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About Tokens on Cardano

Cardano allows issuing tokens and writing decentralized applications. What is the difference between ADA coins and tokens? What market value can different tokens have and why? What is needed to happen for tokens to retain value over the long term? What are the risks related to holding tokens? Let's explore that in this article.

Cardanians.io 14-01-2022, 10:26 · 29 mins read
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TLDR

  • ADA coins are issued by Cardano Protocol. Tokens can be issued by anyone in the world. 
  • New tokens have a low network effect, a short history, and the price can be uncertain.
  • Price and value are two different things. We can find out the market price immediately. Value can be individual. 
  • Tokens can be NFT, they can be associated with digital or physical value, or they can have social meaning.
  • Tokens are bad money if they are volatile. If volatile tokens are used to pay for the use of a service, the project may become unusable. 
  • It is not always necessary to hold tokens for the long term. Sometimes you just need to buy them when you need to use them.
  • Staking tokens may not be economically sustainable or profitable.
  • Projects need tokens because they allow independence from the environment. The economy cannot be built on a single cryptocurrency. 
  • The market price is always driven primarily by demand. 
  • The emergence of state-independent money will lead to the creation of new groups. These groups may need tokens to manage themselves.

Issuing tokens

The first generation of blockchain projects came up with the idea that the number of native coins in circulation would be controlled by the protocol itself. Bitcoin is in full control of the monetary policy of the project and through BTC coins it essentially controls its own economic model. Cardano works very similarly, but uses its own native coins and has different rules for redistributing ADA coins within its ecosystem. In addition, Cardano allows users to issue their own tokens, at any time and in any amount. The Cardano protocol treats tokens similarly to ADA coins. Users can own tokens without an intermediary and the network can transmit them in a decentralized manner. In the case of tokens, however, the Cardano network has no control over the number of tokens issued, their release into circulation, or their purpose. All of this is the responsibility of the authors who issued the tokens. In this article, we will discuss what meaning or value these tokens may have.

Value and price

Economists have been studying the relationship between value and price since the 19th century, and have basically agreed that they are two different things. Price is a reality determined by the market, as it is the result of price negotiations between buyers and sellers. The market price is mainly influenced by supply and demand and we can usually find it out very easily. In a shop, for example, we can look at the price tag. In the case of cryptocurrencies, we can have a look on a server like coin-market-cap to find the current prices and their development over a longer period of time.

People buy cryptocurrencies for many reasons. The main ones are speculation, long-term investment, ideology, and specific uses. Often it’s a combination of several reasons together. We can find out the current price at any point in time with relative accuracy.

How to find out the value of coins and tokens correctly? Let’s first deal with native coins. In general, we can define value as the ability to satisfy a certain need. The more the need is demanded, the higher it can be worth. Blockchain networks have specific features or capabilities that people can use essentially as a service. What need do cryptocurrencies satisfy?

  • Native cryptocurrency coins usually have limited quantities. For example, ADA coins will only exist 45,000,000,000. Scarcity and the desire to own something of which there is a limited amount push the price higher.
  • Networks have the ability to transmit information and thus grow their number of users and hence the network effect. Blockchain networks transfer coins and some, like Cardano, can also transfer tokens. Networks can transfer value in a decentralized way. 
  • Cardano will allow people to issue their own tokens, so we can talk about the possibility of creating new value. 
  • Decentralized networks are generally trust machines, meaning they can establish trust between participants. The capabilities of this feature will grow over time. Smart contracts will enable more than just unconditional transferring value. Trust machines will thus allow for more complex mechanisms and through that new financial and social services.
  • Decentralization as a concept has the potential to solve some specific problems. A decentralized infrastructure is useful for things like ballot collection in voting, where the emphasis is on ensuring that the system is not owned by one particular party or state. Another problem is that the big IT giants have enormous power and can wipe anyone off their network. If the world is going to become even more digital and we are not only going to have fun in the Metaverse but also work there, the IT giants must not have so much control over us.

Obviously, the value will be perceived differently by each individual and mostly subjectively. Every person in the world, but also companies or countries, has different needs, preferences, ideas about the cost of using the network, ideological views, etc. Objectively, we can compare individual projects according to predetermined criteria, but we can only get close to the real value. We can compare the number of users, media interest, community size, number of transactions on the network, value transferred, adoption of the network by companies or countries, the growth curve of new users, and many other metrics. The value of a particular network will always be overestimated by some supporters and underestimated by opponents.

The market capitalization of projects and real value should correlate, but they may not. The crypto market can behave in a completely irrational way and it is logical. Blockchain technology is disruptive, which basically means that almost no one can correctly estimate the potential. Price bubbles and market irrationality is quite common.

Difference between native coins and tokens

Tokens will only have a certain market value if they are involved in a functioning market economy. People must have an incentive to hold and use the tokens. The Cardano network has succeeded in doing this and that is why ADA coins have a market value. Why is that? 

Cardano has been around since 2015 and ADA coins hit the market in 2017. The project has been around for a long time and people can see that the IOG team is still growing and the project is doing well both technologically and in terms of adoption. The IOG team has tried to build a strong community since the beginning and it is succeeding. ADA coins represent the belief in the success of the project, but they are also an opportunity to own a part of the project and participate in its success. Specifically, by owning ADA coins, owners will be able to make decisions about future development and receive rewards for being involved in decentralization. The newly issued ADA coins and the fees collected are redistributed to all participants who actively participate in the operation of the network. ADA coins are thus circulating and will continue to grow in importance as they will be the main payment medium in the Cardano network. ADA will serve as an underlying asset for stable coins, they can also be locked in various DeFi applications, ADA is used as payment for NFTs, and can be used to pay in the physical world.

It’s important to note that when someone releases new tokens on the Cardano network, those tokens usually don’t have anything that ADA coins have. Their value is individual and should be researched thoroughly before considering purchasing them.

The purpose of newly issued tokens can vary significantly and is defined by the issuer. Initially, only a small number of people know about tokens, so the network effect is negligible. It is difficult to estimate the market price of tokens and it is necessary to look for the value in the project itself or in what the tokens represent, whether in the digital or physical world. Tokens may not be listed on an exchange and it is quite possible that some will never be listed. However, this does not mean that they cannot have some added value for the user.

Tokens have different characteristics than native ADA coins, which can be an advantage. ADA coins have global significance and may be in high demand. This is not necessarily expected of tokens. An author may issue tokens with the expectation that they will only have some local or short-term significance that is not associated with price speculation. Stable coins, for example, are also just tokens, but because the price is stable, people are more likely to use them as a medium of exchange. For such a stable coin to work, it must be accepted by the merchants and it must be well assured that the price will be truly stable in the long term. A group of people, or a gaming team, may decide to issue their own coins for their own short-term use. Nobody expects these tokens to be in demand globally by large investment funds. However, they can fulfill their purpose.

The issuer of the tokens can arrange the issuance in a way that once they are issued, the issuer has no control over the number, existence, and circulation of the tokens. Users will own the tokens and decide what to do with them. This possibility did not exist until now, because in today’s client-server world, the issuer often has control over the database. Thus, the value of anything issued is physically owned by the issuer, despite the fact that the users are the owners. If the token issuer also decentralizes (at least partially) the service associated with the tokens, it can create a functioning economy over which it no longer has direct control.

Tokens will come and go on the Cardano blockchain. Not that the tokens will be deleted from the blockchain. Rather, they will cease to be of interest to users and thus to exchanges if they have listed given tokens. The ADA coin has been around since the beginning and will be relevant for the lifetime of the Cardano network. It is therefore the greatest certainty in terms of value retention and eventual growth. The value of ADA coins will grow with the success of DeFi services and tokens, however, their life will be shorter and the network effect will always be smaller. One could say that the success of the Cardano network will be the sum of the successes and failures of the individual services and tokens. A single killer application on Cardano can increase the price of not only the token associated with the application but also the ADA coins. On the other hand, if hackers succeed in breaking the security of applications, the platform as a whole may lose trust.

What can tokens be?

Tokens can be literally anything. It is up to the imagination of the authors and especially the users what they see value in. Let’s take a look at a few uses of tokens. The list will not be complete. We just want to outline some possibilities.

Tokens can represent digital art, as can be seen in the NFT trend. With the advent of the Metaverse, we can imagine a world where companies like Meta (Facebook) or Samsung build their world where people visit galleries, cinemas, or concerts and everything is built on NFTs. NFT tokens will represent not only images but also songs, videos, books, games, etc. Tokens in the Metaverse can be identities, tickets, tradable rights to view content, clothing (skin), and basically almost any item.

NFT is the current biggest blockchain trend and interestingly, no one expected it. A lot of people thought that DeFi would be the most important sector, but it was only NFT that forced many traditional companies to deal with blockchain technology. It shows how difficult it is to predict the evolution of disruptive technology. This is not to say that DeFi has lost relevance. DeFi is still a relevant sector, but at the moment it is overshadowed by NFT’s success.

Tokens can be associated with physical objects. This is often used in finance, where money, stocks, bonds, property, etc. can be tokenized. There can be a disconnect between what is written in the blockchain and what happens in the physical world. It is always good to know what the legal enforceability and risks are in terms of owning tokens on the blockchain.

Tokenization must provide users with some obvious advantage over using a database. The advantage may be the ability to omit intermediaries from some processes. A decentralized network runs 24/7 and is independent of servers. For example, it would be possible to trade stocks 24/7, including weekends. Moreover, without expensive and inefficient intermediaries.

Tokens are often issued in conjunction with some new service on the blockchain, such as a decentralized exchange (DEX). In this case, it is good to know what exactly the function of the tokens is. If you expect the price to rise, ask about whether there will be demand for the tokens and what benefits are associated with the tokens. Governance tokens are popular, but they are not necessarily high priced. Not everyone is interested in deciding what direction a given DEX should take. The team usually knows best. Ideally, a service’s tokens are somehow linked to its success. A workable economic model could be similar to how the Cardano network has it. A successful service should generate some profit, and that profit should be redistributed to the token holders. However, this model is too much like stocks, and regulators may not like it, especially in the US. Similar to regular start-up companies, many projects fail in the competition and die. In the world of cryptocurrencies, this will be doubly true.

Tokenisation, together with decentralization in general, enables the creation of new business models. With new models, profit can be redistributed in a different and fairer way, or features can be provided that client-server architecture does not allow. There is a lot of talk about how tokens can help celebrities or, for example, sports clubs to establish new ties with their fans and involve them in the decision-making process. Decentralized governance is likely to be a hot topic for years to come. As with the NFT, no one knows what other surprises we will see.

Few people realize that the most valuable thing we build on social media is media reach, and for authors, the most important thing is the connections with users. For example, the Twitter platform needs to ensure that users find exactly who they are looking for and not a fraudulent imposter account. For an author who has many followers, their followers are important. Once Twitter decides to remove an author from the platform, the author loses his followers. Would it be possible to decentralize the links between the author and his followers? The author could easily change platforms and still keep his followers. No one could take away his media reach. Ideally, there should be a mechanism to prevent the platform owner from deleting someone’s account.

The only ways that exist to disempower the IT giants are very strict regulation by the states or changing their decision-making processes. Decentralization can generally blunt the power of individuals and give decision-making power to the majority. Through tokens, there is probably a way to apply this concept to corporate governance processes. That is not to say, and we don’t expect, large companies to commit to this anytime soon.

Tokens allow people to create something completely new and take advantage of decentralization. Tokens can have a greater connection to the physical world. For example, they can be used by Oracles in order to establish facts from the physical world. The price of money and commodities, exchange rates, weather, match results, and many other things can be linked to the benefits of decentralization. Oracles services take advantage of the principles of decentralization, including economic incentives. In the past, we have seen a minimum of problems associated with Oracles, which is a positive. A higher degree of decentralization within mainstream financial services will bring greater user confidence and, more importantly, make these services globally available. Today’s centralized world is exclusive. Decentralization is automatically inclusive.

Now you have a general idea of what tokens can be. Let’s now take a look at some of the risks associated with holding tokens.

Tokens are bad as money

Some projects are trying to build a service or a game that is supposed to use its own tokens as money. However, volatile coins and tokens are not a good medium of exchange. In extreme cases, such tokens can prevent users from using the service or playing the game. 

Imagine an exchange with its own SWP token where you pay 1 SWP per swap. How much is that in USD? It could be $0.1 in a bear market and at the end of a bull run, it could be $10. So only those users, who were lucky enough to buy tokens cheaper, will be able to use the exchange. Newcomers will probably not be willing to buy SWP tokens to pay $10 per swap. However, in terms of tokens, the price will still be stable, i.e. 1 SWP. This economic model cannot work for long. The team would have to continuously adjust the price per swap in such a way that it reduces the price to, say, 0.1 SWP during the bull market.

You face a similar problem when buying NFTs. The price of an NFT is often expressed in the native coins of the blockchain network. For example, in ADA. If you buy an NFT today for 100 ADA, how much will you actually pay? You have to convert the price into USD. For example, the current price of an NFT is $130. But you could buy ADA coins a year ago in a bear market for $0.1, so you’re really only paying $10 for the NFT. A year from now, the ADA price might be $5. Will the NFT also be worth $500? Probably not, and this despite the fact that there will forever be a record in the blockchain that 100 ADA was paid for the NFT.

Note that if the price of coins increases over time, early adopters of the ADA cryptocurrency actually buy everything cheaper over time than those who buy ADA later. This phenomenon can create a sense of unfairness.

Payments with volatile coins and tokens are opaque and people are unable to stop converting value into fiat currencies. Things get complicated if you have to research the price in the past. The reason is obvious. People know the value of their labor and know how much they have in their wallets and what their social status is. People know the value of everything they normally buy with fiat currencies and they know what a reasonable price is. In the case of paying via volatile token or coin, this does not work well. The conversion is unnatural and will hinder the use of the service or purchase of NFT. Let’s just add that payments via cryptocurrencies for goods in the physical world will face a similar problem.

For any DeFi project to be economically sustainable in the long term, projects must carefully consider how they will incorporate tokens into the economic model. Fees for services could be in stable coins and tokens could serve only as a tool for redistribution of the profit among holders. In a rational world, the value of the tokens would then roughly correspond to the profit of the service and the future potential.

The question is whether the service should be paid for in cryptocurrency. As we described above, it does not make sense, and in principle, it does not matter whether one pays with the service’s own token or with cryptocurrency. In either case, users and the team face the risk of volatility. A long-term economically sustainable model must not be built on price speculation. Price stability is a very important factor for business. Shares are also not commonly used for payments, as you hold them if you believe in growth and sell when the company is not doing well. Tokens that replicate the stock model make sense. Such tokens would essentially represent the success of a given project. Tokens have the advantage over traditional stocks in that they are easier to engage in some on-chain governance. Moreover, some innovative models can be devised. For example, tokens can be used as collateral or for staking.

It is not always advantageous to hold tokens for the long term

If tokens offer a unique ability, it doesn’t mean you have to hold them all the time. Monero, for example, is known for making transactions anonymous. That’s a great feature, but if you need this service once a year, you can buy Monero right before you pay for something and spend it all. In other words, you don’t care what the current price of XMR coins is. If you need to make a $1000 payment, you buy up the given amount of XMR and pay. The recipient of the XMR coins may also be concerned about volatility, so they will sell the XMR immediately. Importantly, this model does not have the potential to maintain the value at the same level in the long term.

It can be similar to tokens. If tokens have some similar special feature, it doesn’t necessarily mean that it is worth holding such a token for the long term. If the token has no market value, you don’t have to worry about it. However, if it does, make sure it makes sense to hold the token even with the risk that it will lose market value. Holding tokens with the market price only makes sense if they give you some direct advantage that you need or want. 

Tokens can have a stable price. For example, if a service will sell tokens at a fixed fiat price as a right to consume content, there is no volatility risk associated with the long-term holding. You can sell the token on the market slightly below the price if you stop being interested in the service. If the service becomes more expensive over time due to inflation, you can buy cheaply today and profit in a few years.

Tokens that have a demonstrable value may be interesting, but this may fluctuate over time. If an artist sells the copyright of their song through a token, you can bet on the success of the song. Here, the value of the tokens will depend on how famous or popular the artist is. In this case, you need to verify that you are buying tokens from a real author and that it is not an identity fraud.

Until this kind of music trading becomes mainstream, you’re taking a risk too. Just because someone releases art via NFT doesn’t mean there will be a demand for NFT. Not because it’s not an interesting idea, but because most music consumers may not even know what blockchain, NFT, decentralization, etc. are. Most use cases need adoption. Companies like Meta, Microsoft, Samsung, Ubisoft, etc can bring masses of people to NFT. But we are not at that stage yet and it may take a few years to get there.

Staking might not always work well

Staking is an interesting concept in terms of motivation to hold coins or tokens. The reason is that it provides passive income. However, staking is not always economically sustainable or profitable.

If only, for example, 10% of the coins are in circulation and the rest are released through staking, inflation can be almost endless. It is important to remember that the network can create new coins for free. For staking to be economically sustainable and for tokens to keep value, the project must have some revenue to use for rewards. Ideally, most of the coins are in circulation, the number of coins is capped at some amount, and the rewards are the result of the project’s profit. For service to generate profit, it must be adopted and used. If there is no interest of people in the project, it cannot be profitable and therefore the rewards cannot be paid.

Do not confuse the number of token holders with the number of users. The number of token holders may be high, but the project mainly needs a large number of users who will pay for the service. A working economic model must have revenues on one side and expenses on the other. The rewards from staking are an expense from the perspective of the service. Staking is attractive, but unsustainable without revenue.

Staking is usually done with tokens that have a market price. If their price rises, the number of rewards will necessarily rise as well. This can be a problem if fees are paid in stable coins and the amount of fees collected does not cover the cost of the expected rewards. In such cases, staking may not be the ideal solution for distributing the profit of the service. It can be a challenge for teams to set the parameters of staking well from an economic perspective.

What if we do not need tokens?

It is sometimes argued that tokens are not needed at all and that all decentralized services can only be built on Bitcoin using BTC as a currency. Let’s look at this purely from an economic point of view. Something like this cannot be achieved in principle, primarily because of volatility. As we described above, a decentralized service cannot fix fees in volatile assets. There would always have to be someone who would change the amount of the fee depending on the value of the service relative to the current market price of bitcoin. 

Decentralized services will only be adopted if they are affordable and generate a stable profit to cover the cost of operation. In the first step, the costs of an underlying decentralized network (the first layer) must be covered. Each transaction in a block or processed smart contract is a cost that users must pay. Running a given service may involve additional costs and only the team can define how large these costs will be. The team may want a reward for creating the service and for maintaining it.

Tokens are well suited for on-chain governance. If, for example, ADA coins were used for everything, ADA whales could make decisions about pretty much every project in the Cardano ecosystem. Teams wouldn’t have a chance to create their own independent structure. With tokens, teams have the chance to create a model that ensures a high level of decentralization. For example, they can give tokens to users of the service and associate the validity of the tokens with a specific address. It won’t happen that tokens are bought in bulk to control the service. Such tokens may not have a market price, but they will allow users to make decisions and determine the future of the service.

Tokens allow projects the creation of their own economic models and their own rules. If a service has a limited capacity, it can issue 1000 tokens and provide 1000 units of service to the token holder each day. If there is demand for the service or product, people can trade the tokens on the open market.

It doesn’t make much sense for the current price of ADA or BTC coins to affect the economic model of each service. It makes sense to pay a predictable price for services. As for price speculation on the potential of projects, it is good that projects can create their own token and link that to potential success.

Thanks to tokens, each project has the chance to create its own independent means for measuring success. Thus, success or failure will depend on the project itself and not on the cryptocurrency. The price of cryptocurrency may rise just when people stop being interested in the project. Imagine if there were no stocks and the success of companies was measured by the value or power of USD. It would make no sense. All companies would do well or badly in exactly the same way. The failing projects would share the success of the thriving companies. In a bull market, everyone would prosper and in a bear market, everything would crash. The tokens would allow individual projects to be separated from each other.

With higher adoption, there will be some decoupling of projects’ dependence on the price of cryptocurrencies (mainly Bitcoin). We’ll probably see this first at the first layer protocols level. Later at the project level on platforms.

If we really want to create a functioning decentralized economy, we need more projects that will emerge and disappear over time. Projects with their own working economic model will together form one big global decentralized economy. If we decentralized only the currency, everything around it would be centralized. That is certainly a possibility too, but let’s not forget that a 100% decentralized project without interaction with the outside world has no chance of creating the most important thing for a functioning economy, and that is price stability.

Price is determined by demand

If there is a token on everyone’s radar that is traded on an exchange and has a market price, always think before you buy it. Tokens only have prices if there is demand for them. As we said in the introduction, you can find out the price quickly, but what matters to you is the value. Always ask yourself what the token is worth to you and what it might be worth to others. Try to find out how many people hold tokens and how many are in circulation. Be interested in what the initial distribution was and what the reasons were for it.

If the tokens are linked to the success of the service, try to find out everything relevant around the service. If the service is already up and running, find out how many people are using it. In the world of the Internet, the success of services is almost always based on the network effect. If the number of network users grows over time, the demand for tokens will almost certainly grow, and the price of tokens will naturally grow with it.

Don’t forget that in the digital world, it’s easy to create scarcity (a limited number of tokens). Thanks to tokens, almost anyone on the planet can do it for a small fee. What’s hard is creating some in-demand value and associating that value with tokens. Value can be anything in the physical or digital world. The value can be a service, content, secrets, money, financial products, your identity or work, etc. Always ensure that holding a token really represents real value and that you are able to sell the tokens. If you are unable to sell the tokens at the expected price, demand is low or your price is too high.

The social aspect of tokens

From our point of view, people greatly underestimate the social dimension of cryptocurrencies. Bitcoin is being talked about as the first money that is independent of the state. However, the state and money are close to each other. Money is one of the most important components of states, alongside, for example, national borders, culture, and history. If we create new independent money, we are necessarily creating a new group of people. This group does not have state borders but has some common history and even culture. If we allow disruption at the level of states, we must necessarily ask what will replace the states. Cryptocurrencies will not create a crowd of independent people. New groups will emerge, bound together by a particular cryptocurrency and later by history and culture.

Cryptocurrencies, but also tokens, can be helpful in creating new groups and with their management. For example, there are NFTs that give you the right to be in an exclusive group of people. You can say that people buy a membership through NFTs. Groups will sooner or later need to make decisions and vote together. This group only exists in a virtual world and individual members are physically located literally all over the world, so they will interact primarily digitally. This is one of the reasons why Twitter is so popular for communication between fans of individual cryptocurrency projects. We expect that platforms may eventually create their own meeting space, and tokens may be used for some form of governance. The metaverse makes sense in this context, as members of the groups can virtually meet each other there.

It is very hard to predict the future. However, if new groups are formed at the expense of existing ones, tokens will play a role in this. The only reason can be that you can exclusively own the tokens yourself and the owners of the Metaverse will not become the new rulers. Social networks can take away the most valuable thing you have, your attention and time. However, you feel good and you feel that you are spending time on Facebook voluntarily. If you are part of a crypto community or play a game you want to meet in the virtual world. It will be very similar to using Facebook and Twitter. You definitely don’t want some Metaverse administrator deleting your account, because that’s basically cutting you off from the world you wanted to be in.

Conclusion 

Viewed from a broader perspective, we are still in the early stages of blockchain technology adoption. Most people on the planet know what Bitcoin is, but only a tiny fraction of the population actually holds it in their own wallets. Don’t expect decentralized services and their tokens to be in high demand. People basically don’t even know where and how to buy tokens. The adoption of blockchain networks by existing companies can help the space a lot. Cardano is definitely one project that can succeed and in fact, has already succeeded. Fortune 500 company Dish is using Cardano. More big companies need to come along and implement their ideas on public blockchain networks. The influx of users grows will help the whole sector. 

The NFT industry has attracted the interest of big companies in blockchain technology. It seems that companies are not interested in payments via volatile coins but in other use-cases. We expect that interest in NFT will endure and other uses for tokens will be found within existing businesses. The advantage is that progressive startups can compete with large companies. The time of tokenization will come, but it will take time.

We hope we’ve helped you navigate the world of tokens. Many tokens have been created and more will be created. The intentions of token issuers are not always honest. Any technology can be exploited for personal enrichment, and it was much the same in the early days of the internet. So be very careful.

Source: About Tokens on Cardano

Author Cardanians.io
We are cryptocurrency enthusiasts, especially believing in Cardano. We are official ambassadors operating staking pool. We write articles, translate them and develop tools for the community.
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