You have probably come across the concept of a Token in many sources devoted to cryptocurrencies. It is frequently used to denote a general designation of all types of electronic money on the blockchain. For this reason many people think that Token is the same as Coin. Although the difference between them may be blurred at a first glance, it is important to distinguish these two terms. Like coins, tokens are digital money that does not have a physical expression and is used to pay for goods and services. However, they are inferior to the Coin in value. There is no need for tokens to be mined — they are issued by the project to pay for services within it. This is what makes them different from Coins which can be used at several different sites. The majority of tokens are issued on the Ethereum blockchain protocol because it is superior than Bitcoin. As well as coins, they can be purchased for fiat money to use them for trading on the stock exchange or simply to support the idea you’d like to be implemented. In addition, tokens can be used as a means of voting on a specific issue regarding the project launch — this is similar to shares operation principle.

Why are tokens important?

Tokens are mostly used as a form of attracting investment in ICO projects. This is kind of a stock that makes it possible to invest in a startup. Before launching an ICO the project releases a certain number of tokens for its own needs. Investors who are interested in the idea can contribute to it with their fiat money. This gives them a right to take part in the project development by voting in the blockchain. However, not every token gives this right.

As you might have guessed, like coins, they have not been without classification. The Swiss Financial Market Supervisory Authority (FINMA) and the U.S. Securities and Exchange Commission (SEC) distinguish two types of tokens:

Utility token — service token;

Security token (SEC) / Asset-token (FINMA) — investment token.

Let’s start with the utility tokens. Let’s imagine a certain form of payment instrument that can be used in one place only. For instance, since 1953 to 2003 in order to take a metro trip in New York passengers needed to buy “Subway Tokens” that looked like regular iron coins. By throwing them into a special terminal people paid for their one-time journey in New York subway only. Utility tokens work roughly the same way. Using them, you can pay for a service or product within a specific project. Also, owners of such tokens have access to various discounts and bonus programs from the company for products and services that will be launched in the future.

Utility tokens are especially popular on blockchain gaming platforms. Let’s consider the example of the KittyCash project, the creators of which used the concept of the popular in former times game Tamagotchi. These are virtual tokenized cats that you can play with, breed, feed and sell. In order to play the game, you must purchase “The Kittery” wallet that will later allow you to buy kittens. Namely, users purchase utility-tokens of the project to use them only within this game. They do not have any value. In fact, they are the same as coins used in any game in the AppStore or Google Play. Moreover, these tokens are not securities and are not registered with any government body, meaning they cannot be considered as an investment instrument. Let us recall the example with the metro: the fare payment (or payment for the service or product you need) does not mean you invest money in the development of the metro and can influence its fate.

Security tokens operate in a different way. By purchasing them you get access to the basic assets of the project, to profit making, as well as the opportunity to vote on its further development. Smart contracts on the Ethereum network allow projects to issue such tokens, which are similar to the shares of companies and assume official registration. Investment tokens are safer and more profitable for investors, but they require projects to comply with the KYC (Know Your Client) and AML (Anti-Money Laundering) procedures. Since 2017, security tokens owners must comply with the law on securities if they make profit from them. That makes the holders of such assets resemble to stockholders. At the moment there are only two bodies that have begun to regulate cryptocurrencies — The Swiss Financial Market Supervisory Authority (FINMA) and the U.S. Securities and Exchange Commission (SEC). From their point of view, security tokens are legal.

Despite the opportunity to release real assets that are valuable to investors, the projects still prefer to issue utility tokens. Why is it so? The thing is that registration of tokens with government agencies requires a substantial documentary base and time from the projects, so they follow a simplified path. Most likely, the situation will not change until the states come to a common decision to regulate the cryptocurrency and ICO market.

Digital currency market experts have already expressed a positive attitude towards officially registered coins. Former Chief Development Officer of Facebook and Snapchat Anthony Pompiano recently published on his blog “The Official Guide to Tokenized Securities”, in which he shared his conviction that security tokens are a new technology that will make old things better. In his opinion, security tokens are superior to traditional stocks and bonds because their use does not require the intermediary bank services. Thereafter, the investment process becomes easier for users, since it requires:

Less financial expenses due to the reduced amount of commissions;

Less time input due to the fact that transactions are made via the Internet.

These advantages allow you to attract more investors.

If you still consider what kind of tokens you should buy, we advise you to pay attention to the latest news from the US SEC Commission, which decided that utility tokens cannot participate in the pre-sale. So, if a company wants to attract investment in its project, it should focus on the security tokens emission.

But how to determine which token is in front of you and how not to get lost in them? For this purpose there is a Howey Test. This is a list of questions that will help you to check your already acquired or future token:

Does a token buyer expect revenue? Is its main function — investment? Does the token holder have a profit from a third party? Is the money from the sale of an asset invested in the company?

If your answer to all questions is “yes”, then you have a security token.

So, now you know how to check which digital currency you are purchasing from the project. And then the choice is yours. We decided to devote our next article to those cryptocurrencies that retain their stability regardless of the project reputation and other factors. Do not miss!