Utility Tokens: A General Understanding
“A digital token of cryptocurrency that is issued in order to fund development of the cryptocurrency and that can be later used to purchase a good or service offered by the issuer of the cryptocurrency”
The above is the Merriam-Webster definition of a utility token. Yes, it is actually in the dictionary.
Let’s unpack it.
A utility token is a non-physical token (think of a Chuck-e-Cheese or Dave & Busters arcade token that you can’t touch, or hold in your hands) that has been created for crowdfunding purposes (think of KickStarter, GoFundMe — those types of sites). This means that the buyer of a utility token has paid the issuer of the token money NOW so that the company can develop a product that the buyer of the token can LATER redeem for that good or service.
Blockchain startups raised $5.4bn (Source: CoinDesk) through Initial Coin Offerings (ICOs). An ICO is the process of when utility tokens are issued and sold in a crowdfunding manner. So why are people — and these people range from taxi drivers to doctors to Wall Street bankers (including me) — buying these tokens that they can’t touch or redeem for a product or service?
For better or worse, speculation and fear of missing out (FOMO) are major culprits behind why people have been buying and trading utility tokens. Although you can’t redeem a utility token for goods or services, a holder can go onto crypto exchanges (think of a thinly regulated NYSE or Nasdaq type of entities) to buy and sell utility tokens. A person purchases a utility token hoping that there will be positive sentiment towards the underlying project, which will entice someone else to want to pay a higher price for the same token. Another person sees how the utility token has been increasing in price, and fears that if he or she does not buy now, he or she will miss out on buying the utility token cheap enough (i.e. FOMO), and thus buys the utility token at the higher price.
The price or value given to the utility token is derived mostly from speculation, and the merry-go-round of price appreciation continues as long as there is a third party willing to buy the utility token at a higher price. That being said, utility tokens have the potential to create and retain real value, but how that is achieved is outside the scope of this post.
Hopefully this post gives you a better sense of what a utility token is and how it operates within the current crypto universe. A lot has been written on utility tokens. If interested in learning more, see links to further readings below:
Disclaimer. This post is intended for informational purposes only. The views expressed in this post are not, and should not be construed as, investment advice or recommendations. This document is not an offer, nor the solicitation of an offer, to buy or sell any of the assets mentioned herein. All opinions in this post are my own and do not represent, in any manner, the views of CMX Capital or affiliated companies.