Types of Tokens Explained

Since Bitcoin's launch in 2009, the crypto space has evolved massively. Initially, the technology behind the digital currency was designed to cut out the middleman and offer privacy and control in transferring money using an electronic, peer-to-peer system. In the last ten years, however, things have advanced rapidly.

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Since Bitcoin’s launch in 2009, the crypto space has evolved massively. Initially, the technology behind the digital currency was designed to cut out the middleman and offer privacy and control in transferring money using an electronic, peer-to-peer system. In the last ten years, however, things have advanced rapidly. With the advent of Ethereum’s smart contracts, a token’s utility has grown from a transfer of value to a lease for computational cycles on the “world computer”. This change in token utility has led to the rise of the Initial Coin Offering (ICO).

The ICO has shaken off competition from traditional VC funding and seed investment to become the dominant form of fundraising for crypto projects. There’s a reason for this. An ICO offers multiple benefits to crypto startups that weren’t offered by traditional capital-focused investment methods.

We’ve previously explored the benefits and strengths of ICOs here:

But, when all promotional events surrounding an ICO are specifically designed to build a sense of excitement and possibility, how do you separate that hype from the potential long-term value of your investment?

Knowledge is key. One of the best ways to break down the difference between short-term hype and long-term value is to understand the type of token you’re investing in. By knowing the individual strengths and weaknesses of each of the token models, you can gain an understanding of which one holds the most value to you.

The ICO sphere is cramped, so by thinning it down to a specific token type, it becomes a simpler task to sort the quality ICO projects from the crowd. So, let’s break down some of the more common token types.

Currency

The currency token is perhaps the easiest to understand. Like fiat currency it has a value based on supply and demand, can be used to buy and sell goods and can be held as a store of value. However, unlike fiat, cryptocurrency is entirely based online and is decentralized.

Because it works on a peer-to-peer payment system, it can be used to store, send and receive money without the need for a financial intermediary. Utilising this network, all transactions leave an immutable record, making cryptocurrency an incredibly safe and secure method of finance. TLDR Partner, Graham Friedman explains further:

“Digital money also permits new feature sets, creating an evolution from dumb, analog money, to digital smart money. These feature sets range from transactional speed to digital protection, anonymity, dividend yields, built-in messaging, and factional ideologies.”

The liquidity of cryptocurrency is an attractive feature, as unlike traditional currency exchanges, it isn’t tied into a strict time period and can be floated on the market almost immediately after purchase if desired.

Utility

Utility tokens are usually a native currency to a particular decentralized application (dApp) or system, giving you access to the ecosystem designed and created to fulfill a project’s future purpose. The aim of the utility token is that it will increase in value as more people join the network, and demand for the company’s product or service increases.

Utility tokens cannot be used outside of the ecosystem, so are unlike true cryptocurrency, but they can be used as in-platform coins for purchases of goods and services made available by the project. As such, they have little value outside of the platform. Graham breaks this down further:

“Projects build utility tokens on top of various protocols, each of which offers unique features. For example, one might build their utility on top of the Stellar network if they are looking for high transaction volumes. The reason why these custom tokens are generated is that they can be coded to meet highly specific needs, each tailored to maximize the output of their parent systems.”

Utility tokens are highly dependent on a fully functioning ecosystem for their value. Without a platform to drive, there’s no need or use for a utility token, as Graham summarizes:

“In order for a token to be deemed a utility, it must be released into a functioning ecosystem. Modern utility token projects must, therefore, go beyond an MVP and release a fully functioning platform to their public, who are then able to receive utility tokens in the understanding that they will be used to engage with the platform.”

Security

The security token, sometimes also known as the equity token, is designed to act as a stock after the ICO has ended. They work like traditional stocks — they can be bought or traded and give the rightful owner a certain percentage of a company.

Because of this definition, they are subject to some of the biggest global regulators, much the same as stocks. Both imply ownership and control. Tokenized securities fall under the regulatory scope of the US SEC and several other global regulators since they have been deemed securities under securities laws. Unlike utility tokens, which are purely in-platform currency, security tokens will go on to gain and lose value with price fluctuations and allow the holder to be paid dividends under some models.

However, while security tokens do offer a tangible reward for ownership, many in the cryptosphere are put off by the bureaucracy and regulations surrounding them. Graham sees a future full of potential for the security token:

“Security tokens open up the crypto space to the full gamut of Wall Street wealth creation. They permit a variety of products to be created, from derivative baskets to asset back tokens. Once the security token is comfortably accepted, all things will be eligible to have an accompanying security token.”

Reward

Reward tokens are generally of little interest to investors as they don’t really have a value. Instead, they’re offered as rewards for participating in events, bounty campaigns or as an early-bird bonus. Graham sheds further light on reward tokens:

“They usually have only sentimental or aesthetic value and are oftentimes non-fungible. An example of this is a secondary token received through an ICO that resides in your wallet as a memento for participation. A good example of this is the Kyber Genesis Token.”

Collectibles

Collectible tokens are perhaps the oddball of the bunch. They’re generally as aesthetically pleasing as a reward token. However, they do hold some value.

Take for example the hugely popular and infinitely adorable CryptoKitties. Users can spend ETH to purchase a pair of cats, which they then breed to create new cats which can be sold on the in-platform market. It’s mostly designed to be a fun game (akin to Tamagotchi), with little interest to investors. But, with a little luck in cyber genetics, you could be sitting on a kitty goldmine, with rare cats selling for upwards of $23k.

It’s impossible to track every single type of token, as the cryptosphere is an innovative sector and is constantly evolving. Tokens are rapidly growing and expanding and broadening their use and value, so it’s vital to evolve your knowledge alongside the market to ensure access to the most valuable and creative ICO projects. Graham puts this neatly into perspective:

“Between 2008, the advent of Bitcoin, and Ethereum’s launch in 2015, the token economy was dominated predominantly by cryptocurrencies. Currently, we enjoy the variety listed above, as well as bountiful ideas for new token types. Who knows what the future holds and how the society of tomorrow will trade goods, both physical and digital, via new token means.”

The TLDR Recap

  1. Tokens are no longer strictly used as online currency.
  2. One of the best ways to assess long-term value is to understand the different types of token.
  3. Currency is the simplest type of token and works much like fiat currency.
  4. Utility tokens are usually a native currency to a particular dApp or system and can be used for in-platform purchases.
  5. Security tokens are similar to traditional stocks.
  6. Reward tokens are of little interest to investors as they don’t have readily accessible and liquid value.
  7. Collectible tokens are similar to a reward token, however, do hold some value.
  8. Tokens are rapidly growing and expanding and broadening their use and value.

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This article is based on views and information held by TLDR on publication date and may be subject to change, although TLDR does not undertake to update them. Nothing contained herein constitutes investment, legal, tax or other advice, nor a recommendation or solicitation of an offer to buy or sell any securities or to adopt any investment strategy. No representation or warranty, express or implied, is made or given by or on behalf of TLDR as to the accuracy and completeness or fairness of the information contained in this article.