Digital Tokens 101: What Does it All Mean?

“Cryptocurrency” can refer to both tokens and coins, but differences exist between the two labels.

Welcome to the world of cryptocurrency, where the conversation is constantly changing, can be a bit confusing, and usually, cryptic — especially when it comes to tokens.

Ever heard tokens being referred to as coins, and coins as tokens? Or what about cryptocurrency together with labels like “security” and “utility”? We have too. A lot!

This is why we’re breaking it down as best we can. It might seem a bit repetitive but we’re going to start with some of the basics before launching into the specifics.

First off, we’re going to define cryptocurrency because, yes, tokens do fall within this general category:

Cryptocurrency is decentralized and encrypted using cryptography and is a digital or virtual currency created and stored on the blockchain. There are numerous types of cryptocurrencies, all of which are used to control the creation of monetary units and to verify the transfer of funds. The term “cryptocurrency” refers to all tokens and coins.

So, what’s the difference between a digital coin and a digital token? Coins — Bitcoin and other Altcoins — typically possess their own independent blockchain and a coin’s overt purpose is to act like money, which means operating as a unit of account, store of value and medium of transfer.

Knowing the difference between a utility token and a security token is key to navigating the changing landscape of cryptocurrency.

Tokens, on the other hand, are generally hosted on top of another blockchain and represent an asset or a utility.

They require a platform, like Ethereum, to exist and operate on, and are created when a project launches an Initial Coin Offering (ICO). Tokens, also referred to as crypto-tokens and digital tokens, are usually given to early investors in exchange for cryptocurrencies like Ether, Bitcoin, or any accepted Altcoin, and are also used as a form of payment for using a platform, app, or system.

Now, how can you tell what token does what? There are multiple types of tokens, each functioning independently from the other, but the two main types you need to be aware of are security and utility tokens.

Security Tokens

Put simply, security tokens are synonymous with an investment contract, which means security tokens could represent shares in a company, earnings streams, an entitlement to dividends or interest payments. In terms of economic function, they are analogous to equities, bonds or derivatives.

As securities, asset tokens, from a general perspective, fall under specific regulatory guidelines, which means they are subject to the given federal laws of a country. This means regulations vary jurisdiction to jurisdiction. So, if launching an ICO, you’ll need to verify which jurisdiction(s) your token may fall under in order to know what regulations apply.

In general, if trying to determine if a token is a security, ask this question: “Is the token increasing in value over time, and is that increase connected to the company’s performance?” If the answer is yes, it’s probably a security token. The Howey Test is key legislation in determining whether a transaction can be viewed as an investment contract.

Summary

Regulatory framework, depending on country

Expectation of return

Similar to a stock

Utility Token

Utility tokens are similar to the tokens you would buy at an arcade as utility tokens provide access to a company’s product or service. They aren’t regulated, and are not investments.

Sometimes, the lines between a security and a utility token can become a bit blurred, especially when you add in shifting regulations and the lack of a globally-accepted framework. However, if a utility token is properly structured and acts as a “coupon” for the company’s services, it remains a utility and typically exempt from strict regulatory oversight.

Summary

Not, or less, regulated

Are not investments

Provide access to product/service

Why It Matters

Knowing the difference between a utility token and a security token is key to navigating the changing landscape of cryptocurrency. Whether you’re holding tokens or are planning a crowdsale, you need to know the difference.

First, you don’t want to buy into something without knowing what it is, and second, you need to know what laws the token needs to be compliant with pre-launch of a token crowdsale.

Before choosing what coin to launch your ICO with, you need to ask yourself one question: “What are the needs of my ICO?” and be sure you don’t fall into these common traps:

Avoiding Security Tokens

Don’t avoid security tokens because you want to bypass regulations as this can land your project in hot water with securities commissions. By merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security. If a security token has the characteristics your ICO requires, then choose a security. If there is no need for a security token, don’t create one unnecessarily.

Underutilizing Utility Tokens

Utility tokens are dynamic. There are multiple types with different uses and characteristics that could cover the needs of your ICO. A lot of people overlook utilities, but it’s important to do your research before dismissing the option entirely.

We’ve only scratched the surface, but knowing what a token is, the difference between a coin and a token, and the difference between a security and a utility will help you join the conversation, participate in an ICO, or launch one yourself.

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