The Internet of Things is a world of machine to machine communication. Communication can be of different kinds. For example, communication can be a one-way information, a two- or multi-way communication, be private or open. These kinds of information can be handled with protocols to exchange data like, for example, the omnipresent Transmission Control Protocol/Internet Protocol (TCP/IP) that virtually everyone is using in today’s world.

One important subpart of communication is the exchange of value on top of pure information. Up until the invention of Blockchain protocols, this part of communication was not possible in the digital world without the use of an intermediary. It was only possible to send digital copies but not the property of a unique resource. The Blockchain revolution enables the opportunity to actually transfer value in the digital space on the sole basis of a protocol without the need for any intermediary. Circumventing intermediaries on the basis of such protocols is not limited to human interaction, but encompasses machines as well. Thus, it enables a fully machine-based economy where machines pay each other for various services.

Thinking of all different kinds of machines — cars, washing machines, light bulbs, computer, smartphones, 3D-printer etc. — it is easy to imagine that the number of transactions in a machine-based economy reaches billions over the course of a single day. Given this vast amount of transactions that are likely to occur in a machine based economy, its backbone protocol needs to

(1) be highly scalable,

(2) have zero transaction costs, and

(3) allow offline transactions.

Current Blockchain technologies, including highly praised Ethereum, do not provide these properties. They are neither fully scalable, all require transaction costs — at least in the sense of Proof of Work algorithms, and also only allow to initiate transactions when a node is online. In other words: pure Blockchain technology is insufficient for a machine-based economy.

The good news is that a new distributed ledger technology based on Directed Acyclic Graphs (DAG) provides exactly these properties. In a DAG the blocks do not need to be connected in a specific order but can rather be connected in a tangled manner across each other. This makes the chain scalable and converts, or rather upgrades, it to a so-called tangle. And if each block is formed by a single transaction, this much more powerful second generation Blockchain comes without blocks and without a chain.

IOTA is the first token based on a DAG and it fulfills all three properties of a token-based machine economy: IOTA is infinitely scalable by having each new transaction confirm two old transactions. Transactions in the IOTA network are free of transaction-costs. And offline transactions are possible that form subtangles and are later attached to the main tangle, when a node comes online again. IOTA is the one and only technology that can form the backbone of a token-based machine economy.

Tokens of the IOTA network are premined, as all tokens that will ever exist are already in circulation. Premined tokens often raise concerns among the community around cryptocurrencies, because it is feared that the developers control a large part of the tokens and there is no incentive for miners to provide stability to the network by confirming new blocks. The latter concern does not apply to tokens that are based on a tangle, where each transaction confirms old transactions, and there is no need for miners at all. This is actually the very reason why transactions can be conducted without fees.

As a disclaimer: you can still interpret the necessity to confirm two old transactions as a form of transaction costs. These are not very high, but might still be too much for a simple light bulb or even a smart phone that depends on its battery. There are two solutions to this: (1) exporting this Proof of Work to a trusted external validator (e.g. a computer at home or a node run by a trusted party like the IOTA foundation) and (2) using permissioned subtangles for specific purposes, in which the demand for Proof of Work can be significantly reduced.

The other concern against premined tokens, that the developers control a large part of all tokens and thus control the economy and might become the superpower of the network, is potentially a viable concern, though. I will address this concern in the next blog post by investigating the distribution of IOTA tokens.

— — —

This blog post is part of a series on IOTA consisting of three articles:

1. Properties of a Token-Based Machine Economy

2. The Distribution of IOTA Tokens

3. Optimal Inflation Rate in a Machine-Based Economy