When is a token a needed component of a system?

A token can represent two things.

The first is simple to understand. The token is a placeholder representing an asset in the physical world. Any physical asset can be represented by a token. This is only practical if it is truly an asset. Digix Gold is a good example. So are land titles. The rightful owner of the physical asset is the person in control of the private keys of the representative token.

The other purpose of a token is as value needed to incentivize a behavior. A token can be built into a protocol to motivate behavior that benefits the stakeholders in the protocol’s ecosystem.

Who are the stakeholders? The stakeholders are the people who opt-in to using the network. Networks are made to optimize value/time. If you could do this on your own, you wouldn’t need to collaborate.

Let’s take Bitcoin as an example. The stakeholders are the coin holders, the miner’s, and the community. Coin holders obviously want to be holding more value. Miner’s want more value because this is what their reward is for the service they provide. The community such as merchants, developers, and other’s who have contributed time to building the network. Think of a Ford Truck mechanic. Even if she drives a Honda, it still benefits her to have more Ford Trucks on the road. There is potential value to her in the time spent learning her skills that is only potential on the condition she has the opportunity to use her skills.

Stakeholder’s opt in to a network. They are incentivized by their view of the potential value of the network. In order to participate, they must believe the potential value of the network can give to them is greater than they can provide on their own and greater than that of any other network.

The next concept that must be understood is that not all networks are created equal in ability. Think of networks like people. Some are leaders, some are followers. Some lean towards the edge of chaos. They gamble on new ideas creating new frontiers while others wait and follow. Great leaders no longer need to find new hires. People flock to them because they see perceived value in being a part of a great leaders network. Some are creators, while others are maintain the status quo.

Bitcoin is not the leader of the digital world. It is simply the network that is currently out-competing all other networks with a goal of being a currency. Like any great leader it is attracting those who see its potential value.

Ethereum is the network that is out-competing all other networks in perceived potential value relating to the goal of computing transactions and securing the result.

These protocols need to allow for interaction with others. Protocols are built so digital networks can collaborate to more quickly achieve whatever goals the protocol is built to chase.

Similar to the way APIs allowed platforms to build networks faster, protocols need to allow collaboration with both lower and higher layer protocols. This allows any network to receive more value based on how many other networks choose to collaborate with it, and choosing the correct networks to collaborate. Why would other networks choose to collaborate? Because they see the potential value of participating being greater than not participating.

Like people networks are goal seekers and they are not created equal in ability. Those with great potential and a good amount of luck will find the most followers. A token allows the followers to be owners of a shared goal.

When is a token necessary as an incentive mechanism?

Wherever the creators of the world find a new goal.