We often hear people talk about Bitcoin as though it represents the many cryptocurrencies in general, often accompanied by a comment on how useless and lacking in real value Bitcoin is. For better or worse, the world has started to pay attention to Bitcoin over the past year, as the media has increasingly focused its gaze upon the turbulent and controversial world of crypto. Many people now have some understanding of what Bitcoin is, albeit usually a poor one. Very few people, however, know that there are many different kinds of cryptocurrencies that are quite different from one another in design and purpose.
The first distinction to make is the difference between “currency-coins” and “tokens”. While many tokens are intended to be used as a currency within a blockchain-based system, they serve a larger purpose than being purely a digital currency such as Bitcoin or Litecoin. Aside from the fact that Bitcoin has come to be treated as a commodity of sorts (lately more so than as a currency) these coins would not be considered tokens in the same way that many cryptocurrencies are. Currency tokens are generally decentralised and operate independently of a central bank. This doesn’t have to be the case, however, with Ripple being an example of a different model. In the future all currencies might be digital, including fiat currencies controlled by central banks.
A security token is a token that represents a share in the enterprise being carried out. Like a regular security, the token can be bought and sold on exchanges and is not meant to be used to directly purchase services in a blockchain ecosystem. One example could be a clean-energy bitcoin mining company that promises high returns, based on cheap electricity and issues a security token to raise capital. Legally, it is up to the startup to demonstrate that the token they are issuing is not a security in the traditional sense. It is quite likely that companies doing ICOs will be under increasing pressure to clarify the nature of their token and prove that it is not simply an Initial Public Offering (IPO) with a different name.
Utility tokens represent access to services that can be purchased on a blockchain based platform. This might be a Dapp development platform, such as Ethereum (ETH), or a distributed energy trading platform such as Power Ledger (POWR). In facilitating the sale of access to future services, utility tokens are a means to fund projects that couldn’t otherwise be easily funded. Rather than being based on Proof of Work algorithms like Bitcoin, these tokens are pre-mined, sold in crowd-sales or ICOs and then traded freely on exchanges.
A common suggestion is to think of utility tokens like a public transport access card. The card will get you access to the bus system, but it doesn’t represent a share in the ownership of the transport system. This point can be quite confusing to new investors and even seasoned crypto enthusiasts. Many of the tokens, for example, don’t have utility from day one, as the funds raised from their sale will be used to build the project within which they will function. Also, many investors are hoping that as the company grows (expands, makes partnerships, acquisitions, new clients etc.), so too will the value of the utility token that they hold. This is a reasonable assumption, and one that is built into the design of many utility tokens. Power Ledger, for example, will utilise another token called Sparks, which will be pegged to the local national currency.
The ability to buy and sell utility tokens freely in the market, especially prior to the associated projects being developed, is one factor that has many people confused as to what really makes utility tokens so different from security tokens. In can be very confusing for new investors to ascertain the purpose of the token they are purchasing, or whether or not there is any need for a token in the first place. In some cases, it is quite likely that the tokens that people have bought into during ICO’s will hold very little value in the future, even if the associated company is still operating.
The crypto space is generally a very difficult thing to regulate, which is why governments around the world are approaching it cautiously at best. In cases where a token is clearly a security, ICOs that are not carried out under the normal regulatory guidelines for security offerings will be deemed illegal. In the United States, the argument has been made that a Utility Token should be treated as a Security Token until such time as the relevant blockchain network is operational and in use. This is intended to stop blockchain companies from simply calling their tokens utility tokens to avoid strict regulations. It is argued that these sorts of regulatory rules are put in place to protect small-time investors from larger actors in the space as well as from outright scams and schemes. Even once you understand the main differences between the types of tokens and have researched a project thoroughly, it is still easy to find yourself unsure about what it actually is you’re buying into. For many investors, especially those of a value investing bent, this can be worrying to say the least. It’s always important to do your own solid research on any project you are thinking of buying into. Analysing the type of token you are planning to buy as well as the role it plays or will play in the project is critical to truly understanding what it is you’re investing in.