Characterizing a Cryptoasset

A framework for understanding how an asset operates in the crypto landscape

NOTE: Before we get started, I want to disclose that this is not financial advice. This content is for informational purposes only. I can explain things to you, but I can not understand it for you. DYOR! (Do your own research!). 

As we begin to enter a more digital world, the popularity of crypto is quickly crossing the threshold from experimental & academic to legitimacy. The applications of these assets are building new economies and opportunities that can democratize financial freedom over the world. Many cryptoassets have already crossed that threshold for some time. Their popularity has not only caught up to the legitimacy, but in some cases, it has transformed into hype. As the hype cycle continues to climb, it is hard to ignore some of the misrepresentations of cryptoassets from participants (or lack thereof) trying to emerge themselves into the space. We’ve seen evidence of this lack of understanding even at the highest level of the US Government that has included language towards the crypto space that comes across as uneducated, disappointing, and (honestly) embarrassing. 

One thing that gets misconstrued the most is the way we characterize everything in crypto as a currency. Yes, there are assets in crypto that do fit the characterization of a currency. However, the broad stroke of naming every asset as currency is inaccurate and leads to a floodgate of confusion about the industry. 

There have been many conversations in the community about correctly identifying crypto at a more extensive level to provide people who are "greener" on the subject a clearer picture of what crypto is. A majority of the consensus has fallen on the term “cryptoassets" - a thesis former Ark analyst and current founder of Placeholder VC, Chris Burniske, has been pushing since 2017. However, to this day, there is still evidence from the highest forms of financial media that the correct characterization still needs to be reiterated. 

Why “Cryptoassets”?

To understand the foundation of the term “cryptoassets,” we must first understand that a majority of the assets in crypto are not currencies. Yes, there are many assets that fit into the characterization of currencies, such as Bitcoin, Monero, Litecoin, Decred, and many more. Nevertheless, that is only a partial chunk of the industry. Below are some examples of what a cryptoasset can be defined as: 

  • Defi Tokens

  • Smart Contract Platforms

  • Currencies

  • Stablecoins

  • Exchange Tokens

  • Lending Tokens

  • Derivative Tokens

  • Asset Management Tokens

  • Data Management Tokens

  • File Storage Tokens

  • Gaming Tokens  

However, without getting into the giant weeds - at a basic level, there are three main characterizations of crypto assets that are fundamental to know: Cryptocurrencies, Cryptocommodities, and Cryptotokens. 

Why is it important to understand the difference?

The crypto landscape is moving fast, and investors are quickly trying to gain exposure to the assets crypto offers. However, investors tend to approach these assets with the same framework as a stock on the Nasdaq. The issue with that approach is that these cryptoassets do not function like a company; they function as economies, with other emerging economies built on top of each other. Therefore, it is imperative to understand how to characterize these assets to begin to build a framework for understanding how they would function inside the emerging crypto ecosystem. Currently, the mainstream investing landscape revolves around Bitcoin and Ethereum, but soon that landscape will evolve far beyond BTC and ETH. Therefore, it is essential to have a historical context, ability to categorize, and understanding of the applications of these assets so we may be able to identify potential investment opportunities. 

Cryptocurrencies:

A currency is characterized by a couple of well-defined characterizations; a medium of exchange, store of value, and unit of an account. Much like the fiat currencies today, cryptocurrencies share these same characterizations. One of the most significant pushbacks from crypto critics is the social construct that a currency has to have a physical object to complement it, such as the paper fiat we use currently. The irony about that assumption is that there was evidence of similar pushback on the use of paper as a currency going all the way back to 1000 BC.

“A key characteristic of modern money is that it is uniformly worthless in itself. That is, bills are pieces of paper rather than coins made of gold, silver, or bronze. The concept of using paper as a currency may have been developed in China as early as 1000 BC, but the acceptance of a piece of paper in return for something of real value took a long time to catch on.” (Investopedia)

Paper currency has value because there is universal consensus throughout members of society agreeing it has value. Nevertheless, cryptocurrencies are also gaining that volume of universal consensus in value, and it's happening fast and at scale. If you really do your research, you will find that the cryptocurrency’s ability to grow to a universal consensus in value this quickly without the support of a government and its military is one of the more astonishing accomplishments in monetary history. Here are some other examples of cryptoassets that are currencies.👇

Bitcoin

Bitcoin is the first distributed consensus-based, censorship-resistant, permissionless, peer-to-peer payment settlement network with a provably scare programmable native currency (that’s a mouthful I know). In addition, the native asset to Bitcoin's blockchain, BTC, is the world's first digital currency without a central bank or administrator. Bitcoin's market cap is currently ~$891B.

Litecoin

Litecoin was created as a fork of Bitcoin’s codebase. Litecoin has 4x’s faster block times and 4x’s larger supply. Litecoin was created as a complement to Bitcoin, usually tagged as the silver to Bitcoin’s gold. Litecoin's market cap is currently ~$12.71B. 

Monero

Monero was created with an emphasis on privacy preservation and fungibility. Monero is a fork of the Bytecoin code that provides anonymous value transfer through ring signatures, stealth addresses, and confidential transactions. Monero's market cap is currently ~$4.94B

Decred

Decred is a cryptocurrency that provides a hybrid between proof-of-work and proof-of-stake, focusing on community input, open governance, and sustainable funding for development. Decred takes advantage of its hybrid consensus and on-chain governance systems to ensure that no one can dominate the flow of transactions or make changes to Decred without the community's input. They also fund their own development through a decentralized treasury. Decred's market cap is currently ~$2.32B. 

Cryptocommodities:

The SEC defines commodities as goods that are typically used as inputs in the production of other goods and services. Its prices are determined by supply and demand and market conditions are affected by factors such as weather and geopolitical events. Some examples of commodities include grains, beef, oil, natural gas, coffee, and lumber. 

Throughout history, commodities have always been thought of as raw materials such as the ones we just named. However, every day we are accelerating into a more digital society. So it only makes sense to have digital commodities. Some of these digital commodities include computing power, storage capacity, and network bandwidth. Similar to the physical commodities, these all fit the characterization of inputs into a finished good. 

The confusion we usually see with cryptocommodities is that they have a “native currency” assigned to their blockchain that can be invested in, traded, utilized to access the value of a service, used as an incentive to secure the network, and enable the holders of the token to govern the community revolving around the asset. Cryptocommodities often serve as a base layer to decentralized apps (dApps) that are built on top. Some examples would be smart-contract platforms, which are self-executing computer programs like Ethereum, Polkadot, Cardano, and Solana. 👇

Ethereum

Ethereum is a distributed blockchain that has been described as the future of computing. Ethereum is a computing platform for smart contracts and decentralized apps (dApps). The native token of Ethereum is ether (ETH), which serves as a means of payment for transaction fees and as collateral for specific ERC-20 tokens with the DeFi sector (decentralized finance). It has also gained even more recognition for the recent London fork of EIP-1559, a proposal to make transaction fees more efficient by using a hybrid system of base fees and tips to incentivize miners more evenly in periods of high and low network congestion. Ethereum's market cap is currently ~$382B.

Polkadot (Dot)

Polkadot is a blockchain network designed to support various interconnected, application-specific sub-chains called parachains. Each chain built within Polkadot uses Parity Technologies’ Substrate modular framework, allowing developers to select specific components that suit their application chain. Polkadot refers to the entire ecosystem of parachains that plug into a single base platform known as the “relay chain.” This base platform, which also leverages Substrate, does not support application functionality but instead provides security to the network’s parachains and contains Polkadot’s consensus, finality, and voting logic. Its native token is DOT which serves four functions: payment for fees, governance over the network, interoperability, and bonding. When messages are sent between two blockchains on the network, DOT’s are used to pay for fees. Polkadot's market cap is currently ~$23.23B.

Cardano 

Cardano is an open-source, smart-contract platform that aims to provide multiple features through layered design. Its modularization will eventually allow for networks delegation, sidechains, and light client data structures. Cardano uses a version of Proof-of-Stake called Ouroboros to secure the network and manage the block production process. In addition, the network features a native token called ADA that provides stakers a claim on new issuance in proportion to their holdings and allows users to pay for transactions. Cardano's market cap is currently ~$68.70B

Solana

Solana is a public base-layer blockchain protocol that optimizes for scalability. Its goal is to provide a platform that enables developers to create dApps without designing around performance bottlenecks. Solana features a new timestamp system called Proof-of-History that enables automatically ordered transactions. It also uses a proof-of-stake consensus algorithm to help secure the network. Solano's market cap is currently ~$17.56B

Cryptotokens and dApps

A decentralized application (dApp), in most cases, is the “finished product” that a cryptocommodity would support. A cryptotoken is the digital asset associated with the dApp. A dApp can provide digital goods and services such as media, play-to-earn video games, social networks, and many more products like fan tokens to a professional sports organization. Cryptotokens can be used as a representation of a dApp that resides on a cryptocommodity's blockchain. For example, the “play-to-earn” video game, Axie Infinity, is powered by its native token AXS, built on top of Ethereum’s (cryptocommodity) blockchain. Cryptotokens can be used as an investment, make or receive payments, and have utility applications such as community governance. 

For the risk of sounding repetitive (and confusing), a dApp and its cryptotoken can use ETH as a cryptocommodity to pay Ethereum to process a dApp transaction. Most dApps use a cryptotoken, but in many cases, a native unit of a dApp should be classified as cryptocommodity layered on top of Ethereum, so not all dApp’s native currencies are cryptotokens. 

The best way to indicate whether a dApp’s native currency is cryptotoken or a cryptocommodity is if the raw digital resource is being provisioned, it is a cryptocommodity. On the other hand, if the dApp provides a consumer-facing finished good or service, it’s a cryptotoken.

Examples of some cryptotokens:

Filecoin (FIL)

Filecoin is a decentralized data storage network. Filecoin acts as the incentive and security layer for IPFS (InterPlanetary File System), a peer-to-peer network for storing and sharing data files. FIL is the native token of the Filecoin network. Token holders can use FIL to participate and transact in the FIlecoin network. Users pay the miners in FIL to store or distribute data to retrieve their information. Storage providers also post FIL as collateral to provide a minimum level of guarantee of their service, which gets slashed should a deal with a customer fall through. Filecoin's market cap is currently ~$7.09B

Uniswap (UNI)

Uniswap is a decentralized exchange built on Ethereum that utilizes an automated market-making system rather than a traditional order-book. Holders of UNI are responsible for governing the protocol. Uniswap's market cap is ~$17.82B

Chainlink (LINK)

Chainlink is a decentralized oracle network and one of the first networks to integrate “off-chain” data into smart contracts. Chainlink is one of the major players in the data processing field. Its token LINK can be used as a “payment token” in which it is used to pay Chainlink node operators for providing oracle based services. It can also be used as a “work token” staked by node operator as collateral to provide oracle services. Chainlink's market cap is ~$13.11B

Closing:

The information provided above is by no means a fixed or standard process. However, as the crypto landscape continues to grow at the pace it’s currently growing we can not ignore the impact it is going to have on the economy and the innovation it will bring. When you have an industry that’s attracting talent, capital, and growth like the crypto community is gaining it would be foolish to say that there aren’t significant investment opportunities. However, it’s important to understand that innovations of such significance can fuel hype and mania of over-optimistic investors who will make bets with conviction that is 5x’s their research convincing you to do the same. It’s in these moments that best investors stay within their process and do their homework. With that being said, having the ability to characterize the asset is a great start to finding your crypto investment process. 

“People who invest make money for themselves; people who speculate make money for their brokers.” 
- Benjamin Graham, The Intelligent Investor