At fairs and festivals, you’d exchange cash for a token that you could use for food, drinks, or rides. Similarly, it could also signify membership of a group or some type of proof of ownership.
With the rise of cryptocurrencies, the term token has found a new life in a new context, and it’s now part of the technological revolution currently sweeping our society. In the crypto space, a token is simply a cryptocurrency built on top of an existing blockchain.
In this article, we’ll go through what a token is in the context of blockchain, what characterises it, what types of tokens exist, and what they’re used for.
Token definition
The most basic definition of a token is that it constitutes a unit of value issued by an organisation. If we transplant the notion to the crypto industry, we must add the fact that it’s accepted by a community and it’s also supported in a blockchain.
An organisation creates a token in the context of a specific business model so that it can incentivise user interaction and distribute rewards throughout the network of token holders.
We’ve focused at length on the difference between a token and a cryptocurrency in another guide, but because they’re used interchangeably, it’s essential to establish what differs them quickly here as well.
While a cryptocurrency operates independently and uses its own platform, a token is a cryptocurrency built on top of an existing blockchain. For example, Bitcoin is an independent cryptocurrency, while 0x is an Ethereum-based token.
Types of tokens
When a company raises funds in an Initial Coin Offering (ICO), it does so by issuing tokens which it distributes to buyers interested in contributing with crypto-funds.
These tokens can have many different uses, but we can classify them into two sections: security tokens and utility tokens.
Security tokens are similar to traditional shares because their value is derived from a tradable external asset.
Once governments agree on the right regulatory framework, it’s safe to assume that, because of their nature, security tokens will be subject to the same regulations. The companies that fail to meet this standard will incur substantial fines and their projects will grind to a halt, while those that abide by it will stand to gain immensely from being certified investments.
On the other hand, utility tokens aren’t designed as traditional investments. Instead, they grant holders access to a company’s future product or service. Depending on the design, utility tokens could very well be exempt from the regulation aimed at securities.
In the same way that a bookstore can accept orders for a book that hasn’t yet come out, a blockchain start-up can sell digital tokens which will allow the buyer to acquire a product that hasn’t been built or a service that can’t yet be provided.
Think of this method of raising capital as a way to bypass investors and going straight to your future customers. This way, if a start-up finds enough people interested in paying for the product or service before it can be delivered, they have enough capital to get the project off the ground without having to grovel at investors’ feet.
How can a token be used?
In the case of security tokens, their most common use is as a fundraising vehicle in ICOs.
However, if we’re discussing the “ICO” of a utility token, those companies prefer the terms token generation events or token distribution events.
Since the token industry is still in its infancy, it’s hard to categorise potential token uses in this manner. Ultimately, the possible uses of a given token will be determined by the company that issues said token.
As blockchain enterprises mature and address the issues of government regulation and investor and customer accessibility, we can expect more innovative ways to put tokens to use. Tokens will be used as a method of:
- Payment between different parties who accept to use it as a currency
- Digital asset ownership (real estate, products, company shares)
- Accounting for digital actions
- Reward to participants in a network
- Ensuring network protection
- Installing a gateway to extra services
- Providing a better user experience
The possibilities are endless, and, much like with the advent of the internet, still remain largely unexplored.
A look at the future of tokenisation
Given its potential to change the way our society organises itself, the tokenisation of real-world assets such as gold or real estate needs to be taken seriously.
Once tokens integrate with the existing global banking infrastructure and operate under sensible government regulation, they will gain the public’s trust. Highly optimistic observers even consider that ICOs might replace Initial Public Offerings as the primary share-issuing method.
At that point, our economy will be set to capitalise on the democratisation of assets, which will allow even the smallest investors to buy a fraction of a booming asset.
For more information about cryptocurrency, check out our other guides here.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.