We’ve heard it before.
“I like blockchain but not bitcoin.”
This is a sentiment usually echoed by industry outsiders who are ignorant of cryptocurrency’s underlying technology. And while it’s not an uncommon opinion, it is fundamentally wrong.
I’ll get into why. But first, let’s rewind a bit.
The Value Proposition of Blockchain
A blockchain is a type of public ledger. It’s a self-sustaining system used for recording and authenticating transactions between peers.
It is decentralized, meaning that there is no central authority that owns or operates it. Instead, it is a peer-to-peer network that lacks any single point of failure. This makes the blockchain immune to many security vulnerabilities known to centralized systems, such as those used by banks.
Blockchains use cryptography to facilitate secure and irreversible financial transactions, and then to record them in chronological order. For this reason, a blockchain cannot be tampered with. Once recorded, the ledger is set in stone. This is a mathematical certainty.
Bitcoin is the world’s leading cryptocurrency. Unlike commodities or hard currencies, cryptocurrencies are an asset class of their own. Cryptocurrencies like Bitcoin work through a blockchain to produce coins, and allow for their exchange. The blockchain provides a trustless system for cryptocurrencies. This allows cryptocurrencies to bypass some of the vulnerabilities inherent to other monetary platforms, such as the double spending problem.
The Ledger Needs a Token System
At its core, a blockchain is a currency-making machine. All cryptocurrencies, from Bitcoin to Ether, are blockchain tokens. These tokens are fundamental to blockchain technology, as they provide the incentive necessary to maintain the public ledger.
User participation is required for a blockchain to sustain itself. Operating the nodes (or “blocks”) requires energy-intensive computation. This is what’s called “mining”.
Since their computing power is necessary for the blockchain’s survival, miners need to be given an incentive to provide it. This incentive come in the form of “tokens” which the blockchain’s algorithm spits out for those who provide the requisite amount of computing power.
You can think of a token as a form of payment given out by the blockchain in exchange for the labour needed to keep the system alive.
Valuable Tokens Make the System Trustless
For a decentralized system to work, we know that it needs a ledger that produces tokens. But these tokens must also be scarce (i.e. in limited quantity) and transferable. This gives the tokens the qualities of a bearer asset. That is, it ensures that their value is untethered to the value of anything external to the system.
In other words, a token’s value cannot be fixed to an asset in the real world, such as an ounce of gold. Otherwise, you would have to trust that the other party would provide that gold for you in exchange for the token. This would rob the blockchain of its entire value proposition — that it is kept decentralized, or outside the control of any one trusted party.
Token Value Plays a Major Role in the Network’s Success
Blockchain networks rise and fall according to their popularity. Participation in the network is marked by the number of shares acquired through either the purchase or mining of the tokens. As the network grows in popularity, its tokens rise in value, which further encourages more user participation in the form of mining.
There’s no avoiding it. You can’t build a sustainable blockchain that doesn’t produce a token. Since these tokens are inherently scarce and transferable, they can be used as a means of exchange — or, you know, a currency.
The task for developers, then, is to reimagine the decentralized ledger. For a blockchain to not produce a currency would require the system to have a completely revamped incentive structure. To do this would usher in a new wave of industry adoption for blockchain, as it would introduce a wide range of new use cases for the technology.
But the real challenge is to find a way to replace the token system without unraveling the blockchain’s decentralized structure. Because without decentralization, what value can blockchain really provide?
Liam Hunt is a contributing author and freelance writer based out of Toronto, ON.