Cryptocurrency is an umbrella term for digital assets; however, these assets can be mainly categorized into coins and tokens. Coins help to transfer monetary value, e.g., Bitcoin and Litecoin. In contrast, tokens are a different class of cryptos built on another cryptocurrency’s blockchain, representing what a person owns. The most common tokens are governance, security, and utility tokens. According to industry experts, all tokens are not coins, but all coins are tokens.
A token can technically be another word for cryptocurrency or crypto asset. Also, a token can represent a non-cash asset, like a stake, ownership, or special rights within the blockchain. A token can also be represented as an asset or unit of value issued by a company. A token is issued when a company issues its Initial Coin Offering (ICO), similar to Initial Public Offering( IPO).
Governance tokens are created to represent ownership in a decentralized system. It provides the token holders to influence the decisions and the protocol’s direction. Here holders can change the governance system by deciding which features to develop, how to spend a budget, integrations, partnerships, etc. The proposed changes can be vetted and voted on through smart contracts. These tokens are an excellent decision-making mechanism for DAO, also known as Decentralized Autonomous organizations.
In traditional organizations, a central authority, board of directors, or shareholders makes the prime decisions regarding the organization’s strategic direction. In DAOs, they don’t have a centralized group of decision-makers. Still, they need to make decisions, and the decisions are governed by a governance process involving proposals and community votes.
A common feature of the DAOs in the governance tokens connotes certain characteristics such as immutable ownership and transparent distribution, making them suited to distributed decision-making. Governance holders place their vote on a chain, and the weight of the token holder is directly proportional to the number of tokens they hold.
More democratic processes: These tokens follow decentralized decision-making, leading to faster decision-making and efficient use of resources, where each participant is involved in the project’s future.
Increased security: These tokens have more security as the blockchain backs them, and they can be a significant advantage for businesses and organizations requiring high-security levels.
Increased transparency: The tokens can increase transparency as every stakeholder has access to the same information, reducing corruption and increasing trust in the system. It also increases the transparency in the voting system, making it more reliable.
A utility token gives holders access to special services or preferential treatment, such as a discount launch of a start-up’s product line. These tokens are promotional tools and don’t grant ownership stakes in companies or considered investments.
They are not guaranteed digital assets and can be considered digital coupons that can give you access to a company’s product or service in the future. For example, a Football club can launch Utility Tokens for their fans. The value of the ticket increases if the team wins enough matches to participate in the championship, and the value decreases when the team starts losing. However, ICOs are famous for producing some of the largest returns possible.
The ease of production of these tokens has led to quality and regulatory assurance in the crypto space. These tokens also serve another purpose apart from raising funds, including creating unique incentive schemes enabling people to perform unique actions within the ecosystem. A few other roles they perform are:
A token owner has certain rights, including the right to use or own a product and vote for specific cases or topics. Having these tokens offers decentralized storage. These tokens also provide the exchange value for the services or products. It also improves the consumer experience by offering rewards for particular things. They act as currency within the blockchain. It can also be an alternative to financial payments in the coming years.
Besides regulatory challenges, these tokens are associated with technological and market challenges. The technical challenges involve transaction fees as most tokens are ERC-20 tokens whose gas fees can sometimes get very high, making the Ethereum network more expensive. Like most altcoins, these tokens are also used as vehicles for financial speculation. This could raise issues when the dollar value fluctuates, and users struggle to anticipate how many tokens they need. Due to this, some tokens are stable coins designed to maintain a 1:1 ratio with another asset, for example, fiat currency like the U.S. dollar.
Security tokens are digital assets that derive value from an external source that can be traded. These tokens are subject to federal law, and failure to comply leads to severe consequences, including penalties. Financial regulatory authorities consider these tokens as securities. These tokens provide all the legal protections and regulatory clarity the traders are accustomed to.
A company issues a security token representing a claim of ownership in the business. It creates a whitelist of the crypto wallet address of the investors who are allowed to purchase the tokens. The potential investors need to prove they are compliant with any restrictions and regulations on that security. At a bare minimum, this involves compliance with KYC and money laundering laws. This helps with restricting who can buy and hold the token. These tokens can be traded freely, and Open Finance, Blocktrade, etc., are some of the exchanges designed for this activity.
They are based on blockchain and will play an important role in the future of digitization. However, there is little consensus on the regulation of cryptographic tokens. Divergent approaches are adopted to classify cryptocurrencies and tokens regarding due diligence requirements. Many authorities are working towards clarification and classification to maintain continued growth and innovation in the fintech industry.
Security Tokens, Utility Tokens, and Governance tokens can be differentiated based on the following points:
A security token is an investment contract used to represent legal ownership. It can be verified within the blockchain. Utility tokens help fund ICOs, create an internal economy, and provide voting rights. In contrast, governance tokens are an updated version of the utility token and can be used for other purposes like staking and creating loans.
A governance token provides value to every person in the organization; in a security token, the company’s value is directly proportional to the company’s valuation. However, a utility token has no relation between the company’s valuation and the value of the token.
Governance tokens have the least fear of security as every decision is made by the protocols and the voting rights involved in passing any decision regarding the project. In the case of security tokens, they are highly regulated; therefore, the chances of scams are less. Utility tokens are highly unregulated, and there can be a serious security and trust issues, as scammers can create bogus ICOs and tokens to make quick money.
Utility tokens are highly unregulated; however, in the case of security tokens, the company and the investor must go through the Howey test in security tokens. While across Governance tokens, every trade involved is regulated and secure.
Before investing in cryptocurrency, it is always important to understand the difference between coins and tokens and how this asset will suffice. Out of the different types of tokens, governance and security tokens are advised to be more secure than utility tokens due to the regulations imposed upon them. However, we should understand the intricate details that differentiate between the different types of tokens and decide before making the investments.
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