Sometimes described as ‘crowdfunding on steroids’, digital token issuing has recently become a preferred means of fundraising for many organisations. This is bringing new resources to innovators and enabling the funding of innovations which would be unfundable via conventional routes. Some of the protocols being funded this way are giving rise to new ways of coordinating resources, interacting and innovating on a truly global scale.
Through digital tokens fundraising organisations create and sell their own digital tokens online, often in exchange for common cryptocurrencies like Bitcoin or Ether. Ownership of the tokens is recorded on a blockchain – either a wholly new chain or, as is increasingly common, established blockchains like Ethereum. These new tokens can convey various rights: in some cases, they act like share equity in the organisation which issued them, in which case they are referred to as ‘security tokens’; in other cases, they are more akin to a pre-order of a future product, or the right to participate in a future service which the organisation is building, in which case they are called ‘utility tokens’. The difference between token types is somewhat analogous to airline shares versus AirMiles.
Such ‘crowdsales’ clearly have characteristics of both crowdfunding and initial public offerings (stock market floatation). Unlike traditional crowdfunding, however, the new tokens are typically available globally and tradeable via online secondary markets shortly after issuing – this greatly increases liquidity, encouraging investment.
This phenomenon is interesting for several reasons. First, within a very short space of time, token sales have become a major funding mechanism for innovative startups: in 2018, over $12 billion was raised globally via this route, or around 7 per cent of all venture capital worldwide. This new funding method has in turn enabled a digital ‘Cambrian Explosion’ – a rapid appearance and evolution of a wide variety of innovative digital firms, especially in the fields of blockchain and open, decentralised technology.
Significantly, these firms are freed from the pace and strategic constraints that venture capital usually entails, and hence arguably able to explore a wider range of innovative ideas. For example, Lithuanian digital bank Bankera underwent an initial coin offering (ICO) between November 2017 and early 2018, raising over $150 million. Vytautas Karalevicius, one of the co-founders, says that an ICO was definitely preferable to conventional venture capital: 'An investor looks to the company as an investment, not to the product the company is creating,' he says, 'and they have a short term vision, too'.
Other entrepreneurs have found token offerings better suited than venture capital given the stage of their business. For example, Vasja Veber, co-founder of Viberate, a curated live music database, turned to an ICO after failing to raise venture capital. 'Silicon Valley investors are only going to invest into companies that are [generating] at least some revenue, and we didn’t have that,' says Veber.
A second major benefit of tokenisation is reducing coordination costs and bringing new economic incentives into markets which otherwise would not be viable, thus enabling innovative value creation. For example, organisations like Storj and Filecoin are creating systems for decentralised cloud data storage, where users can pay to store their own files, and/or be paid for offering unused storage space into the network.
Tokens aid this process by facilitating micropayments between users, which may be otherwise infeasible, and by providing an incentive to help develop and adopt the system. The latter works because as the system matures and grows in popularity, demand for the associated tokens (which are usually limited in number but required for usage) increases, and hence they typically appreciate in price.
In this way, tokens help kick-start systems that have network effects, providing an incentive for early-adopters and thus solving the chicken-and-egg problem which has plagued many network-related innovations – that is, how to attract initial users to a network before that network has any real utility.
Thirdly, tokenisation is enabling new forms of organisation. Whilst some of the organisations raising funds in this way are conventional, legally-incorporated companies, others are instead temporary foundations which aim to dissolve themselves in due course, leaving behind ‘unowned’, self-governing, decentralised systems or protocols – like Bitcoin itself.
In fact, for many token offerings, the creation of such a protocol is the end-goal, rather than a profit-making company. Such innovations have been termed ‘fat protocols’, to denote the fact that much of the value lies in their creation and adoption, and that this value can be captured by token holders. This contrasts with earlier internet protocols like SMTP and TCP/IP, which were tremendous enablers of innovation, but whose value was captured primarily not by the protocol developers but by the internet companies which built applications on top of them.
Many hope that such protocols will democratise innovation on the internet, and allow all those who contribute to the success of new services to share in the value created – in contrast to the centralised, extractive, platform monopolies which characterise much of the web today. For example, user-generated content contributes much to Youtube’s estimated $160 billion value, but little of this accrues to the users themselves.
Taking such organisational innovation even further are new – and potentially revolutionary – entities known as ‘Distributed Autonomous Organisations’ (DAOs). These are cooperatives of people in pursuit of some common goal, trying to do for organisations what Bitcoin can do for money: that is, provide resilient, distributed systems of governance which do not require centralised authority to achieve consensus, are ‘trustless’ (minimizing the trust required of any single actor in the system and resilient to a minority of bad actors), and which can function largely autonomously. DAOs are, in essence, attempting to marry decentralised protocols with human collective intelligence – automating as much as possible, while developing ways to ensure that people interact reliably with the system.
Tokens can help kick-start systems that have network effects, providing an incentive for early-adopters and thus solving the chicken-and-egg problem which has plagued many network-related innovations – that is, how to attract initial users to a network before that network has any real utility.
While DAOs could potentially be created without digital tokens and related protocols, in practice almost all depend upon digital tokens as a means of fundraising, incentivising participants, co-ordinating and automating the transfer of resources, and ensuring accountability. The use of economic incentives to prevent bad actors within decentralised systems is central to all DAOs and indeed to all cryptocurrencies. The study of this emerging field, which draws heavily on game theory, has become known as ‘crypto-economics’ or ‘tokenomics’.
The provenance of digital tokens is both very new and very old. The current explosion of digital tokens and protocols has clearly been enabled by the acceptance in recent years of digital assets such as Bitcoin, together with the establishment of blockchain infrastructure like Ethereum (which not only acts as a distributed ledger of resources but enables the creation of ‘smart contracts’ – irrevocable computer programs that ‘live’ within the distributed network and automatically execute when specific conditions are met).
However, in other ways, digital tokens are clearly a continuation of the millennia-old financial innovations designed to allow the peer-to-peer exchange of value with as little friction as possible. They echo promissory notes and private currencies, and can also be seen as having similarities with local currencies, Conder tokens, and trade tokens – except that they are intended to spur the development of ecosystems which are functionally, rather than geographically, contained.
As with many of the other ‘innovations in innovation’ discussed in this collection, digital token sales are evolving exceptionally rapidly. ‘Initial Coin Offerings’ have morphed quickly into ‘Securities Token Offerings’ and ‘Initial Exchange Offerings’, reflecting the fact that the industry is grappling with regulation and trying to distance itself from disreputable actors. Nevertheless, much regulatory uncertainty remains around digital tokens: authorities in the US and in China have tended to view crowdsales as unauthorised fundraising activity, whilst many European regulators have taken a more liberal view, often issuing explicit guidelines for Initial Coin Offerings. Part of the future success of token crowdsales will thus depend on how this problem is resolved.
Other important factors will be public acceptance, trust, and usability. Whilst theoretically open to all, many token sales currently require some technical knowledge in order to participate, which may inhibit mass adoption. Similarly, whilst many of the systems are theoretically ‘trustless’ – in that the code is open-source and verifiable in principle – in practice a considerable degree of trust is needed for non-technical investors and users. If mechanisms are not developed to build such trust, this may again inhibit mass adoption.
Alternatively, just as brands played an important role historically in signifying ‘safe’ medicines before government regulation, the space may become dominated by the digital ecosystems of familiar names like Facebook and JPMorgan – to name but two of the corporations creating their own digital currencies. This may potentially undermine the benefits of decentralisation and open-source, which include security, democratisation and ‘permissionless’ innovation.
Perhaps the greatest future potential, however, lies with DAOs. Many challenges remain, including clarification of their legal status and liability, which will undoubtedly test much of our current law, especially if it leads to automated ‘firefly’ companies that exist for mere moments. The extreme volatility of cryptocurrencies also creates uncertainty for organisations whose principal assets are held as such. Finally, there are inevitable questions about the feasibility of hard-coding governance rules and structures which allow for all possible unexpected circumstances.
Nevertheless, through the use of digital tokens in decentralised systems, researchers and innovators are learning how to construct mechanisms for achieving consensus and economic coordination, without centralised control. They are learning how to use economic incentives to guarantee the reliable behaviour of crowds, and thus how to harness collective intelligence to automated systems that are fully transparent and incorruptible.
Solving these governance issues will provide decentralised, self-organizing collectives with new tools for coordinating resources on a genuinely global scale, increasing our capacity to solve some of the world’s hardest problems. As such, digital tokens, fat protocols and Distributed Autonomous Organisations may be some of the most powerful tools for innovation in the decades ahead.
 We presume a basic familiarity with blockchain and cryptocurrencies. There are numerous online primers, such as: https://taylorpearson.me/blockchain-explained/
 Source: Click Ventures Blockchain Ecosystem Report 2018. Excludes the $1.7 billion raised by Telegram.
 Coined by Joel Monégro, https://www.usv.com/blog/fat-protocols
 This argument is complicated by considerations of ‘consumer surplus’ – the value that consumers would pay for a service but receive for free – but the fact that tokenisation can improve this model has led some to call it ‘better-than-free’.
 Local currencies are currencies, typically complementary to the principal national currency, that can only be used within a particular sub-national geography, and are often intended to stimulate economic activity in that area. One historic example is Wörgl in Austria, which used a local currency during the Great Depression. Examples in the UK include the Brixton Pound and the Bristol Pound.
 Conder tokens were privately minted token coins, used mainly by businesses in the late eighteenth and early nineteenth centuries to address the national shortage of small denomination coins.
 Trade tokens have been used for centuries by businesses in lieu of cash, for various reasons including the pre-sale of goods, insulation from inflation and the desire to keep resources within the related ecosystem (e.g. paying staff with tokens that can be redeemed only in stores owned by the business).
 ‘ICO’ was an original term deliberately intended to mirror the term ‘IPO’; ‘STO’ evolved in response to ambiguity over whether some tokens should be treated as securities; ‘IEO’ is a more recent term, reflecting tokens whose issuance is managed by a cryptocurrency exchange, with a guaranteed listing on that exchange and potentially also some due diligence by the exchange concerned.