1 — Technical Engineering
Technical engineering of the system largely revolves around whether you are implementing an infrastructure token or an application token.
It is dependent on whether you require a whole ledger based infrastructure or if you want to piggyback off preexisting infrastructures as an application which will differ significantly in terms of developmental cost.
After that, you will need to consider a couple of technical factors.
- Security — How secure do you need your token to be? What kind of processes do you need to support and how can your technical team fulfill on that?
- Scalability — When scaling a ledger based solution, different techniques such as sharding, interoperability and state channels can be used. One needs to weigh the pros and cons before designing on the token structure.
- Privacy — Do you want to provide full privacy for your users like Monero does? Or do you want to control all the information in the system?
- Token standard —Which token best suits the work that needs to be done? Are you using an NFT or a plain vanilla ERC-20 token?
These questions will help guide you in your pursuit of which infrastructure you’d like to be attached to.
Lens #2 — Legal Engineering
This part is probably the most important aspect to consider.
Because laws around tokens and cryptocurrencies are still extremely new and subject to many changes, it might be the defining factor that will kill the viability of your project.
The laws around finance and property are particularly tricky to navigate, so it would help to consult a professional with these questions:
- Which national, cross-border or local laws do I need to abide by?
- What are all the regulatory bodies that I need to report to?
- Are my smart contracts legally compliant?
- Do I need to transfer my jurisdiction to another country to support what I want to achieve with my Web3 solution?
Lens #3 — Economic Engineering
Studying the economy of different token systems are extremely helpful in designing and engineering one by yourself. How this affects resource allocation, the flow value is something that might land you in hot water. If the system is too centralised, it can be open to exploitation (both inside and outside of the system).
Understanding the flow of goods and services will help pinpoint areas of concern and strength.
In regards of the economy within a company, understanding how the token system affects the cashflow of a company can help plan for different financial scenarios.
In the case of USD Tether, it has been reported that only about 74% of their tokens are backed by fiat USD and other debt based securities. This can affect the whole crypto market as “more” USDT is exchanging hands in the market and can cause the price of Bitcoin to inflate.
These factors can be dangerous and must be looked at carefully, both for the survival of your business and how it will affect the market as a whole.
Lens #4 — Ethical Engineering
This is probably the most overlooked part of any token design. Is your project an ethical project? Are you using the power of an immutable ledger to progress selfish agendas at the expense of other people?
Are you using a ledger based system to infringe on people’s rights? How much privacy should be designed into the system?
If a fully private system was designed, then this opens up floodgates to more seedy individuals using the system to their advantage. Would you be comfortable knowing your system is used to support potential criminal activity?
These questions need to be carefully thought out.
At the same time, designing the power structure of the system is important too, understanding who holds the most power is key to understand whether the system is truly “autonomous” and “decentralised”.
Token engineering is a very new field and one can expect it to grow with time. However, many decentralised finance (DeFi) projects have very poor token engineering which have led to massive technical hacks and a lack of specificity in their USP (unique selling point). Many projects copy one another and expect a different result.
This is all fine and dandy in a bull market, but once the crypto market hits a bear run, expect to see many lousy, me too projects quickly weeded out. Proper token engineering can help you find the USP needed to sustain a project as well as safeguard the business from nefarious actors in the ecosystem.
Hope you’ve enjoyed this week’s sharing!
Till next week!