On Thursday, 24 April, 2008 one of the team members of The Factory Banking Project wrote what is perhaps one of the first full-fledged academic essays penned on digital currencies. There was no Blockchain, of course, but digital units of value had started appearing on the scene in simulation games as far back as 2003. The essay examined one of these easily-forged, early, crude versions of tradeable digital value units called the Linden dollar, created by Linden Lab, and the nascent community which had flourished around it in the simulation game Second Life. World Stock Exchanges, virtual land and simulation-based casinos were all the rage. The paper was graded A- by Michael McIntire, a Pulitzer prize finalist and investigative journalist for the New York Times. At the top of the page, McIntire’s summary notes included a caption that stands out:
I still would like to have seen some exploration of what motivates people to “invest” in these make-believe companies, other than to simply flip their shares to some other sucker. This certainly happens in the real world too, but at least the investment is based on something tangible and expectations that it will rise or fall are tied to all sorts of genuine factors. The virtual stock trading seems to be nothing more than a shell game where everybody is in on it.
A decade on, and it is alarming to note that the same things are often found said about digital assets in their contemporary incarnation as cryptocurrencies. For despite the enormous advances in technological production of digital currencies in the past decade, most notably marked by Satoshi’s Bitcoin Blockchain and the Ethereum smart contract created by Vitalik Buterin a few years after, there remains almost nothing in the way of value innovation on Blockchain today.
And yet is there is one defining feature of the turning point in every category of innovation imaginable, from commodities mining processes, to transportation technologies to pharmaceutical drugs to construction and most recently, in communications devices via the internet and data messaging applications, it is that value is the core sustainable driver of each of them. Since the industrial revolution and well into the start of the technological one, specific value superiorities exist around almost every innovation that becomes a perpetual force of social change.
Cryptocurrencies, loaded as they are with payment utility, are somewhat of an odd exception to this rule. Because they are at their heart mere methods of payment, there is a sense in which value is loaded onto these assets from the outset. Payment currencies always have transactional value at some point, after all, or they would be useless. In the past year however, more than 1,000 of such digital assets have littered the internet highways, with Blockchain giving rise to smart contracts wherein trillions of individual payment units have exploded onto the scene in the form of potential payment methods for various purposes.
At the same time, more conventional value investors, accustomed to the income-share model of investing, are beginning to concoct security tokens for Blockchain. These tokens, usually issued via a smart contract on a Blockchain such as Ethereum, are intended to be the answer to the exclusively payment utility-oriented units of digital value. This notion is more incomprehensible than the one wherein pure payment utility is all that Blockchain is about. Putting dividend-enhanced tokens on the Blockchain as securities issuances is about as revolutionary as giving a gold bar a dividend – it’s another way of expressing a simple interest-rate function. It does nothing whatsoever for global wealth redistribution other than put more money in the hands of the ones who already have the most.
Ironically but perhaps not surprisingly the bulk of confusion over this recent innovation has been perpetuated most of by securities regulators, particularly those in the United States. On July 25, 2017, the Securities & Exchange Commission issued an investor bulleting stating that, among other things “a virtual currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, unit of account, or store of value”. The Commission went on to characterize the issuance of such mediums of value exchange as being “issued by a virtual organization or other capital raising entity” adding that “a smart contract serves to automate certain functions of the organisation.”
In the same report, the Commission advised investors to “ask what your money will be used for and what rights the virtual coin or token provides to you. The promoter should have a clear business plan that you can read and that you understand.”
Less than six months later, in December last year, the SEC stopped a number of Initial Coin Offerings (ICOs) in their tracks, but most notable of all was a California restaurant offering utility tokens that doubled-up as multi-level marketing-style customer (token purchase) recruitment rewards. What was notable was the SEC’s comments about Munchee’s top management activities: the tokn was “marketed to people interested in those assets [the tokens] – and those profits [from the token sales] – rather than to people who, for example, might have wanted MUN tokens to buy advertising or increase their ‘tier’ as a reviewer on the Munchee App.” The token profits would involve “significant entrepreneurial and managerial efforts of others”, according to the SEC. Because of this, among other things, the tokens qualified as unregistered securities.
An investor who may have been diligently following the SEC’s advice from January and had thus scrutinized Muchee’s management team and business plan, and who had determed the individuals to be capable project leaders might have been a little surprised to note the return of the MUN tokens shortly after contributing to the ICO. That it was the same government agency that had initially instructed the investor to pay close attention to where the money was being deployed and for what purpose it was being used, and to make a judgement based on a project’s business case who now seemed to be implying this was not appropriate no doubt created more than a little confusion.
More puzzling still, in neither case was the Commission either right or wrong. Digital assets are indeed a “store of value” but smart contracts, which seek to synthetically replicate Blockchain payment mechanisms on a lighter-weight platform, have nothing at all to do with any of the “functions of an organization.” Similarly, while Munchee’s management ought not to have been implying that their own corporate profitability was relevant to their token offering, advocating that investors would be able to make a profit does not in and of itself transform a utility token sale into a full-fledged securities offering.
The challenge is one that requires a proper definition before absurdity takes hold. For it is clear that no one is participating in an offering of any sort of digital asset without having at all in mind the idea of selling later on for a profit. And yet the SEC seems to be most displeased about any sort of claim of future profit share from the purchase of utilty tokens on the part of promoters: that same December, the agency filed fraud charges against Canada-based Plexcorps founders for promoting a 1300% return on their utility tokens and a handful of other similar cases. It referred back to a July 2017 report in which the agency cited Stock.It’s use of the Decentralised Autonomous Organisation (DAO) to raise capital “with the objective of operating as a for-profit entity that would create and hold a corpus of assets through the sale of DAO Tokens to investors.”
These sorts of dichotomies have given rise to something resembling more than a mere mild absurdity in cryptocurrency circles, whereby one is by inference expected to issue and to purchase utility tokens that are tradeable on crypto exchanges around the world without any utterance of the intention of making a profit from doing so.
Clearly, this is simply not the case and rather than leave the subject of profit as a grey area, it would seem to be much more practical to define the sort of profit and the way in which profit occurs that is acceptable for Blockchain-based utility tokens than to suspend what is otherwise an inordinate amount of disbelief. It is our aim here to clarify these very issues and crystalize much more definitively the definition of a token offering as understood from the point of view of having predominant Blockchain utility.
A Decade of Useful But Valueless Innovation
When Vitalik Buterin composed the Ethereum White Paper in 2014, Blockchain technology evolved from being a somewhat geeky side-interest among coders and anarchists opposed to governmental fiscal controls into a commercially-manageable, potentially fully-fledged industrial-scale technology capable of handling a substantially increased number of payment transactions throughout the world. What is more, the sophisticated smart payments it enabled were made possible with a simple laptop and not much else.
What this meant was that in actuality, all of a sudden Blockchain solutions went from looking like bulky, standardised and expensive mining hardware obtainable via mail order from specialist manufacturers to negligible-cost, customised software that was easily available online. When a technology experiences such a dramatic shift in user optimised delivery it generally signals the dawning of a radical innovation, and so it was with Buterin’s Ethereum.
Since the deployment of the first smart contract in 2016 however, there has been nothing in the way of radical innovation in distributed ledger technologies. There has of course been plenty of money raised in initial coin offerings (ICOs) and not a few additional Blockchain innovations have been proposed and even developed over the past couple years, but by and large all of the activity that you see today was enabled by or copied from one source: the Ethereum Virtual Machine.
If that sounds surprising, then consider this: since long before Ethereum, right back to the point 9 years ago when Satoshi Nakomoto published the Bitcoin White Paper, the amount of value innovation in digital assets ahs equalled exactly zero. That’s right – despite nearly half a trillion dollars in market growth, over 1,000 different digital assets that have been created to trade on more than one hundred Blockchain currency exchanges, not one innovation has moved the dial an inch in terms of technological value innovation from the early days of the creation of Bitcoin.
This is to say in effect that, unbelievable as it may sound given the extent of financing made available to Blockchain solutions in the recent past, digital currencies are still valued, bought and sold on exactly the same basis that Bitcoin was bought and sold 9 years ago. Specifically, this means that buyers and sellers of digital currencies use only one criteria to pour billions of dollars into these digital value units today as they did to snap up hundreds of thousands of dollars of Bitcoin on Japan’s ill-fated Mt. Gox exchange in 2010: their best guess that the price of what they are buying might go up a bit more than it did yesterday.
That’s until today.
That the token might result in the purchaser of it making a profit is not necessarily in and of itself a regulatory problem. The issues arise when the token becomes disentangled from its core function as a mechanism of payment and instead seems to resemble a passive income investment that benefits the holder no matter what.
In Blockchain circles, one hears a lot the term “utility” thrown about, but what does this really mean? Utility is a type of functionality specific to a product’s manufacturing. A car stereo or a television has an entertainment utility; an automobile or a private jet has a transport utility etc. For Blockchain assets, the function is one of being a payment utility. Satoshi invented Blockchain as a means of manufacturing a method of unique and non-forgeable payment for use across the world by anyone, no matter their domestic, political, racial or whatever other conditions. Thus, Blockchain as a ledger based technology is understood to be a method of manufacturing payment.
For a payment mechanism to be valid, value must at some point in the utility equation be loaded onto the object in the same way as for transportation to be justified as a core utility, speed must be applied to the product. This is different however to saying that a car must perpetually be in motion and increasing in acceleration all the time, or even that it must be varying its acceleration constantly. If that were the case, a transport utility would resemble something that looked much more like a planet or a comet, and would assume a very different sort of utility – it would in effect have a satellite utility. Just as a transportation vehicle cannot be considered to be in the same class as a satellite operator, and must therefore be handled differently, so it is the case with Blockchian assets and securities. Specifically, the asset must be first and foremost predominantly a method of payment before it is anything else. Therefore, a dividend-loaded, guaranteed and/or management- enhanced token defeats the purpose and, one must concede, point, of justifying such utility in the first place.
That is not the same thing as saying that a token cannot be considered to be a profitable purchase item, however – it can. We believe we have found the perfect middle ground to the ambiguity that has been stirred up around this subject lately in our innovation of a new sort of payment utility – the manufacture of a profitable payment.
Profitable payments are a strange occurrence in conventional economic environments, since they only really occur in situations where there is either hyperinflation or hyperdeflation in one of the currencies being used to pay for goods or services. In cryptofinance however, hyperdeflation and hyperinflation are very much the norm in terms of everyday economic conditions.
This is because while they are structured for the most part like commodities, with finite supply sources and tightly-held (non-liquid) stakeholder clusters, they are traded against one another indiscriminately in the way that standard payment utilities – i.e. sovereign currencies – are. This unique status makes Blockchain assets the perfect profitable payment source.
A Basic Token Family Structure
By employing the concept of profitable payments in their utmost extensive use-cases within smart contracts, the token family is an innovation I conceived over a period of years beginning sometime in 2014. The delivery of the first half of the first token family system ever built was in January this year, marked by the deployment of the first utility derivative – FUTR, and its sibling token, FUTX.
In a nutshell, the system takes the form of an inter-dependent variety of smart contracts that form a combination of independently-operational but co-dependently operable token exchanges.
By virtue of harnessing the value of the most heavily-traded digital payment units created using distributed ledger technology (e.g. Ethereum), the model allows a cryptocurrency investor to evaluate and forecast the likely price performance of the gross payment utility of any currency.
What is really groundbreaking about the token family is that the measurements and forecasts of value in tokens such as Ethereum, NEO, EOS and others are not calculated with some weird new esoteric employment of financial knowledge, but in the exact same way that the earnings forecasts and net asset values are calculated of a share on a stock exchange. Still, even while the token’s utility can all-of-a-sudden be ascribed a value, there is no securitisation of any token employed whatsoever. You hard that right: at no point in the model is any digital asset remotely made comparable in functionality to the securities with which they can now be directly compared and valued side-by-side.
How Token Families Work
A token family is a composite of four tokens that are all playing essentially different functions within the system. These four token functions are broken down into their respective origins, which is to say, into seed, embryo, child and parent smart contracts (and sibling smart contracts that lie between children):
In the case of embryos (the first of which we called COE), the embryo token is sent to the embryo smart contract whereupon a small fee is extracted from it in the form of a fractional unit of the token and the embryo is sent back to the address from which it was sent along with a pre-set number of “parent” tokens. The embryo is frozen inside the sender’s wallet address for a fixed period of time thereafter (we opted for 3 months). The parent token (MNY) is then sent to the parent smart contract, a small fee is extracted and the remainder of the parent is destroyed. At that point, a small portion of the contents of the parent smart contract are then returned to the sender in exchange for the parent tokens sent.
What makes the innovation so potentially exciting however is not these admittedly very unusual series of swaps transactions. It’s what lies in the parent smart contract – which is to say, a multi- billion dollar daily average traded volume cryptocurrency. Further, the employment of derivative utility – in which value is referenced from one token to another – can have wildly different trading results, depending on how the asset is configured.
Take a look at how an option utility trades in ordinary circumstances and you begin to see the volatility advantage offered to traders of such blockchain assets:
The chart here represents a random one-day period in the life of COE when it was in Waves format (it is scheduled for release in a month’s time in ERC format – go to The Factory Banking Project website for more information). In a single 24-hour period, the token plummets 40% only to leap back 80% after that. Even by cryptocurrency standards, that is some substantial volatility.
At the same time, digital currencies such as FUTR have a steadier, more stable upward curve due to their near asset-backet properties:
In the token family, the child token represents a type of derivative payment functionality – it’s a reference point of the “seed” token, which is the end product of all this token harvesting intra-swap. So in the particular case of our own token family, Futereum, often called by its symbol FUTR, a derivative utility token, is exchanged with Ether in a regressive Fibonacci pattern throughout 10 levels. That means that in level 1, a sender of 1 ether receives back 114 FUTR; in level 2, the amount received in exchange for 1 ether is just 89 ether etc. At the end of the year FUTR can be swapped back via the child smart contract on a pro-rated 1-for-1 basis with the Ether held in the smart contract.
As the Ether is sent to the child smart contract, what happens is that a portfion of the Ether received retained – you’ve guessed it this time – as a fee. Part of that fee is split up and sent to be deposited in the parent smart contract where it is later exchanged for parent tokens via a separate swap.
Payer-To-Payee – The Profitable Exchange of Payment Identities
When you consider carefully what this innovation achieves, the core value proposition of the token family is nothing less than to make various types of potential payment problems – such as Ether, for example (e.g. it falls 20% in a day between payments occurring) – all-of-a-sudden into a unit that is measurable as a form of value-assessed financial markets traded solutions. Further, with no profit share, but rather just an interconnected series of swaps between unregulated assets, there is a complete lack of securitisation of tokens entered into the system.
In the case of the token family, the digital asset holder is afforded a unique prospect: that of effecting payment transactions and of harnessing the billions of other transactions of others in the digital area into an identifiable payee-actionable value system wherein all tokens can be valued on a net asset, price/ and even earnings per share comparison bases. In such a sense, the token family may turn out to disrupt much more than digital assets, but rather, mainstream finance itself.