The crypto community divides all cryptocurrencies into two main types: coins and tokens. Coins are divided into groups according to distinctive features: Bitcoin and altcoins; originals and hard forks; pseudonymous and anonymous. Tokens are divided into two main types: utility and security tokens. If you are wondering how one kind of token differs from another, this article is for you.
Tokens VS. Coins
There is a significant difference between coins and tokens. A coin is a cryptocurrency that has its own blockchain. A token is a cryptocurrency created on a “foreign” blockchain, for example, Ethereum, Binance Smart Chain, Tron, and others. There are thousands of tokens; they are created daily, literally by pressing one button. The price depends on the marketing and PR of the company and ultimately on supply and demand. In some cases, a token is an analog of a company's stock, and its value depends on the success of this company.
Utility tokens are designed to solve issues unrelated to investments and settlements outside the project. Such a token is created based on a third-party blockchain platform, and an internal currency (in millions of units) is issued according to its standard. The most common platforms developers create tokenized projects on are Ethereum with the ERC-20 standard, BSC with the BEP-20 standard, and TRON with the TRC-20 standard.
Utility tokens are limited in use. They only provide access to the services or functions of the project. They can be compared to tickets, tokens in vending and slot machines, and fuel coupons. The supervisory authorities do not perceive this type of token as a threat to the markets or the monetary system, so they do not even spend their efforts controlling their issuance and circulation.
Utility tokens are distributed via an Initial Coin Offering (ICO). The initial coin offering is a crowdfunding campaign on the cryptocurrency market, analogous to an IPO in stocks. Startups launch ICOs to raise money for a new project, application, etc. Utility tokens have a clear goal — to ensure work in the network. These tokens don’t have investment value. However, the greater the demand for the protocol, the higher the token's price and the project as a whole.
Security tokens are digital analogs of securities that certify ownership and give owners the right to realize their investment interests (the right to shares, dividends, profit shares, etc.). These rights are recorded in a smart contract. By buying ordinary shares, an investor invests in a company in anticipation of its capitalization growth and profit. In fact, a person acquires a share in a business to receive dividends. In addition, certain types of shares grant the right to vote at the general meeting of the owners of the company.
Security tokens work similarly. They prove that the investor owns part of the company that issued the token.
This type of token can also grant its holders the right to decide on the project, product, and function. Investors can influence events within the framework of the project’s activities: the introduction of a new function, changes in token distribution models, and even the reconstruction of the governance system.
The most popular platforms for issuing security tokens are Ravencoin and Polymath.
Companies that issue security tokens promise their buyers (investors) the distribution of further profits or the right to a project share. The turnover of security tokens occurs following the legal norms of financial regulators in various countries, for example, the U.S. Securities and Exchange Commission (SEC) or the Swiss Financial Market Supervisory Authority (FINMA).
Security tokens are distributed via Security Token Offering (STO). STOs involve the issuance of digital assets in full compliance with the requirements of securities legislation. This should provide a higher degree of protection of investors’ rights and reduce regulatory risks for token issuers.
As you can see, despite being seemingly identical from a technical point of view, security and utility tokens function according to radically different economic models. Due to strict regulation, investments in security tokens are safer and potentially profitable. On the other hand, utility tokens can also act as an investment tool. For example, users participating in the ICO can get tokens at a low price, and if the project is successful, they can sell tokens much more expensive. On the other hand, if the project fails, investors suffer losses.
Therefore, to minimize risks, it is recommended not only to understand what kind of token to invest in but also to study the team carefully, the tokenomics of the project, and its prospects.
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