The 3 Types of Tokens and Why They’re Worth So Much
Tokens are a fascinating topic and every day there is new innovation coming out. As a developer it’s an amazing feeling to be able to create value that anyone can access from a computer anywhere in the world. We’re in the new decentralized economy and it’s only growing! I’m constantly talking to people who see a world where tokens are used as ubiquitously as credit cards, personally I give it 20 years.
Right now there are three main token types: utility, commodity and security. Each of them have their own regulation, levels of scrutiny, complexities to them and a lot of cool examples coming out.
Utility tokens is a token that only has value in the use of a system.
You could potentially pay for fees of transactions like with 0x or Lif, buy a real business asset like storage with Storj or get paid for looking at ads with BAT.
Most ICOs use utility tokens because they’re considered generally safe for most countries in the world. Investors buy an early stake in these tokens with the assumption that the price will go up once the utility increases and the businesses develop. From a legal point of view the issue is that the intention is that the value will go up so the SEC uses this logic to say that utility tokens are a security.
I tend to disagree, for example you can go buy an expensive car with the intention that value of it is going to go up because of appreciation, international arbitrage or any number of reasons. It happens all the time but regardless of the intention to make more money with the car, it’s still a car. You can use it to drive it around, it has a distinct utility. Would you ever think that a car would be a security? Obviously not because that’s insane.
There’s a lot of amazing crypto-economics that goes into deriving the value of the tokens so there is a lot of sound logic behind the creation of a utility token and its increasing value proposition.
Macroeconomics derives value to a medium of an exchange, ergo a utility token or cryptocurrency, as MV = PT.
Number of Coins * Number of Times the Coin Changes Hand Per Day = Price of Goods and Services it Accesses * Transaction Volume Per Day
In one of his fantastic posts Vitalik derives MV = PT into a much simpler equation of MC = TH.
Market Cap = Value of Goods Transacted Per Day * Average Holding Period
So the best way to grow the value of a utility token is to have users who have reasons to hold your token: staking being one of the predominate ways right now. Along with a reason to transact real utilitarian value such as buying a airplane seats with Winding Tree, purchasing tokens via a DEX with 0x or buying access to computing power using Golem.
There needs to be a real utility to a business or a person for the token to make sense. That’s why you’ll see a lot of tokens going after real world business models that exist already but by using smart contracts to remove issues like fraud, remove the banking industries obviously enormous fees, or any other issue that the creators know exists.
I love projects that find real issues that exist and see a solution via smart contracts. A lot of the solutions that come now are using the most basic feature of smart contracts: the ability to move value anywhere in the world for pennies. This is great but over time I think we’ll see a lot more creative and advanced uses of smart contracts.
Commodity tokens are tokens backed by a standard assets that already have an independent value such as gold, oil or a sovereign currency.
A lot of projects focus on pegging tokens to sovereign currencies, USD being most common. Most of their strategies are fairly simple with users giving cash to a custodial account that is regularly audited by an outside firm but there have been rumors of problems with the largest of these tokens, Tether, that they may not have nearly as much money as they state they do. Personally I don’t trust any of these tokens because they are not truly decentralized, you are putting trust into multiple entities that could easily fail because of human greed.
One project that is trying to do a better job of Tether’s model is TrustToken with their soon to be released TrueUSD. Hopefully the model will work, personally I would like to see projects with multiple reserve systems, auditing companies and custodial systems to decentralize the risk.
Simultaneously there is also a project by MakerDAO called Dai attempting to create a soft pegged USD cryptocurrency. It’s collateralized by Ether (and in the future a basket of cryptocurrencies) but it comes with the issue that if there is a major (ex. 90% drop) in cryptocurrencies it will not be able to keep its soft peg of 1 USD per Dai and lose most of its value. It is also extremely overly collateralized right now on purpose to keep price parity with USD because of the extreme market volatility that occurs in cryptocurrencies.
Oil is also a hot topic right now when it comes to commodity tokens because of the Venezuelan governments effort, El Petro, which intends to tokenize 5 billion barrels of oil that are still in the ground. This is also the most dangerous token, in my opinion, to be coming out because the government is tokenizing future profits. That’s great for the people of Venezuela in the short term because they’ll have money in the country but long term if the country continues to borrow against its future production it will run out of its only way to sustain it’s government. This could potentially accelerate another collapse and generally exacerbate the next major financial crisis the country has.
Lastly, DigixDAO is trying to have a coin attached to the price of gold with provable gold reserves certificates posted to the blockchain. This is exciting from the aspect that blockchain can soon start to capitalize on markets that are traditionally controlled by large banking corporations and stock market companies. We could see massive decentralized commodity markets existing, allowing cryptocurrency investors to diversify into real world assets.
While most of these tokens should generally stay at price parity with their underlying assets because of the arbitrage opportunity I believe that instead the price of the underlying asset will only be the floor of an asset and there will be a liquidity premium because of the ease of transferring the asset to anyone in the world.
Security tokens are tokens that equate to an ownership stake in a company or DAO.
When you buy a security token you’re buying it with the intention that the value will be derived on the value the company or its future profits/dividends may be worth.
There are a lot of existing valuation methodologies, regulation and systems to doing security tokens. All of this regulation forces them to be the most restrictive in who can purchase them. Most of the systems in place for US investors will require you to be an “accredited investor” which requires the investor to have a net worth of at least $1 million or an income of over $200,000 for the last two years.
Currently there a lot of new exchanges coming out that are only for security tokens and some current exchanges adding functionality for it with some extreme restrictions and controls on who can own or have these security tokens transferred to them.
A lot of experts believe that this may be the new direction for the market because valuation becomes substantially easier and there exists opportunities for dividends and buyback programs to legally exist for tokens.
While security tokens have limitations on the open market is does have advantages in allowing for investors to get liquidity on private stock essentially whenever there is a willing buyer. As with commodity tokens I believe this will have a liquidity premium attached because of the ability to freely trade private stock.
About the Author: Petros is a Blockchain Engineer at a growing ICO launching company Block 16. We are a full service blockchain agency that does crypto-economics, network syndication, marketing services and blockchain development. If you would like to reach out to me send an email to [email protected].