Your Guide To Utility Tokens
Utility tokens provide users access to apps or decentralised apps (dapps). They are not speculative tools and should only provide value in the app for which they were designed. Users might earn the token by doing work, completing tasks, sharing resources or otherwise. A token holder could use a token as a means of payment to use an app coded on a smart contract, as a security deposit or towards usage fees for the app.
Users purchase utility tokens in order to use a token for many types of purposes. In a perfect world, utility token purchasers wouldn’t anticipate a profit. They wouldn’t purchase utility tokens as an investment. Utility tokens are generally not mineable like the cryptocurrencies Bitcoin, Monero, and Litecoin.
What Are Utility Tokens For?
Utility tokens should enrich user experience of a network and perhaps even connect users with each other, too. In some cases, tokens are used to onboard a new customer or as a network’s means of payment. An individual or entity might need a certain utility token for access to a certain product; allow to participate in grant a governance action (like voting on consensus); allow a user to contribute something to the app or network; grant ownership over, say, virtual items on the app; act as a reward; grant the user shared ownership over a product or service; allows users to create a new product or service.
Utility tokens first gained notoriety as the asset most often sold in an Initial Coin Offering (ICO), in which a company issued a certain number of tokens to sell. ICOs are probably more accurately referred to as token sales. In many of the so-called ICOs, which garnered mainstream press attention in 2017, a project would sell future access to their network. Ethereum was one of the first and most successful projects to follow this model, and some have suggested that ether was in fact a security token when first offered. But, over time, the network became functional, the token found a use, and became a utility token.
The top 10 utility tokens are generally settlement tokens (EPP22S classification from ITSA’s ITC framework). A Settlement token is designed to settle transactions within the environment for which the token was created. (e.g. purchase of goods or services in a third-party ecosystem).*
Ethereum allows individuals or entities to use the Ethereum mainnet for complex transactions via smart contracts. The platform is known for smart contracts and the complex transactions they make possible. Ethereum could potentially play a major role in the Internet of Things and is central to the idea of Decentralised Autonomous Organisations (DAOs).
One of the first use cases demonstrated on Ethereum was that of the Decentralised Autonomous Organisation (DAOs). The DAO was a digital decentralised autonomous organisation designed as an investor-directed venture capital fund on the Ethereum blockchain. The DAO sought to create a new decentralised business model for commercial and non-profit enterprises sans conventional management structure or board of directors.
Hackers exploited a vulnerability in 2016, however, enabling one-third of the DAO’s funds to be stolen. The Ethereum community then hard-forked the blockchain to restore virtually all funds, which resulted in controversy and ultimately led to a fork in Ethereum, wherein the original unforked chain was dubbed Ethereum Classic. Ethereum had broken into two separate chains, each with its own native cryptocurrency.
Unlike spending tokens, discount tokens are not annulled when used. Instead, they remain in the possession of holders throughout. Each token provides increased discounts as the network to which it belongs grows. (i.e. more people use it)
Holders gain access to networks via the discount token. Early users benefit from the growth of the network or network effects as the product is adopted. For every dollar spent by early participants, the discounts realised later in the network’s lifetime grow along with use of the network.
What is The Difference Between A Security Token And A Utility Token?
In a traditional sense, securities can represent an ownership position in a publicly-traded corporation, a creditor relationship with a governmental body/corporation, or rights to ownership as represented by an option. A security token is a tokenised, digital form of traditional securities.
Security token holders rely on the “efforts of others”, as outlined in the U.S. Securities And Exchange Commission’s Howey Test. A utility token must serve a purpose, and it must have a function. If a network becomes useful and realises a profit, it may no longer be substantially dependent on the creator/sponsor, but, rather, on the market’s demand for the functioning utility of the network. Then, we’re no longer relying on the “efforts of others”. The token may no longer be a security token, though the network sponsor may still update the software and fix bugs.
How Are Utility Tokens Made?
Most utility tokens have been issued on the Ethereum blockchain, although utility tokens could be issued on other blockchains. Blockchains such as NEO, Counterparty, or Hedera Hashgraph allow developers to design in-app utility tokens.
The Ethereum platform’s ERC20 tokens, a technical standard for smart contract-based tokens, is essentially a list of rules that Ethereum-based tokens must follow so they can be shared and exchanged for other tokens or transferred to a crypto wallet. The main difference between assets, such as Bitcoin or Litecoin and ERC-20 tokens, is that, while the former run on their own blockchain, utility tokens mostly run on the Ethereum network.
Although a great majority of utility tokens were marketed as utility tokens, many are more likely to be security tokens. Not only do they have no use, but they also serve as speculative instruments; that is, people expected to profit from them.
Utility Tokens: A Review
In general, tokens are similar to privately issued currency. The blockchain empowers private organisations to issue and govern their own digital currency. The business definition posits a token as a unit of value issued by an organisation either as a feature of the business model (utility token) or representative of a share or stock (security token).
If an organisation introduces a token as a feature of the business model, it might facilitate product access, distribution or the sharing of rewards. Utility tokens must have a role, feature, and purpose on a network. Holders of a utility token enjoy certain rights to use a certain product and help govern the app.
SEC Director of Corporation Finance William Hinman sees bitcoin as perhaps the best representation of a utility token, for Bitcoin doesn’t appear to have “a central third party whose efforts are a key determining factor in the enterprise.”
He adds: “The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value.”
Perhaps, however, the argument could be made that bitcoin is a security. After all, the developers of Bitcoin exercise a lot of control over the direction of the world’s first cryptocurrency. They in fact had so much control they were able to revoke Gavin Andresen’s access keys to the developer’s repository after he corroborated Craig Steven Wright’s claim of being the real Satoshi. All the developers of Bitcoin had to do was claim Andresen might have been hacked.
Among the most popular utility tokens, for instance, is the Basic Attention Token (BAT), an Ethereum ERC-20 standard-based token used for the interactions with the Brave internet browser. BAT tokens allow users to block ads, specific changing type of viewed ads or to earn tokens for viewing it. Other utility tokens include Ripple, EOS, Cardano, Stellar, Tezos, and Chainlink.
Utility tokens are not necessarily a means of exchange, though they can be transferred like cryptocurrencies, such as Bitcoin. Holding or spending utility tokens may benefit users by allowing them the right to use the functionality that the network provides.