Over the last few years over $1bn has been invested in digital currency startups from venture capital firms and institutional investors. Then something odd started happening over the last 4 months. A handful of blockchain-based projects have raised a combined $250m+, but none of that money has come from venture capitalists. So what the heck is going on?

Blockchain tokens.

These projects are raising money by creating and then selling their own tokens through crowdfunding on a blockchain. At first glance this just looks like a new way to raise money, much like how a normal company issues and sells stock to raise capital. At second glance it goes far beyond that.

There are a few key components to these tokens:

They are the currency that is used in the app itself.

Contributors to the app are directly paid for their contributions in tokens. This can be extremely granular.

The tokens are easily converted to any local currency since they are on the blockchain.

As an example, let’s take Storj. Storj is a system for decentralized file storage. Like Bitcoin or Ethereum, there is no central operator of the network. The project raised $500k of Bitcoin through a crowdfund of their token, Storjcoin, on the blockchain. Storjcoin allows you to buy storage space on the Storj network, and conversely, you earn Storjcoin if you contribute your own computer’s storage to the network. If you buy or earn Storjcoin, you can purchase storage on the network, hold them if you think they will go up in value, or convert them to your local currency (1 Storjcoin is about $0.11 right now).

This is where the phenomenon goes beyond just a new way of raising money. It is projects creating their own economic ecosystems to make the entire thing tick. More precisely, it is about an entirely new business model that is being created and tried for the first time: a decentralized business model. In this model there is no central controlling company, and has shared contributions and ownership by all involved. This business model is uniquely enabled by the combination of the internet and cryptocurrency.

Other projects using this model include:

Steem, a decentralized Reddit where people are paid to contribute news and content.

Augur, a prediction market where people are paid to contribute the outcome of events as “oracles”.

IPFS, a decentralized file storage system with a native token called Filecoin.

Even Ethereum and Bitcoin themselves, where people are paid to contribute their computing power to process transactions. Ethereum originally raised $18m in Bitcoin in a crowdsale.

You’ll notice one other thing about these “projects” or “apps”: they are really decentralized software protocols. A protocol is a fancy technical term that means: a standard language that lets a bunch of people on the internet work together on a specific problem. Popular internet protocols that have existed for a long time include HTTP (protocol that defines how information is transmitted over the web), SMTP (protocol your email app uses for sending and receiving email), SSL (protocol your browser uses for secure data transfer, the little green key in your browser when you are making a credit card payment).

Historically it has been difficult to incentivize the creation of new protocols as Albert Wenger points out. This has been because 1) there had been no direct way to monetize the creation and maintenance of these protocols and 2) it had been difficult to get a new protocol off the ground because of the chicken and the egg problem. For example, with SMTP, our email protocol, there was no direct monetary incentive to create the protocol — it was only later that businesses like Outlook, Hotmail, and Gmail started using it and made a real business on top of it. As a result we see very successful protocols and they tend to be quite old.

Now someone can create a protocol, create a tokens that is native to that protocol, and retain some of that token for themselves and for future development. This is a great way to incentivize creators: if the protocol is successful, the token will go up in value. What if the creators are too greedy and keep too much of the tokens for themselves? Since this is all open source code, people can just copy all of the code (called “forking”) and start the exact same network over again.

In addition, tokens help solve the classic chicken and the egg problem that many networks have. To illustrate this problem, consider the beginning of Twitter. The value of being one of the first few users on the network was low — no one else was using it, so there was no content! Now millions of people are on Twitter so people find a lot of value in it. In other words, the value of a network goes up a lot when more people join it.

So how do you get people to join a brand new network?

You give people partial ownership of the network. Just like equity in a startup, it is more valuable to join the network early because you get more ownership. Decentralized applications do this by paying their contributors in their token. And there is potential for that token (partial ownership of the network) to be worth more in the future. This is equivalent to being a miner in the early days of Bitcoin.

These two incentives are amazing offsets for each other. When the network is less populated and useful you now have a stronger incentive to join it.

This system has been used by startups for years to attract employees to a young company, and now decentralized apps are using it to incentivize all potential users around the world to join the app early on.

This will make it much easier to get a network going. Networks have tried all sorts of things to bootstrap past the chicken and the egg problem in the past: Reddit generated their own content before users sustained the platform with their own content, Facebook ripped Harvard’s student directory to seed the network, amongst other examples.

Bitcoin and Ethereum were the first to use this decentralized model, and they used it to bootstrap currency/transaction networks. The same model is now being used to bootstrap other networks.

Network with a centralized company as the operator

Imagine if this had been the model from the start for projects like Twitter, Wikipedia, Facebook, Reddit, or Uber. Instead of a central company making money by owning and extracting rent from the network they created, a software protocol replaces the central operator, and all of the creators and contributors to the network mutually own it. Contributors to networks (like drivers for Uber) look less like worker bees and more like mutual owners in the network they are creating value in.

Network with a decentralized protocol as the operator

This decentralized business model can be described as: X without the need for the central network operator X. Uber without the need for Uber as a company controlling the network of drivers and riders. Reddit without the need for Reddit as a company centrally hosting and creating the platform. Facebook without the Facebook. There will still be businesses which support these networks through value added services (e.g. auto financing or driver background checks for Uber); just not one company who “owns” the network.

It is very early, but tokens and this new decentralized model can mean a number of other things for the world:

Businesses that are based on network effects will start to be built “decentralized first”.

This will look much like how some businesses started to be built “internet first” in the late 1990s or “mobile first” in the late 2000s.

Access to capital will be more equal, as anyone globally can contribute to a project. The project started in Africa is on the same network (a global blockchain) as a project started in Silicon Valley.

On the flip side, investing will get a lot more equal globally. Everyone has access to the same set of investments.

Thus, blockchains first gave us the Internet of Money, now they are starting to give us the Internet of Assets.

The future of corporate law looks like a hybrid lawyer/coder.

It’s worth noting this phenomenon is not exclusive to any single blockchain. Some projects have created their own blockchain (Steem). Others have been created on top of one of the major digital currency protocols (Colored Coins on Bitcoin, Augur on Ethereum). However, it’s likely we will increasingly see tokens being built on the major existing blockchains like Ethereum. This will be driven by developer tools being concentrated on these blockchains, much in the way we saw lots of web apps be built on Ruby on Rails as they made it much easier to spin up a web site. Some of the most important work still to do is to make it as easy to create a decentralized app and corresponding tokens as it currently is to build a web application from a developer standpoint.

The growth in the number of tokens is likely to mimic the growth of apps in the App Store: it will start slow and then grow exponentially.

Like web apps and mobile apps, there will be thousands of tokens, eventually millions. And like all apps, many will never amount to anything, some will be moderate successes, and a few will be huge hits.

This coming wave of decentralized apps will have its share of massive failures as with Internet companies. There will be many more painful learning experiences like The DAO. Some of the projects I listed in this article may very well fail. Some people will myopically focus on the financial elements of this wave, calling it Stock 2.0 or maybe Wall Street 2.0 if they extrapolate, but it is so much more.

This is the biggest and most important trend we have seen in digital currency in a few years. It will likely be the underpinning for the first killer apps it feels like we have been talking about forever.

One only needs to think about the few major protocols that exist in the world today to see how much common good they create: HTTP gives us data across the internet, SMTP gives us email, SSL gives us secure data transfer online. Decentralized protocols and the tokens that make them tick are the beginnings of a mechanism to create more of these. This means more global equality and opportunity, mutual ownership in the networks we contribute to, more innovation in the world, and better options for consumers and businesses.

Regulators like the SEC will certainly want to learn more. My hope is that they see how tokens have fundamentally different properties than what we currently think of as securities and enable them to grow like any software protocol. By doing so, they would enable protocol innovation that has the potential to be an equalizing force for the economy like the internet had on information.

EDIT: I think most of the core concepts of this post are still true — however, app coins is a poor term. Protocol tokens is more appropriate. Fundamentally protocols should be as basic and modular as possible. As mentioned in my subsequent post, we will see decentralized applications which are built atop a series of many different protocols. “App coins” is unclear because it makes you think one app has one token, when in reality there will be one token for one protocol, and apps will be constructed by a series of base protocols.

Thank you to Chris Dixon, Fred Wilson, Brian Armstrong, Dan Romero, and Juan Suarez for reading and providing feedback.