What Are Soulbound Tokens?

FXOpen

Soulbound tokens, or SBTs, have been a hot topic in the crypto community lately. But what are SBTs, and how do they work? In this article, we'll provide an overview of SBTs, examine their potential use cases, and weigh up their pros and cons.

Soulbound Tokens: Basics

Soulbound tokens (SBTs) were first introduced in a 2022 blog post by Ethereum co-founder Vitalik Buterin. In the post, he describes the concept of “soulbound items” in World of Warcraft, which are items that cannot be transferred, bought, or sold once acquired, and how this idea could be applied to Web3 technology.

The idea of soulbound tokens was expanded upon in a paper co-authored by Vitalik entitled “Decentralized Society: Finding Web3’s Soul.” Here, Buterin and his colleagues envision a decentralised society that uses SBTs to represent the “commitments, credentials, and affiliations” of each citizen.

In simple terms, they propose that verifiable information about a person’s identity and reputation could be held in “Souls,” or dedicated accounts for storing data about an individual on the blockchain. The authors suggested that a person could use a range of Souls in their daily lives, like one that holds identification documents and another that holds credentials issued by a third party.

The idea of SBTs is closely related to non-fungible tokens (NFTs). In their most basic form, NFTs are used to verify asset ownership on the blockchain and are transferable. The key difference between the two, however, is that SBTs can't be transferred. Unlike soulbound tokens, NFTs can be traded for thousands of dollars and are often used to signal status. Instead of demonstrating their owner’s wealth, SBTs display their reputation, identity, and credentials.

SBT Use Cases

One of the main challenges facing Web3 right now is trust. In a trustless, pseudonymous digital environment, how are we supposed to trust each other? Soulbound tokens pose a solution to this problem. For example:

  • Universities could issue SBTs to graduates that prove they hold their qualifications.
  • Employment history and skill certificates could be verified by looking at the SBTs issued by previous employers and institutions.
  • Event holders can issue SBTs to attendees, proving attendance.
  • Lenders could examine a borrower’s SBTs to determine their risk of default.
  • Decentralised autonomous organisations (DAOs) could use reputation-based voting to prevent bad actors from buying up voting power.

Advantages of SBTs

In his initial blog post, Vitalik argues that the current hyper-financialisation of NFTs “limits the appeal and long-term sustainability of the culture” surrounding these assets. He points out that by introducing soulbound items to the crypto space, “NFTs can represent much more of who you are and not just what you can afford.” SBTs could be the first step toward the mass adoption of NFTs by contributing to the development of a decentralised society instead of simply being a symbol of wealth and status. These will be so-called soulbound NFTs or non-transferable NFTs.

Additionally, SBTs can offer verifiable proof of a person’s reputation. Financial scams have exploded thanks to cryptocurrency, and being able to confirm someone’s identity, reputation, and past actions could go a long way to preventing fraud.

SBTs may also make many processes more efficient. For example, you could grant someone access to an SBT that holds your medical history in seconds, removing the need for time-intensive paperwork filing. Or, a DeFi platform could use various SBTs to determine your default risk and offer you a more favourable lending rate, given your status as a responsible borrower.

Finally, SBTs have the potential to revolutionise DAOs. Many DAOs currently offer voting power proportional to the number of governance tokens a person owns, meaning that an individual or group could take control if they hold the majority of these tokens. This is known as a Sybil attack. If voting power is allocated according to a person’s reputation instead of their resources, then the chances of a Sybil attack are reduced.

Disadvantages of SBTs

While SBTs seem like the answer to many of Web3’s current issues, they haven’t been without criticism. For example, some have drawn parallels to China’s social credit system. Under an oppressive regime, you could easily be identified and excluded from social activities if you hold a particular political or religious group-affiliated SBT.

This isn’t just a political issue, however. Private entities, like lenders, institutions, and even individuals, could discriminate against holders of certain SBTs. Those looking to harass a specific group of individuals could quickly identify potential targets by examining their SBTs, while unscrupulous lenders could use a person’s poor credit history to automatically offer predatory loans.

Some also point out that SBTs could make identity theft a more complex issue. If someone takes over your Souls and gains access to your SBTs, they can do much more than simply steal your credit card information. They could use your name to promote other scams, open bank accounts, and destroy your credit history. If each of these actions is tied to your Soul, then proving that they weren’t your actions might be tricky.

Another problem is inability to recover your Souls if you lose your private keys. Private keys are secret cryptographic codes that play a vital role in keeping your crypto wallets and Souls secure, and if they fall into the wrong hands or are lost, the consequences can be devastating. In this scenario, how would you regain access to your SBTs? Introducing soulbound tokens, Ethereum co-founder Vitalik Buterin thought over a “social recovery” system where trusted “guardians” can vouch for you and help restore your private keys. However, if you’re no longer on good terms with a guardian, this recovery process could be exceptionally difficult.

Can You Buy SBTs?

If you’re wondering how to buy soulbound tokens, we have some bad news. Unlike currencies in Forex trading, SBTs can’t be bought and sold on the open market. What is a soulbound tokens’ price? Soulbound tokens don’t have a price, and can’t be traded on platforms like TickTrader. Instead, they’re likely to be given to you by individuals, companies, or institutions.

By design, they’re unable to be transferred, except from issuer to receiver. For example, your driving licence could be issued as an SBT by the government, but you wouldn’t be able to transfer its ownership to anyone else, much like your physical licence.

*At FXOpen UK, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules. They are not available for trading by Retail clients.

This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.

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