The blockchain has presented startups with a lucrative new fundraising model: issue tokens through a decentralized system in exchange for capital despite being pre-revenue; and without unloading any equity at all.
Yet, while the extraordinary momentum of this multi-billion-dollar ICO industry is unprecedented, its exact future remains anyone’s guess.
Why Cryptos Exist
Cryptocurrency and tokens exist for several reasons: storage or transfer of value (Bitcoin); to guarantee preliminary access to a new, decentralized service (Filecoin); or to receive a financial benefit in the event of a company’s success (most Altcoins).
Yes, most tokens trade on exchanges; but it is the underlying use case which determines how authorities regard the asset — and this classification defines how it is regulated.
Utility Tokens
Utility tokens grant future access to a specific product or service; plain and simple — kind of. In essence, the token represents a ‘pre-access coupon’ to the promised deliverable, with first dibs once the platform is operational.
The token itself may also often have a platform-specific use — transactions, rewards, discounts — and those who hold the utility token will play an active role in growing the ecosystem.
This gives the token an intrinsic value; a value which other tokens can lack.
Structuring the token as a utility allows companies to avoid traditional financial regulation, simplifying the issuance process. As such, entities tend to opt for the generic ‘Token Generation Event’ rather than pursuing an ICO — though both events are, effectively, the same.
While utility tokens are not investments per se, there is still scope for financial gain.
Should the product or service become popular, the value of the token will rise courtesy of growth in demand; so, holders profit, while users go on — using. The dynamic has led to discussions over whether utility tokens are more of a security, but the jury is still out.
Security Tokens
In the eyes of the regulator, any asset that determines its value exclusively from activity external to company operations (i.e., being traded on an open market) is a securitized asset. So, where a token is listed on an exchange with investors seeking to profit purely from growth in the token’s value — equals, a security.
The token has no utility for a specific platform; it is merely an investment vehicle.
Therefore, securitized tokens must abide by the local financial regulation. And this is a good thing. As once governments define their oversight of security tokens, ICO investments will become safer.
With investors, in theory, protected.
Which is Better? It’s a Question of Utility.
For utility tokens, the regulatory landscape is currently less clear. The ‘dual-use’ of the tokens is causing headaches for the powers that be, while the uncertainty raises questions about its future.
However, when applied to the right context, the utility token becomes a powerful means for generating interest in — and scalability of — disruptive platform ecosystems. When platform economics require an exchangeable asset to enhance the product experience; enter, the utility token.
The regulated security token, on the other hand, plays a different role.
It provides a structured investment vehicle; it allows market participants to invest with confidence, and it guarantees transparency and due diligence of those seeking to raise capital.
Confidence + transparency = liquidity; which lays the foundation for a viable market.
Hence, many start-ups favor the securitized token; they do not need an internal method of exchange. However, where a product relies on the interplay of its users, the utility token will always win out.