Token Standards used for digital assets
Monte de Paschi was the world’s oldest bank back in the 15th century, but it took until the 20th century before there were global banking standards. And, as the FT reminds us: “Regulation, or lack of, is connected to each of these stages in the evolution of finance - it’s an essential step on the journey to legitimacy and widespread adoption. Asset classes - including equities, securities, cash, and real estate have been subject to waves of regulation. The US Securities Act of 1933, for example, was introduced following the 1929 stock market crash, and promised new transparency and fraud protection. As a brand-new asset class, crypto is set to follow this well-trodden trajectory.” For a few years, there have been calls for regulatory clarity and the need to agree standards as regards cryptocurrencies. In the light of the collapse of FTX, these clamours for regulation have unsurprisingly grown. Added to this, we are seeing more digital assets being created such as digital debt instruments, digital publicly traded equities and private equities, digital share classes of private equity (PE) and mutual funds, and digital ways to hold commodities, data, art and even fiat currencies (not to mention NFTs). The challenge is that, as yet, there are no agreed standards as to how these digital assets should be created and treated. This leads to confusion, where by making it harder for regulators to agree on any consistent means to monitoring the creation of digital assets.
In brief, standards are consensual rules that steer the design, development, behaviour and operation of digital assets on any given blockchain protocol. Different standards exist for different types of digital assets. Terminology is used in different ways, i.e., a digital asset, a token, a cryptocurrency or an NFT. Such terms are used interchangeably and could mean the same thing, or not. For example, crypto coins could be referred to as a replacement for traditional fiat currencies. A crypto token is a digital asset created on a blockchain or by using distributed ledger technology; crypto tokens then are traded on digital platforms. Different definitions of cryptocurrencies exist, such as those used by the Corporate Financial Institute, which include:
● payment cryptocurrency
● utility tokens
● central bank digital currencies (CBDCs)
Number of blockchain developers
There are now estimated to be over 25,000 developers and, with over 5,000 Ethereum developers, many firms have historically turned to the Ethereum blockchain to issue tokens. Ethereum’s ERC (Ethereum Request for Comment) is the most common type of standard and it has a myriad of standards, all fulfilling different purposes. Some of them (together with their functions) are listed below:
Other Ethereum standards and their functions
One standard that has been extensively used to create digital assets is the ERC3643 standard, which has now been used to create over $ 28 billion of tokenised assets and has been endorsed by the Ethereum community. Luc Falempin, CEO at Tokeny, comments:” The ERC3643 standard brings a common compliance framework to the tokenization industry. This means that tokenised assets may carry compliance rules and interact seamlessly with other players in the value chain. It is now possible to compliantly digitise any type of asset and to transfer them within seconds among market participants. Enforcing controls, tracking ownership, and accessing the asset data become real-time operations. The next key trend in finance is definitely a massive tokenization movement and the emergence of real-world assets in DeFi.” Other blockchains which are being employed to create tokens apart from Ethereum are SPL, Tezos, Flow, Neo, EOSIO, BEP and TRON. Just as TRC-20 is the standard for implementing tokens with the TRON Virtual Machine (TVM) on the TRON network, different standards exist for different blockchain platforms. In the case of multiple Ethereum standards, they are usually an update to older standards; ERC-20 by far being the most widely used token standard.
As different standards exist, the need for a common standard is inexistent. Multiple standards can co-exist, but how does this affect liquidity? As regards multiple standards, a ‘wrapping’ solves the problem of liquidity to a certain degree. In basic terms, ‘wrapped’ tokens enable tokens to be transferable from one blockchain to the other. Consensys explains wrapping to be as when a user ‘locks’ the original token in a smart contract, which then mints an equivalent number of wrapped tokens. Wrapping is analogous to a traditionally structured note issued by a DeFi robot and so to unlock your original tokens, you trade your wrapped tokens back to the smart contract. For instance, wrapped ETH (or WETH) transforms ETH into an ERC-20 which provides all the functionality and transferability of an ERC-20 token. However, disadvantages exist with wrapping such as high fees, increased contagion and disparity in the value of tokens. Unlike stablecoins, whose values are tied to fiat currencies, a wrapped token is linked to another token. Wrapped tokens also allow the said tokens to be used in DeFi applications where they are bought, sold and traded on digital asset exchanges. Whilst stocks are issued using the prospectuses and regulations based on the stock exchange on which they are floated, this is not the case with digital assets. All it takes to be listed on a ‘swap’ is for users to join the liquidity pool of the exchange blockchain platform. Cryptocurrencies can be traded like securities on digital exchanges but NFTs cannot as they are non fungible, i.e., not easy to exchange or mix with similar goods or assets.
Subsequently, there is a real need for the industry to coalesce and adopt a standard way to issue digital assets since this will help regulators to be able to define clear rules and guidance. However, this will present a real challenge because there are hundreds of different blockchains. Furthermore, there are many firms that use distributed ledger technology privately between small groups of organisations. Ethereum is the second biggest blockchain in terms of capitalisation and has attracted the most developers, so logic suggests that a robust standard such as ERC 3643 (which has already been widely used) is indeed a standard that could be adopted by others - or at least by those looking to create digital assets using the Ethereum blockchain.