written by @veriphibtc
For those who have been actively interested in the Bitcoin and Blockchain ecosystem for the past number of years, you know how popular the concept of tokenization was back in 2017 and even today.
At that time, the fresh and more modern cryptocurrency platform, Ethereum, promised to democratize the issuance of stock shares and crowdfunding by giving the opportunity to everybody to issue proprietary digital tokens through smart contracts.
These digital tokens were issued through a process called Initial Coin Offerings (ICOs), resembling what is known in the financial world as an Initial Public Offering. An IPO is the process by which companies have to gain regulatory approval in order to make their company public. At this point, their shares can be traded on a public stock exchange.
These two processes are similar in nature as they intend to divide the ownership of a certain asset and distribute it to the public for a certain price. However, the way they are executed varies immensely. An IPO is a rigorously regulated process backed by the law. A company going public has to submit an audited financial statement that certifies the company is legitimately run and its managers can’t defraud their shareholders by stealing, confiscating, or over-inflating the public shares. Of course, this process, as rigorous as it is, isn’t perfect. Inevitably a few bad apples sneak through.
An ICO, in a vast majority of cases, isn’t checked by any legitimate regulatory authority. They can be started by practically anybody that has some minimal technical knowledge, as the most popular token issuance templates, such as the ERC-20, are simple to use. ICOs can also be launched anonymously or under a pseudonym, which makes it difficult for people that have been defrauded to pursue legal action.
Coupled with the Bitcoin bubble of that time, the ICO mania of 2017 led to the creation of thousands of tokens, each one promising to democratize something. There was a coin for dentists, a coin for marijuana enthusiasts (several, in fact!), and even one for Trump and Putin. No matter how ridiculous some of them sounded, the vast majority saw significant price increases throughout the duration of the bubble.
When the honeymoon phase evaporated, the fall for many was shocking and difficult to stomach.
The Token Fallacy and False Promises
So what exactly happened back then? Was the idea of tokenization bad in itself, or simply poorly executed?
The preferred platform to issue assets at the time was (and currently is) Ethereum. Some major bugs in smart contracts such as the DAO vulnerability led to massive hacks and scams. Furthermore, many people may have overestimated the power of a token as a right to ownership. In reality, most tokens (if they aren’t backed by any legal contracts) are simply fancy digital entries in some proprietary database and codebase.
Teams developing these coins are well aware of that reality and they make sure to display finely written disclaimers so they can avoid any legal trouble afterwards. For example, in the terms of conditions of the Basic Attention Token (BAT), which serves as a reward token for using the Brave browser, you can find the following disclaimer.
<< In particular, you understand and accept that BAT does not represent or confer any ownership right or stake, share or security or equivalent rights, or any right to receive future revenue shares, intellectual property rights, or any other form of participation in or relating to the Platform, and/or Company and its corporate affiliates, other than rights relating to the receipt of Services and use of the Platform, subject to limitations and conditions in these Terms and applicable Platform Terms and Policies (as defined below). BAT is not intended to be a digital currency, security, commodity, or any other kind of financial instrument.>>
As you can see, this effectively shows that this token, in particular, wasn’t supposed to even have a financial value as it represents in fact, nothing at all. This is the reality of a majority of tokens currently trading on the market.
But Digital Assets Are so Tempting
Even after all this, people are still enthusiastic about tokens and digital assets.
Even if the article so far sounded negative about tokens and digital assets in general, the enthusiasm and commercial developments around that concept are completely understandable as digital assets can potentially offer greater flexibility, programmability, liquidity, and security to an asset if executed properly technically and legally.
This can be used in various commercial applications and has been for ages. In fact, digital assets existed long before Bitcoin. The simplest prior example is likely in-game currencies exchangeable to tangible assets in real life in games, such as Runescape.
What If the Future of Digital Assets Resides in Bitcoin?
Bitcoin was often criticized for its lack of smart contracts and programmability features. The native language of Bitcoin transactions called Script is in fact pretty stiff in its structure making it hard to develop complicated applications on top of it.
This, however, is now slowly but steadily becoming a thing of the past as new complementary data structures, such as sidechains, are linked to the Bitcoin protocol.
Liquid, A Flexible Yet Robust Bitcoin Sidechain
One of the most popular Bitcoin sidechains is called Liquid and is developed by Blockstream.
Liquid is a federated sidechain that works as an inter-exchange settlement network. Its federation is composed of 15 members, known as functionaries, that are primarily large exchanges that can benefit from its use. They serve the roles of Watchmen and block signers. Liquid tokens are issued through a two-way peg to Bitcoin being used in the network. The functionaries are in charge of creating the blocks on the network at one-minute intervals, as well as supervising the funds on the mainnet when a peg-out is done.
This is a trusted network where the Functionaries form the consensus in a trust-minimized way. The incentives and fail-safes are in place to prevent collusion or the network from swallowing the funds.
The Liquid network, built on the Elements framework, has several benefits, one being the implementation of Confidential Transactions. This means that the transactions and their amounts sent on the network are hidden from all participants, except those involved in the transaction.
Another feature is its one-minute block times. This allows for the rapid transfer of funds between exchanges. This can both benefit the exchanges and traders alike who wish to move funds quickly between accounts without worrying about double-spends.
Issuing Digital Assets On Liquid
Anyone can use the Issued Assets feature on Liquid to create non-fungible tokens, security tokens, and stablecoins. Any digital asset can be created and shared on the Liquid Network. An issuer can decide on the issuance policies, the supply, and its functions, and decide on any other feature capable of the Liquid Network, such as confidentiality.
For example, the BTSE token is the first exchange token running on Liquid. Tether is also issued on the Liquid Network. Using tokens on Liquid has the advantage of allowing us to leverage what these tokens have to offer without having to structure entire money with its own monetary policy and network. These ultimately end up having strong forms of centralization, so why not have a system in place to regulate transactions based on existing and well-functioning money such as Bitcoin?
Whatever token you desire to create, you have a system in place to handle it. There aren’t externalities that can affect your assets’ underlying value. You can simply create digital goods, such as the ones found in games like Light Nite, where game pieces can be exchanged between players. You can sell your buddy armor and have the transaction tracked on the Liquid Network.
No Need to Leave the Bitcoin Ecosystem
Liquid’s privacy, scalability, security features, and governance structure make for a system that far outperforms other alternatives in the market. Tokens allow for easier and cost-effective transfers compared to traditional securities, as well as more efficient transfers of fractional interests in real-world assets.
Issuing securities, whether on a sidechain or not, can still be regulated by securities laws depending on the jurisdiction you’re in and your objectives. Liquid comes in handy in this regard since the platform lets users set the legislative criteria that their tokens must comply with using the Liquid script.
Tokenization has been popular for the past few years and tremendous developments have been made in order to provide better functionality. Some platforms are still easy to use and issue tokens with, such as ERC-20, and offer seemingly advanced features such as smart contracts. Even so, they are still vulnerable to loopholes allowing hackers to steal funds.
Comparatively, assets being issued on top of Bitcoin, by using the Liquid Network, for example, benefit from a much stronger network of participants enforcing the base layer’s protocol rules. Smart contracts such as multi-signature schemes are possible on the Liquid Network, and more is to come with an eventual implementation of Merklized Abstract Syntax Trees (MASTs) in Bitcoin.
It is important to question what the underlying structure of your asset is and properly weigh its benefits and drawbacks. Yes, Liquid is federated, and the consensus is achieved through a quorum of its members, but its objective is focused on allowing users to transact the Liquid token and the assets created securely and confidentially. If you’re dealing with entirely independent monetary ecosystems for every asset you wish to use in a blockchain data structure or ones that do not offer the same level of security as Bitcoin, then the assets that you are using on them are vulnerable to the risks inherent in more centralized, malleable base-layer consensus rules.
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