What is Blockchain?

What is Blockchain?

Many people misunderstood what is a cryptocurrency and why some cryptocurrency is relevant, and why others are not. People are naming some cryptocurrencies as traditional cryptocurrencies, ICO tokens, utility tokens, and so on. But they don’t fully understand them.

People think that everything that is named crypto or blockchain is better than other cryptocurrency or blockchain. Regulators don’t understand or don’t know these new cryptocurrencies or blockchains, so they allow them because it looks innovative.

Here are some definitions and classifications of digital assets.

Definitions and preconditions

A digital asset has a binary format and comes with the right to use it.

Digital assets are scarce. This means that at any particular moment of time there can be only one defined owner (or a group of owners).

A token is an accounting unit that represents the owner’s balance in an asset.

Principles of classification

So, there are five processes in a digital accounting system that could have at least three states such as centralized, decentralized, and not possible. And these states can be managed by one or separate roles:

  • Governance
  • Custody
  • Issuance and distribution
  • Transaction processing
  • Audit

There are different combinations of the ways these processes are managed, so there are different types of digital assets.

Cryptocurrency

There must be a network that performs the issuance and initial distribution of a cryptocurrency, process transactions in a decentralized approach, using a secure mathematical algorithm that prevents hacking.

So, an algorithm manages these processes. Furthermore, a cryptocurrency must have a decentralized nature.

Furthermore, a cryptocurrency must have a permissionless participation that requires a censorship-free system.

There are other conditions for the cryptocurrency. For example, it must have an undefined number of participants-validators that must be fully anonymous, that have no reputation, and whose transactions are fully private.

Bitcoin and Monero are good examples of proof-of-work-based currencies.

Central bank currency

In this case, there is a system with these processes centralized and managed by a central bank. Furthermore, the digital currency is pegged to a national currency.

Digital currency

So, in some systems, the processes like validation of transactions, set-up, and updates can be handled by a decentralized network. Furthermore, in this case, currency issuance and initial distribution are managed by a centralized organization.

In this case, custody is not applicable.

Ripple, Stellar, and IOTA are examples of digital currency.

Commodity-backed tokens

Commodity-backed tokens represent ownership rights in a particular amount of a commodity (which is an item produced to satisfy wants or needs). Furthermore, tokens are managed in a centralized-governance system with centralized governance, custody, and issuance. In fact, these five processes are performed by a service provider, or by the custodian of a physical commodity.

Furthermore, a token is backed by a fixed quantity of the commodity.

An example of a commodity-backed token is Tether. Furthermore, Tether’s processing is decentralized.

Equity tokens

In this case, a security is a fungible financial instrument that represents some type of financial value.

The term equity refers to ownership in a company or participation in its revenue stream. Indeed, security tokens represent ownership of an underlying security or a share in a cash flow generated by the system.

Furthermore, tokens are managed in a system with centralized governance, custody, and issuance. Additionally, these five processes are performed by a depository, or by a company. Actually, a token always represents a certain number of shares or a percentage of cash flow. Additionally, its processing can be done in a centralized way by a depository.

DAO is an example of equity tokens, and its processing is decentralized.

Accounting tokens

In fact, accounting tokens represent something that makes sense to account, but it doesn’t make sense to transfer.

In this case, governance, issuance, custody, and audit are centralized. Some examples of this asset are identity, reputation, and ratings.

Furthermore, web-of-trust identities belong to this category, but issuance, custody, and audit are decentralized.

Digital collectibles

In this case, a collectible is any object regarded as being of value or interest to a collector.

Furthermore, digital collectibles are unique and non-fungible. In this case, the token represents ownership of a particular object. Additionally, governance and issuance are centralized.

CryptoKitty is an example of digital collectibles.

Utility tokens

Utility tokens refer to the right to use system functionality. Furthermore, utility tokens are used to make system usage simpler.

Actually, utility tokens provide several functions such as internal currency, accumulation of system’s value, or accounting. Additionally, utility tokens have to fragment into divisions such as digital currency, security tokens, accounting tokens. In this case, governance and issuance are centralized.

Before Bitcoin (the most popular cryptocurrency), it was believed that these processes could only be handled in a centralized approach.

First, Bitcoin was used for decentralized financial systems. Indeed, Bitcoin was successful in that sector.

So, each process can be executed in at least three ways, which are centralized, decentralized, and the process is not possible). But, it could be hundreds of combinations.

  1. All the five processes are centralized. So, it gives us a central bank currency.
  2. All the five processes are decentralized like Bitcoin.
  3. The first four processes (governance, custody, issuance and distribution, and transaction processing) are decentralized, but the audit is not decentralized. Some examples of this case are monero or zcash.
  4. The first four of the processes (governance, custody, issuance and distribution, and transaction processing) is decentralized, but the audit is centralized.
  5. Governance and issuance are centralized, but the other processes such as custody, processing, and audit are decentralized. Ripple and Stellar are some examples of this case.
  6. All processes (governance, custody, issuance and distribution, transaction processing, and audit) are centralized, but transactions are impossible. An example of this case is PKI (which is a centralized public key infrastructure).
  7. Governance is centralized, but processes such as custody, issuance, and audit are decentralized. And transactions are impossible. An example of this case is Blockchain.
  8. Transactions are impossible, and all the other processes (governance, custody, issuance and distribution, and audit) are decentralized (but audit might not be possible). An example of this case is web-of-trust identities.
  9. Custody is impossible, and the other processes such as issuance are centralized. An example of this case is a land registry.
  10. Custody is impossible. The processes such as issuance and governance are centralized. And processing and audit are decentralized. An example of this case is the land registry on a blockchain.
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Many people misunderstood what is a cryptocurrency and why some cryptocurrency is relevant, and why others are not. People are naming some cryptocurrencies as traditional cryptocurrencies, ICO tokens, utility tokens, and so on. But they don’t fully understand them.
By | 2018-12-05T01:31:09+00:00 December 5th, 2018|Categories: Blockchain blogs, Blog|Tags: , , |0 Comments

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