Most people are not aware of the importance of the use of the token, they simply invest based on the project itself. This is however very wrong, let’s say that you love the McDonald’s business, that doesn’t mean you should “invest” in everything McDonald’s related. McDonald’s stock is different than McDonald’s bonds which is different than McDonald’s loyalty points (assuming they exist) which is different from McDonald coupons for free burgers which is different from small plastic toys from McDonald’s.

Most people don’t understand those differences when it comes to ICO, so just because they like the project they may settle with a “free coupon for a burger” instead of actual McDonald’s stock.

Let’s look at the different types of tokens:

[Very bad] Prepayment for the product: some website is going to be created offering some product or service. The website will exclusively accept that token as payment. So when you buy the token you are basically prepaying for the service in advance. Those tokens make the least sense of all, basically they could just develop the website and accept dollars but since it’s so easy to raise money with ICO they decide to have people purchase tokens as prepayment for a product that doesn’t exist yet. Would you prepay your burger years in advance?

[Bad] Gas token: this token makes a little bit more sense. Here usually there is a need for blockchain (unlike the previous case where the blockchain is just forced where it doesn’t belong) usually for storing data in a secure, irreversible and decentralized way. The main applications that use this type of token are applications related to identity or to notarization of data on the blockchain. The issue with this type of token is that you only need to buy the slightest amount in order to record the transaction on the blockchain. That’s why it’s called “gas” token. Because you only need to pay for the actual gas fees. In general there is no economic reason for which the token should increase in value behind this type of token simply because there is no reason for anyone to purchase more than an incredibly small amount of it. It’s just like water, it is very useful but it’s worth very little because humans don’t need so much water to survive and there is an incredibly large amount of water in the world. So you don’t buy water as an investment, you only buy it when you’re thirsty.

[Average] Security token: a security token behaves in a similar way as a stock. Basically it usually pays dividends or its value is supposed to increase with buybacks or burns. The issue with this type of token is that it follows the usual rules of the financial industry where the value of a security is based on the future predicted discounted cash flow. That means that first of all the underlying business must be profitable. Once it’s profitable the business is then valued based on a multiplier that usually is between 10 and 20 or even more based on the growth rate of the business.

[Good] Medium of exchange token: those are the best tokens. Basically the project is a marketplace where only that token can be used. ETH or BTC are good examples, for example if you want to participate in an ICO you must purchase ETH because it is the medium of exchange for doing the ICOs.

The big difference with gas tokens is that in medium of exchange tokens if I want to invest 10 times more than someone else in an ICO I need to buy 10 times more tokens. With the gas token no matter what I want to notarize on the blockchain I still need the same fixed amount (the minimum amount in order to be included in the blockchain).

The main difference with the product prepayment token is that you have an active marketplace with many buyers and sellers and not just one buyer (the service provider). It would be as if for example ETH could only be used to give money to Vitalik for some services he provides (if ETH was a prepayment token instead of a medium of exchange token).

The main difference between a security token and a medium of exchange token is that the medium of exchange token will never need to make a profit to be valuable. It will be valuable simply because of the adoption as a medium of exchange. Usually if you invest in a company first it must manage to get adoption, then it must manage to monetize (revenue) then it must manage to become profitable (profits). With security tokens you need all those 3 steps to happen for the token to be successful, however with medium of exchange tokens you only need the first one (adoption).