Utility tokens are a type of cryptographic token that give special access to a platform or product, such as decentralized applications, decentralized storage, and distributed computing. A utility token is designed for use with a specific dApp, platform, or protocol. Unlike security tokens, utility tokens are not designed as investments, instead, they are designed to be used within the platform.
The utility token model differentiates from the traditional IPO model in that is currently used by companies when they go public. In the IPO model, a company offers shares of a company to investors in exchange for capital, and these shares are then traded on the secondary market for a profit. In the utility token model, the company does not offer shares of the company but instead offers such tokens as a product or service.
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What Is A Token?
Some may get cryptocurrency and cryptographic tokens mixed up.
The biggest difference between the two is that cryptocurrencies have their own blockchains, whereas cryptographic tokens are built on an existing blockchain.
A token is a digital representation of something that has value outside of the digital asset. Token value incentivizes specific behaviors, like logging into a social media site or uploading content. Unlike cryptocurrency, a token represents value only in its environment.
Different Types of Tokens
Utility tokens based on blockchain technology hold a certain value as well as uses:
Utility tokens, voting tokens, loyalty points for example in the form of an Internal Point System (IPS), tokens for reward or as a donation, and tokens for buying or selling things.
Most tokens are ERC-20 tokens that are equally compatible with the Ethereum blockchain.
How Does An ERC20 Token Work?
Every cryptocurrency has its token but there is a new standard that is being currently used to create new tokens – Ethereum’s ERC20 standard. This standard reserves a specific area of the blockchain in which to store functions and data.
If the platform exists and is used by a specific user base. To make a token valuable, a business must support it by creating a platform for users to interact with the system and use it to buy/sell goods/commands, use as a voting right, a crypto-currency, or any other function.
In the blockchain infrastructure, tokens can be easily transferred between collectors and can be stored in portfolios. Moreover, they can be easily traded on crypto exchanges.
Difference Between Utility Tokens and Security Tokens
When differentiating between utility tokens and security tokens, there can be a bit of confusion. Utility or user tokens, also often referred to as crypto tokens, are not securities and are not subject to the Howey Test. Security tokens, on the other hand, are investment vehicles that represent ownership in a company, asset, or fund. They are subject to the same regulatory requirements as traditional securities and hence are also considered to fall under the definition of a security.
A utility token, specifically, provides a user with a product or service – an entryway into a network most often as a vote. Tokens that collect funds but don’t offer any project or network product or service can legitimately be called utility tokens.
However, utility tokens must provide the product or service implied by their name to be considered legit.
Most companies will pass off their tokens as utility tokens but their uses or attached value doesn’t always match up with the true definition of a utility token – most tokens that pose as utility tokens are in actuality security tokens.
Security tokens are not subject to the same regulations as utility tokens and are investment vehicles that represent ownership in a company, asset, or fund. Security tokens are subject to the same regulatory requirements as traditional securities and hence are also considered to fall under the definition of a security.
Security tokens are like stocks (equity) or bonds (debt). You can usually buy and sell them on stock exchanges. Utility tokens are a bit different. Unlike security tokens, they are designed to be used on a certain platform. For example, a token may have a specific use case within a platform, like providing access to premium features. Or, it may have usage restrictions — for example, one token could be used as an internal currency while another could be used as an anti-spam token.
The main difference between security tokens and utility tokens is that utility tokens have a specific use case within another platform. Security tokens are more like stocks (equity) or bonds (debt) with cash flows and returns.
For instance, the platform may release multiple utility tokens, each with a purpose and set of specifications. Each token will be based on its blockchain and have no connection to other tokens on the platform, at least not directly. For example, a protocol may issue one token to be used as the internal currency and the other to be used as an anti-spam token.
Security Tokens
The Howey Test is used to determine if a token is a Utility Token or a Security Token.
Here are a few questions to determine if the token is a Security Token:
- Is there an investment of money?
- Is this an investment into a common enterprise?
- Is there an expectation of profit for the investors?
- Is the expectation of profit based on the work of others?
Security tokens are a new way to obtain ownership of an asset, and they provide more security than an ICO. They are regulated, and breaking the rules can lead to penalties. The value of these tokens comes from their ability to allow the public to democratize ownership of assets that were once impossible to divide.
Utility Tokens
Utility tokens are not “regulated” by the SEC because they don’t pass the Howey Test, have no expectation of profit, and their value can fluctuate based on supply and demand.
Utility tokens are designed for use in the dApp world. To use a utility token, the user typically needs to hold the correct amount in their digital wallet. The required amount can vary on different platforms, but it often ranges from 1 to 5 tokens.
Because Utility Tokens are unregulated- they can be generated freely making them more susceptible to scams.
Utility Token Use Cases
Digital Currency
Digital currency tokens are a type of digital form of currency that has similarities to physical versions, but with the benefits of the underlying cryptocurrency system. One of the most well-known tokens that represent US dollars is TetherUS (USDT). TetherUS is one of the top five tokens in terms of market capitalization and is used by traders and users to avoid the volatility of Bitcoin and other alt-coins or to move funds between exchanges.
Equity, Utility Tokens and ICOs
Initial coin offerings are a way to fund projects and distribute equity to shareholders, or utility tokens to participants.
Mastercoin was the first initial coin offered in 2013 on top of Bitcoin. Since then, there have been others and the market has exploded in 2017 with billions of dollars raised in digital currencies.
Utility tokens are not designed as investments, but they provide access to a product or service. One example of this is in the cryptocurrency platform Counterparty. There is a fee of fifty XCP per token (counterparty’s in-built currency) created on top of Bitcoin to discourage spam and squatting of popular token names.
Digital Objects
There is a lot of fun, entertaining things in the world, but not all of them require the internet. Before CryptoKitties and other tokens, people used tokens to represent many digital objects, including virtual game cards. Some special or high-valued rare poker cards were traded for around $2-3,000. Other applications of digital objects are tickets, advertisements, and discount coupons, but tokenizing these objects won’t be easy. To do so will require a difficult new protocol that can sense and interpret these items into blocks.
Voting
Digital tokens can be used for verifiable and auditable voting, typically with two tokens, one for yes and one for no. For example, suppose we have tokens with the labels “VOTE-YES” and “VOTE-NO”. To cast a vote, participants must send their vote token to a predetermined destination, at which point the number of tokens of each type will be counted.
An example of this type of system is Project Folding Coin, which utilized this scheme for decision-making.
Access Tokens
Token-controlled access is a fundamental and popular concept when it comes to access permissions. A user’s level of access to a system or information can be determined based on the tokens they hold in their wallet. One example application of token-controlled access is LetsTalkBitcoin.com, which uses tokens to grant users varying levels of access based on their “society” affiliation.
Examples of Utility Tokens
Utility tokens, otherwise known as app coins, are tokens that give holders a product or service. Blockchain technology allows developers to create an internal economy within the blockchain of a certain project.
Examples of utility tokens include Filecoin, Siacoin, Basic Attention Token (BAT), and Golem (GNT).
Filecoin (FIL)
Filecoin is an open-source, public cryptocurrency and digital payment system that allows users to rent out their unused hard drive space. It builds on top of the InterPlanetary File System (IPS), allowing users to store data across the network. It can be mined, earned through tasks, or purchased from miners at a marketplace.
Siacoin (SC)
Siacoin is the native cryptocurrency for the Sia blockchain platform. It provides a way for customers to pay hosts for renting their unused storage space. The price of Siacoin will be correlated with the demand for storage on the network.
Basic Attention Token (BAT).
BAT is a type of token used with Brave, an internet browser that contains ad-blocking and privacy features, which also offers its users the ability to use cryptocurrencies as payment.
The company behind BAT launched these tokens to, create a blockchain platform that helps content creators on all kinds of platforms such as YouTube, Instagram and Twitch make more money. Meanwhile, users can earn a reward by watching ads instead of seeing them interrupted for free.
Golem (GNT)
The Golem token is a crypto-economic mechanism that helps people who need computing power to rent it from those willing to give. The idea behind this system is to create an alternative decentralized market for computing power so that those in need of it can use it for different tasks.
Benefits & Disadvantages of Utility Tokens
A utility token can be a good tool for financing projects that are currently in development, but there are some risks to keep in mind. In fact, the excessive use of this mechanism led many ICO projects to the top in 2017, only to drag them down under high mistrust in 2018.
This is mainly due to many crypto projects promising unattainable goals, not to mention that utility tokens are not regulated. This has led many interested parties and owners of utility tokens to lose their “dreams”. One particularly crude example is when a project doesn’t manage to raise its minimum amount or has no real utility.
Disadvantages
There are some disadvantages to using utility tokens. They don’t have a natural mechanism to increase in value. I the project fails, these tokens will be worth nothing. They also don’t help the community adopt cryptocurrencies — in this case, the founders and core team make all the decisions without input from the token holders. The real issue is that they have a liquidity problem. If a project doesn’t reach the necessary levels of capital for development, these tokens won’t be worth anything.
Benefits
Cryptocurrency tokens are one of the most important innovations of our time and will transform the world. They will provide markets with frictionless transactions and without barriers — eliminating middlemen and other obstacles with ease. The technology also allows for simple integrations in a decentralized way. And we don’t need to come up with any standards or create dedicated channels.
Tokens play an important role in making payments more secure and easy. And they represent a physical asset, too! From investment to securely storing it, trading, and spending — tokens are applicable in every industry. It is a secure, reliable, and efficient way of doing business.
Conclusion
Utility tokens have the potential to disrupt markets and due to utility token issues, some investments are risky. Holders of utility tokens should understand that they are investing in a company’s vision for a better market, not the company itself.
Success is dependent on the team behind the token and its ability to implement a better ecosystem for market participants. On the other hand, don’t we all want to make this world a better place through fair market conditions and balanced ecosystems? Utility tokens may be the new means of achieving these ends.
