Thursday 05, April 2018 by Jessica Combes

Tokenomics: meet the new face of value innovation


Reza Dari, CEO of Global Investment Bank, provides an exclusive insight into the power of distributed ledger technologies and how the bank is leveraging it.

Cryptocurrency is the new show in town and crowds are lining up for a glimpse of the action-packed opening act. The bitcoin hysteria and sudden surge of the so-called ‘Initial Coin Offerings' (ICO) have captivated public awareness by placing the spotlight on the abstract nature of money and value innovation. Protocol developers are raising millions of dollars on the back of untested use cases and theoretical white papers for technology protocols which often stand years ahead of the current rate of marketplace development and mainstream adaption.

Taunted by extreme volatility and wild price swings, cryptocurrencies have grabbed headlines as one of the most divisive topics in the world of finance today. As modern economists struggle to rationalise price predictions through traditional valuation analysis, policy makers scramble to catch up with the lightning speed of digital value innovation. In the aftermath of the opening act, fans and foes have crossed swords and passionate debates are heating up across the board. But in the midst of all the noise one question remains silently unanswered— where is the main featured act?

According to CoinDesk’s Bitcoin Price Index (BPI), bitcoin experienced an astronomical 2000 per cent rise in a wild swing from $1,000 to over $19,000 at its peak in December before falling below $7,000 in February. Other leading cryptocurrencies such as ether, litecoin, and ripple followed suit in a similar spike correlation. Referencing a recent Business Insider UK report, new cryptocurrency ICOs fetched over $5 billion in 2017 mostly supported by early-stage commercial concepts and a small team of developers.

There is no doubt that speculation has played a major role in the sudden growth of cryptocurrency marketspace as was the case in the early days of the information technology boom with investors and speculators throwing hard cash at anything with a dot-com attached to it. But on the flip side of the coin was the simultaneous expansion of key core technology infrastructure which continues to expand the boundaries of traditional market space till this day.

span style="font-size: small;">Once the dust was settled following the dot-com crash of 2001, it was crystal clear—the internet was here to stay. Similarly, today, as an increasing number of sceptics-turned-investors rush to reinvent the experience of early bitcoin days, new alternative coins (alt-coins) and ICOs are spreading like wildfire. However, as an increasing number of professional investors and regulators get more involved, ICOs will gradually evolve from their current form to access bigger pools of institutional capital. In December, Chicago exchanges CME Group and Cboe Global Markets launched bitcoin futures followed by Goldman Sachs and Morgan Stanley announcing plans to clear futures for large institutional clients paving the way for new alternative asset investment vehicles such as hedge funds, mutual funds, and ETFs which will gradually pull this once infamous asset class ever closer to the mainstream financial markets. More importantly, as token offerings start to comply with securities regulations a decrease in the number of conceptual pre-network ICOs is expected resulting in reduction of speculative token offerings and trading volumes followed by a cycle of sustained growth in utility value innovation. 

Unlocking the blocks
Blockchain, cryptocurrencies, and distributed ledger technologies (DLT) are often used interchangeably as they remain largely misunderstood by the general public; however, key fundamental distinctions are worthy of note. A distributed ledger is a database spread over several computing devices or nodes with each node replicating an identical copy of the ledger independently and without a central administrator.

Blockchain is one form of distributed ledger technology, which uses cryptography to bundle and link data in a chain of blocks. Blockchain is not necessarily a new technology in itself but a new architectural combination of pre-existing technologies such as P2P networking, cryptographic hashing, and distributed timestamping. And, despite the misleading name, what is generally referred to as a cryptocurrency is not really currency in the traditional sense but rather it is a digital utility token representing an exchangeable unit of account which can be acquired, stored, and transacted electronically over a distributed ledger network without a central third-party administrator.

Bitcoin, the original cryptocurrency, rose from the ashes of the 2008 global financial crisis as an experimental response to the prevailing sense of scepticism towards global financial institutions failing in their intended role as stewards of trust. Bitcoin is simply a digital unit of account which can be transacted, verified, and recorded on a fully decentralised distributed consensus ledger network (DCL) using blockchain technology. With the first recorded bitcoin payment transaction in 2010, an expression of value was electronically communicated peer-to-peer without any third-party intermediation. And with that, the property of trust which is a fundamental prerequisite in all socio-economic transactions shifted entirely from man to math for the first time.

In contrast with the inflationary print-on-demand protocol of modern fiat currencies, bitcoin protocol limits the total quantity of supply at 21 million units and also determines the rate at which new supply is created. Given that the supply side of the equation is predefined, pricing remains mostly a function of demand or perceived future value which is ultimately determined by the actual utility of the token and its adoption at scale.

Therefore, if digital tokens are to be entertained as investment opportunities, due consideration must be given to the proposed use case and long-term utility application as the basis of value instead of future pricing. Placing undue emphasis on market capitalisation instead of utility value innovation is highly misguided. The emergent application of bitcoin as a digital payment system has overwhelmingly dominated public perception of digital tokens, but from a strategic point of view, the value proposition of digital utility tokens is less as a currency and more as the underlying utility application of distributed ledger technologies to autonomously represent and communicate value without the traditional cost of trust intermediation.

One of the biggest obstacles standing in the way of wider mainstream adoption of digital tokens is the proof-of-work (PoW) scalability challenge embedded in first-generation blockchain protocols which require significant energy consumption for complex mathematical computations called mining. Blockchains, in their current form, have a relatively low throughput of about 10-100 transactions per second with transaction times ranging from several minutes to several hours. Bitcoin has a limitation of seven to 12 transactions per second as opposed to traditional mainstream payment systems such as VISA which facilitate 2,000 transactions per second and a peak capacity of up to 50,000 transactions per second. To overcome these barriers, various solutions are currently under research and development to improve network efficiency by replacing PoW with a more efficient proof-of-stake (PoS) protocol.

In addition, new off-chain alternatives such as Raiden and the Lightening Network are also attractive second layer protocol solutions which operate on top of public blockchains to facilitate transactions over an out-ofband connection residing outside of the public master ledger in order to enhance network capacity at the blockchain level. Block-less protocols are the next generation of distributed ledger technologies as an evolutionary extension of blockchain technologies but are fundamentally different.

span style="font-size: small;">Two such new technologies, Tangle and Hashgraph, have recently emerged as possible alternative solutions for scale. Tangle retains the distributed ledger feature of blockchain but uses Directed Acyclic Graph (DAG) instead to verify two random transactions on the network with little to no transaction cost as it does not involve mining. IOTA is a digital utility token using the Tangle open source public distributed ledger protocol to facilitate large-scale resource sharing on the internet of things. Similar to Tangle, Hashgraph is also a new blockless consensus alternative which uses DAG under a ‘gossip’ protocol. The Hashgraph whitepaper claims to have superior security and scalability with up to 250,000 transactions per second; however, it is not open source and has not been tested in non-permissioned (public) ledgers yet. 

Thinking outside the blocks
As the bitcoin mania continues, a speculative bubble is certainly on the rise but on the flip side of the coin—literally— is the expanding evolution of key core technologies which will continue to impact markets and disrupt industries for many decades to come. Everyone from bankers and economists to cab drivers and enthusiasts have a view on the future pricing of cryptocurrencies now but what has gone largely unnoticed is the dormant potential of their underlying technologies above and beyond their store of value applications. We are fortunate enough to be living and operating in one of the fastest growing technology innovation hubs in the world today which has embraced the power of digital transformation to lead the way for a better future.

Appreciating the vast potential of digital utility value innovation and encouraged by the visionary leadership of the UAE government, Global Investment Bank has embarked upon a journey to further explore the disruptive nature and impact of distributed ledger technologies across select industries in collaboration with a number of strategic partners globally. One industry I have been observing closely over the last few years is the film industry. I am convinced that the conventional media and entertainment business model is long overdue for a seismic paradigm shift and that distributed ledger technologies will lead a new wave of value innovation in this space.

Accordingly, our Digital Innovation Lab has been enthusiastically working on a ground-breaking distributed ledger utility platform in close collaboration with a select group of Hollywood production partners and film finance experts with the view of expanding market boundaries through application of digital utility tokens designed for deep consumer engagement and direct audience participation for the first time in the history of motion pictures. The legacy theatrical distribution model used today is completely disengaged from its consumer base with billions of dollars spent every year to blindly promote and market films without any real visibility on levels of audience engagement and emotional feedback. The motion picture industry has experienced multiple cycles of technological disruption throughout its history and emerging digital streaming and distribution platforms are just the start of a tsunami of innovation heading its way.

Another project we are working on at the moment is a distributed ledger precious stones trading platform to further enhancing market liquidity and transparency in conjunction with US and international securities laws. In recent years, precious stones manufacturers have faced liquidity challenges as an increasing number of banks pull back from extending inventory and trade finance facilities. We hold the view that fractionalised investment-grade security tokens backed by physical assets may help introduce new sources of liquidity beyond traditional physical traders as attractive alternative investments for larger institutional investors. We are now living in a digital era driven by a fast-growing generation of consumers holding a more abstract qualitative view of value where distributed ledger technologies offer the promise of an alternative multifunctional utility whereby users can communicate and express value in ways never possible before.

To that end, it is not far-fetched to envisage early manifestations of a decentralised autonomous organisation (DAO) over the next few years in form of a complex multi-layered smart contract structure, wherein complex governance rules and consumer protection policies are digitally embedded to form the organisational bylaws and implemented without human administrative intervention. Distributed ledger technologies may currently lack the maturity needed for mainstream adoption at scale in their current form but nonetheless they are fast expanding our digital infrastructure to reconstruct traditional governance systems and business models in ways never imagined before. Tokenomics is set to disrupt traditional intermediaries across various industries including but not limited to financial services, healthcare, telecommunication, media and entertainment. And make no mistake—distributed ledger technologies are here to stay!


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