The Ultimate Guide to App Coins and Protocol Tokens
A lot of people face immense confusion over the differences between the different kinds of coins and tokens out there in the crypto space…and for good reason. With the sheer amount of projects out there, it could be incredibly tough for someone, new to the space, to keep up with everything. We have already covered the differences between security tokens and utility tokens. However, in order to get a more intimate knowledge of the cryptospace, it is important to know the differences between application coins and protocol tokens as well.
Understanding Protocol and Protocol Tokens
We all know what app coins/tokens are. These are the coins that fire up various applications and they have existed before the blockchain. An excellent example of this is in-house currencies in online multi-player games. One can use their fiat money to buy tokens in these games which can be used in various ways (to buy in-game armor, skins etc.). However, before blockchain technology, there were no protocol tokens.
To gain an understanding of what protocol tokens are, let’s understand what protocol means. In extremely simple terms, protocols are a set of ideas that govern an ecosystem.
According to created an Internet stack which has “thin” protocols and “fat” applications in terms of how value was distributed.
However, this is where the blockchain came in and completely changed this whole concept on its head because of two reasons.
- Decentralization: Since no single entity owns the blockchain, the barrier to entry is very low. This is why more and more people can come in create application and products on top of the protocols. Plus, as the applications get more attention, it intrinsically increases the value of the underlying protocol as well.
- Cryptographic tokens: More on this in a bit.
Just like that, we had a system which utilized fat protocols and thin applications.
As discussed above, one of the biggest reasons behind the fattening of the protocol layer are cryptographic tokens. Before the blockchain, there was no way to economically incentivize the underlying protocols. These tokens incentivizes the participants to work in the interest of the protocol. The following diagram shows how the internet stack shapes up against the blockchain stack:
As we stand today, companies can now create protocols which will create value for themselves (and for their investors) as long as they retain some of the tokens. In fact, the better the protocol, the more its adoption, the more its perceived value, and hence more the value of the tokens appreciate. This is exactly what has happened with Ethereum.
This change puts the ball squarely in the protocol creator’s court. Earlier the only way that these creators could make money from their protocols was by creating software that implemented on it and then try to sell it for money. However, with the implementation of tokens, these protocol creators can directly monetize the protocols. In fact, as we have said above, as more and more software is created on top of it, it increases the value of the underlying protocol.
Now, what does this type of positive economic incentivization do?
Developers now have a real incentive to create more innovative protocols which brings even more value to the ecosystem. Plus, this is good news for investors as well since they will be able to invest their money in more valuable tokens, which helps the developers make profit as well. On the surface, it looks like a well-oiled machine.
There is another thing that Monegro talks about in his article called the “token feedback loop”. In other words, how do these protocol tokens help increase the protocol’s adoption and hence fattens the protocol part of the value distribution.
The diagram that you see above is what Monegro uses to explain this loop. What happens when the value of the token increases:
- Investors, developers, and other market elements get interested in the project and start investing into and become stakeholders. The influx of value increases the overall market cap of the network.
- Plus, if the protocol is deemed valuable then it will attract more developers to create applications and products on top of it. If the applications are of good quality, then it will attract even more users and developers to the network which will increase the overall value once again. Think about how cryptokitties brought in so many users to the Ethereum network that it actually clogged up the entire system.
In fact, just to buff up this point, the market cap of the protocol always grows faster than the combined value of the applications built on top of it. This how the protocol layer becomes fatter than the application layer.
Analogy For How App Coins and Protocol Tokens Co-Exist
As you would have probably guessed by now, app coins are the tokens that runs the applications built on top of the protocols. So, if Ethereum is the protocol then Augur is the application built on it and Augur’s tokens REP are the protocol tokens.
Let us give you an example as to how the protocol tokens and app coins co-exist with an analogy.
Suppose we have a blockchain called “Singapore” which has a protocol rule that states “transactions can only be allowed by exchange of currency”. To enable this facilitate this protocol, Singapore has a native currency called Singaporean Dollars or SGD.
Now, there is a mall inside Singapore which has a food court. However, one can only buy food inside the food court by exchanging their SGD for food court tokens from a token counter. Once these tokens have been attained, you can use them to buy anything you want inside the food court.
One thing to keep in mind here.
These tokens are valuable only inside the food court. They are not valuable anywhere else. In this example, the food court is an application that has been built on top of the main protocol i.e. Singapore and the food court tokens are app coins.
As of right now, there is a lot of debate going on around the space as to which layer, application or protocol should development be concentrated on. We are not going to take a side on this debate. However, what we will do, is to present all the arguments on both sides. We hope that you can see the POV from both the sides of the debate and come up with your own opinion.
Backing App Coins
Mason Borda, the CEO of Token Soft,