Role of tokens within Web3 networks

A token is a digital asset created and maintained on a Web3 network. Unlike the native network coin, a token is normally implemented through a smart contract or another network-level mechanism.

The network coin supports the underlying infrastructure. It can be used to pay for network resources, compensate node operators and participate in consensus or governance. Tokens use that infrastructure for purposes defined by their creators and communities.

A token can represent money, ownership, membership, access, participation or a claim on another asset. A single programmable network can support many tokens with different rules and governing communities.

This allows monetary and financial systems to be created without establishing a new distributed ledger for each one. Communities can share the security and transaction processing of the underlying network while adopting their own assets and policies.

Understanding tokens

A token policy or contract may define how many units exist, whether additional units can be created, whether units can be removed and who has authority to change its rules.

The token policy or contract could also establish conditions on transfers. Some tokens may be freely transferable, while others may be limited to particular participants or uses.

These properties can differ from the policies governing the network coin. A fixed-supply network coin can support an expansionary token, while a network coin subject to demurrage can support tokens without a carrying charge.

The network therefore provides a shared technical environment rather than one monetary policy that every asset must follow.

Fungible tokens

The remaining analysis in this section is primarily concerned with fungible tokens.

A fungible token consists of interchangeable units. One unit of the same token is intended to be equivalent to another unit, allowing balances to be counted and divided in standard amounts.

Fungibility makes a token more suitable for monetary use. Participants can express prices, settle obligations and maintain balances without distinguishing between individual units.

Tokens may also be non-fungible, meaning each one represents a distinct item or claim. These assets can still be exchanged, but they are less suitable as standard units of account.

A fractionally owned asset may be represented through fungible tokens even when the underlying asset is unique. Each token represents a standard share of ownership rather than the entire individual asset.

Tokens as representations of value

Tokens can represent value that exists entirely within a digital environment. An online community or game can create a token whose use is limited to its own applications and participants.

Tokens can also represent claims on external assets. A token might correspond to fiat money, gold, commodities, property or another form of ownership.

The Web3 network verifies who controls the token and processes transfers between addresses. It does not independently guarantee that an external asset exists or that redemption will occur.

Externally backed tokens therefore depend on both the security of the network and the reliability of the institution or arrangement providing the backing.

A token representing a physical asset inherits some of that asset’s properties and risks. A gold-backed token may reflect changes in the market value of gold, while a fiat-backed token reflects the purchasing power of the associated currency.

Tokens as money

A fungible token can be designed and adopted as money.

It can provide a medium of exchange, unit of account and store of value within a community. The extent to which it performs these functions depends on its acceptance, liquidity and monetary design.

Creating a token does not automatically make it money. Participants must be willing to receive it in exchange for goods and services with the expectation that other people will also accept it.

A token created for another purpose can still acquire monetary use. If two participants value the asset and are willing to exchange it, it can function as a medium of exchange even when that was not its original purpose.

Web3 networks therefore create an open environment in which different forms of token money can emerge and compete.

Stablecoins

Stablecoins are an important example of token-based money.

They are designed to maintain a value connected to a fiat currency, commodity or another reference. USDC and USDT are examples of tokens intended to track the value of the United States dollar.

A stablecoin allows participants to transfer a representation of fiat value through a Web3 network. The token can be used as the medium of exchange while the native coin pays for network resources.

This separates the asset used in the economic transaction from the asset supporting the infrastructure.

The stability of the token depends on its implementation. A fiat-backed stablecoin relies on reserves and the institutions controlling them. A collateralised stablecoin depends on digital assets, liquidation mechanisms and potentially external price data.

A stablecoin can fail without causing the underlying network to stop operating. Users may lose value, but nodes can continue processing other coins and tokens.

Community-specific money

Tokens allow a monetary system to be designed for the circumstances of a particular community.

A national economy, local region, online community and digital game may have different requirements. Each can create a token with its own supply, governance and carrying-cost policy.

The community does not need to persuade the entire global network to adopt its preferred rules. Changes to the token can remain separate from changes to the network coin.

This reduces global governance complexity. The underlying network can concentrate on secure transaction processing, while monetary decisions occur at the scale of the people directly affected.

A token community can also replace its monetary system without replacing the entire network. If the token fails or no longer meets its needs, participants can create or adopt another token.

Tokens and the network coin

Token money does not eliminate the need for the network coin.

The network coin continues paying for and supporting the infrastructure that processes token transfers. A user sending token money may need to provide the network coin for the transaction fee or use an application that sponsors it.

Wallets can automate this process. A user may experience the transaction as occurring entirely in token money even though part of the token is exchanged for the network coin in the background.

The two assets therefore perform complementary functions. The network coin supports the shared ledger, while the token implements the community’s monetary system.

The token can prioritise stable purchasing power and local acceptance without carrying the full responsibility of securing the global network.

Tokens and financial liquidity

Tokens can provide liquidity within local and global financial markets.

A token used as community money may be paired with the network coin, stablecoins and assets relevant to that community.

Local liquidity makes it easier for users to receive, spend and exchange the token. It also supports movement between the community economy and the wider Web3 ecosystem.

The network coin may provide a common global pairing, while token money provides a common pairing for assets used locally.

Liquidity incentives can encourage holders to make tokens available in exchanges and lending protocols. Like network-coin incentives, these mechanisms must avoid rewarding fake activity or unused markets.

The appropriate incentive can be governed by the token community rather than embedded in the underlying network.

Tokens and demurrage

A token can implement demurrage through a recurring charge on balances. The charge can be transferred to a token treasury, removed from supply or redistributed according to the token’s rules.

Token demurrage can be adapted to the community’s circumstances. The community may select a fixed rate, a variable rate or different rates for particular uses.

The token can preserve reasonably stable purchasing power while making prolonged idle storage costly. This separates the store-of-value function from low-cost storability in the same way described for the network coin.

However, token money competes with the network coin and other tokens. If its demurrage rate is high and it provides no corresponding benefit, users can move into another asset.

A token therefore needs sufficient acceptance, liquidity and utility to sustain its carrying charge.

Separation of failure

One of the principal benefits of token money is that its failure does not necessarily become a network failure.

A token may experience poor governance, excessive issuance, a contract defect or a collapse in demand. This can harm the people relying on it, but the underlying network can continue operating.

Other tokens remain available, and users can migrate to another monetary system.

By contrast, a failure involving the native network coin may affect transaction processing, node compensation and consensus.

Keeping community monetary experimentation at the token level therefore limits the systemic risk placed on the shared infrastructure.

This separation does not make token failure unimportant. A widely adopted token can become systemically significant within its own community. It means that its failure does not automatically prevent the network from supporting a replacement.

Competition between token systems

Because tokens can be created relatively easily, token money operates in a competitive environment.

A community can introduce a new token with different supply rules, governance or incentives. Users can compare it with existing systems and decide which assets they are willing to accept.

This competition creates opportunities for experimentation but makes long-term demand less certain. A token that fails to adapt may lose adoption to another implementation.

The ability to change systems rapidly can increase resilience. It also creates instability if communities repeatedly move between tokens or if new assets are introduced without sufficient reliability.

Token money must therefore balance flexibility with predictability.