An Overdue Critique Of Utility Tokens
As the name suggests, the objective is for them to have utility within a particular context — But do they?
“Ideas are cheap. Ideas are easy… Execution is all that matters,” YouTuber and filmmaker, Casey Neistat, once told his audience on his channel. When it comes to securing funding for a startup, most of the traditional methods seem to agree with Neistat.
Venture capitalists prefer to put money into companies with a functional product or service, and proof that they have the potential for growth. Taking a company public generally requires a strong record of profitability over time. Even backers on crowdfunding platforms like Kickstarter at least expect to see a prototype.
But that’s all different in the world of utility tokens, the cryptographic assets companies release to raise money during an ICO (Initial Coin Offering.) These piggybacked on the earlier success of cryptocurrencies. Over the last couple of years, utility tokens have taken off as a popular form of crowdfunding.
What is a utility token?
A utility token is a blockchain-based digital token designed to allow buyers to interact with a product or service in some capacity. Companies release them to fund new projects. This is similar to releasing shares during an IPO (Initial Public Offering), except utility tokens do not give holders any sort of ownership of the company or voting rights. Ethereum, for example, is a utility token for interacting with a platform geared towards building decentralised applications and smart contracts. So the utility token is the basis of a business and the ICO is the process of releasing it.
Unlike a cryptocurrency like Bitcoin, they are not intended to serve any purpose outside of the company’s platform. Another distinction is that utility tokens aren’t really intended as investments.
As the name suggests, the objective is for them to have utility within a particular context.
The intention is for buyers to use them once the project launches, and for the price to increase if it is successful.
What makes a good utility token?
A good utility token should have a strong, unique use-case and a solid surrounding community. The supply should be fixed to ensure scarcity, and ideally, rewards should be available to buyers. It’s extremely difficult to establish how much a token is worth because they’re not backed by anything and prices are purely based on speculation. Traditional methods of calculating asset prices don’t apply in this case.
For example, Filecoin raised 257 million USD selling utility tokens that give users access to decentralised cloud storage space, making it one of the most successful ICOs to date. The idea definitely feels impressive; Filecoin is designed to make use of empty storage in data centres and laptop hard drives, paid for with utility tokens. Decentralised storage is, in theory, safe from the types of attacks that plague centralised storage centres. With a detailed white paper and well-qualified team, Filecoin earned the trust of investors, including notable venture capitalists.
Putting the ‘utility’ in utility tokens
Utility tokens are like the Schrӧdinger’s Token of the crypto world — there’s no way of knowing if it holds any real value when you’re only looking at it on the surface.
So far, many startups have raised billions of dollars through the sale of utility tokens, but their value remains dubious. We’ve yet to see strong evidence of their usefulness for anything other than raising money, although we can’t predict how the businesses will develop in the future.
The main appeal is the low barrier to entry compared to traditional funding methods. Anyone with an idea can set up a website and launch an ICO, with minimal technical knowledge required to make utility tokens.
There’s a reason why traditional funding methods tend to require a functioning product and proof of viability.
Even for professionals, it’s virtually impossible to predict if an idea will turn into a profitable company. No matter how good the idea is, countless things could go wrong on the road to executing it: a recession, technical hurdles, legal issues, another company launching an identical product, and so on.
Why jump the gun?
Purchasing utility tokens for a product that doesn’t exist yet is high risk, and not always necessary. This could be an important change in the fundraising model, giving underdog companies a chance to create impressive products. If you have an amazing idea but need to work full time just to pay rent, then using the utility token method may just get your side hustle off the ground. But for buyers, there’s a strong chance they might not get their money back or ever be able to use the tokens because the product never launches. Without the associated product, utility tokens are entirely useless.
Essentially, is it any different than paying millions for a one-way ticket to the moon?
The idea of going to the moon is a great one, but realistically, no one’s really ever lived there. Can you even live on the moon? We digress, but you get the idea.
Are happy endings just fairy tales?
Bringing it back to Filecoin, the technology didn’t yet exist at the time of the ICO and it still isn’t operational for public use. There are concerns the technical hurdles may be too great, or that the amount of money raised is far larger than what is necessary to bring the project to fruition.
Many, if not the majority, of companies that launch utility tokens do so as a way of profiting from the surrounding hype, and not because it’s truly essential. Some even end up supporting payments in local currencies, making their utility tokens redundant and just showing they didn’t need to launch them in the first place.
Likewise, many buyers choose utility tokens out of FOMO and not because of a true understanding of their potential.
In addition, the low prices (many utility tokens currently trade for a fraction of a cent) make them easy targets for pump and dump groups which falsely inflate their value for a brief time before it plummets back to nothing. This, alongside other concerns, has led to a backlash from regulators who are waking up to the fact that many companies use utility tokens to bypass the regulations surrounding securities. While few countries currently intend to ban ICOs altogether, most are enforcing restrictions.
Are utility tokens needed at all?
In a lot of cases, the answer is no. Using an existing cryptocurrency or even local currency for the platform could work just fine. Utility tokens do have potentially valuable applications, but there needs to be a lot of improvement in the space. One of the main concerns is regulation. Utility tokens have mostly escaped it, but regulators are increasingly realising that many should be defined as securities and regulated as such.
If you’re considering buying utility tokens, it’s important to remember that investing in something that doesn’t yet exist involves a high chance of losing your money.
We’re not saying there aren’t any viable use cases for utility tokens, but at this point in time the industry is still extremely new and we’re witnessing the infrastructure of this new world being built as we speak. We can’t wait for real use cases of cryptocurrencies and blockchain ideas to come to fruition — but this takes years to build and decades to adopt.
Would you front your hard earned money for that ticket on the moon right now? Let us know what you think about buying tickets to the moon and utility tokens and reach out to us on in the comments below or on Twitter.
