The Broad Classification Of Digital Assets
Dr. Pavel Kravchenko holds a PhD in technical sciences and is the founder of Distributed Lab.
We already live in the era when most assets are digitized. Steadily, we’re moving towards the digitization of, basically, any value. On top of it, tendencies set by blockchain technology imply that little by little, we will be foregoing intermediacy and move towards individual control and management of our assets. In order to understand how to work with them, we should know how they should be classified. The article will also be helpful for those who are interested in fintech.
What is what
Digital asset is a digitized right of ownership of any value. That’s the most precise definition, though it doesn’t say a lot, so let’s delve deeper. Generally, digital assets can be categorized by the two basic groups:
- Digital currencies with a limited audit (PayPal’s digital USD or Central Bank digital currency). The fact that they are hardly auditable implies that you cannot assure yourself as to the authenticity of the processes but only trust those who manage them.
- Tokens, the accounting of which is more transparent because some processes can be auditable.
A cryptographic token is an accounting unit used to represent digital balance in a certain value, whilst the ownership of a token is evidenced by the aid of certain cryptographic mechanisms, for example — digital signature.
What blockchain has to do with this?
On the back of the above information, you can come to quite an unexpected conclusion — digital assets are basically defined by the accounting system in which they ‘exist’. Because it’s the accounting system that has properties that determine the way you manage assets and the difference between them.
Blockchain is the technology that grants the accounting system with certain properties. Let’s examine them.
As you can see, properties provided by the blockchain vary depending on the environment where it’s being applied. Permissionless — universally accessible (no permission is required to interact within the accounting) Permissioned — permission is essential in order to participate in the accounting.
Obviously, the supremely decentralized environment in combination with blockchain technology allows for the utmost of features that an accounting system can eventually achieve. It’s especially in this case, you can almost certainly guarantee that collusion of validators (those who mutually participate in decision-making of the system) is impossible. Agreeably, you don’t need to trust the validators.
Though, even in a centralized permissioned environment, where transactions are confirmed by a single party, blockchain still enables certain benefits:
- Regular users can get the proof of them being cheated, in case such situation occurs. Even the single holder of the database wouldn’t be able to turn the situation to his favour.
- You can assure yourself as to the integrity of the data.
- Synchronize data among an unlimited number of servers in real-time (this excludes a single point of failure of the whole system and increases uptime).
Classification criteria of digital assets
In order to know the difference between various digital assets, one should understand how certain processes in their accounting systems are provided. This creates criteria by which assets can be classified. The combination of various states of these criteria distinguishes their accounting systems.
The chart is detailed and may seem laborious, but you’ll get the main idea if compare just the two most distinctive assets:
- Cryptocurrency. The ultimate level of decentralization, where trust factor is ultimately eliminated. The management of the accounting system is done mutually.
- Centralized permissioned digital currency. All the processes are hinged on a private community, accordingly, users have no other choice rather than blindly trust the validators. The example is a Central Bank digital currency.
Now, basing on the criteria of the above chart, we’ll consider the particular kinds of assets and put everything in place.
So again, there are two major groups: tokens and digital currencies with a permissioned audit.
Non-auditable digital currencies
Along with Paypal’s Digital USD, this group includes national digital currencies, where all the accounting processes are managed by Central Bank. Whereas, the price is always linked to that of the national currency.
Token, in itself, is simply an internal unit in a certain digital accounting system. The interesting thing, though, is that depending on the situation, token can be attributed with various properties (be backed by):
- Digital obligations
- Certain currency
- Proprietary rights
- Right to any service
Tokens may be issued in both: centralized (under control of a certain organization) and decentralized (according to the pre-defined algorithm) manner. In this way, token is quite an abstract category of digital assets, that acquires specific features depending on the context.
Evidently, these are tokens backed by any commodity 🙂 The accounting (management, storing, issuance, etc) is accomplished on a centralized basis by the service provider or the organization that keeps the actual goods.
One token is backed by a fixed quantity of the commodity. It is to be guaranteed by a custodian. Referring to the chart (properties that blockchain may give), this can either be the case of a decentralized or centralized permissioned environment. It is principally impossible to make the accounting permissionless if tokens in it are backed by the commodity of a certain organization. It wouldn’t be an organization elsewise.
In this case, equity is a share in the business or any financial flow. The accounting is usually carried out by a centralized organ. One token represents a specific amount of shares or any percent of the money flow. The processing of such accountings can be done in both ways: centralized (by the depositary) or decentralized (by the community of independent validators). DAO is (or was 🙂 ) a good example of a decentralized accounting of the equity tokens.
A digital collector’s item. Note: not digitized, but initially digital. So, it’s not about the digitized proprietary right for a physical collector’s item. It is something unique in the digital field. The main difference with other types of tokens is that these are never interchangeable. This kind of idea is realized in the CryptoKitties project.
This type of tokens is reasonable when you need to keep count of anything, at that, don’t have a necessity to transfer it. For example, digital identity — it is unique and never transferred because belongs to each individual, such as identity or reputation. Most commonly, the processes in the accounting are centralized: managing, issuance, storing and audit.
Auditable digital currencies
These are also cryptographic tokens, but what distinguishes them from those that we’ve just reviewed is that they have attributes of currencies. On top of it, they can be audited easily. One of the representatives of this category is cryptocurrency.
Cryptocurrency is an independent digital currency. Independence is the main point here and is achieved by virtue of decentralization of the following processes:
- Issuance. New coins in the system are to be issued according to the algorithm that’s based on the determined upfront monetary policy.
- Transaction validation. Anyone can participate in the transaction validation process.
- Availability. The system is opened for use for all (it has no registrations or permissions).
- Data storing. Data is available for everyone, that said, everyone is able to store and verify it, which makes transactions irreversible. You cannot fool anyone when you’re in the public eye.
- Everyone can synchronize with other nodes and verify the accuracy of the transaction history.
- No one holds the ultimate reigns of making decisions, rather, they are made mutually through discussions on forums.
Needless to say, that the initial code and specification of a cryptocurrency should be in the open source. Eventually, all the properties we have just considered can only be possible in case of a sufficiently big and open community.
Even if you copy the initial code of Bitcoin, which is kind of designed for a decentralized digital currency, and create a fork that only you control — it won’t be a cryptocurrency.
Other auditable digital currencies
This is about digital currencies that’s not yet cryptocurrency because some of the processes are not decentralized, though the database can be audited by any or some external parties (which significantly distinguishes it from non-auditable digital currency, where it’s all based on trust and confidence). That’s where many people get frequently confused because they think that it’s a cryptocurrency, but it’s actually not.
Ripple and Stellar are good examples. The issuance and distribution of coins are centralized, though everyone can audit the whole database and verify the accuracy of the transaction history.
Various accounting systems and their properties
Finally, we would like to share the comparative chart we’ve made. It demonstrates the properties that various accounting systems possess. It’s quite massive actually and requires a separate article in order to review it to the full extent. On the other hand, it wouldn’t be inappropriate here, because having it analyzed you will be able to have an objective opinion about specific accounting systems, basing on the actual properties they give.
Digital assets are at the very beginning of a long and advanced path. Yet, it’s hard to make a universal classification of various kinds of them. Here, we’ve tried to come up with the essential criteria that may help people understand the difference between the digital assets and don’t fall into a “buy the new improved cryptocurrency” trap.