What is my token worth? - Part 1 : Tokens and their types
This is the first part of a 4 part series in evaluating a token and its price before investing.
“Bitcoin is more than money, and more than a protocol. It’s a model and platform for true crowdfunding — open, distributed, and liquid all the way.” — Balaji Srinivasan
The Bitcoin protocol was the first ‘killer app’ on blockchain and the incentive mechanism built into the Bitcoin protocol lay brought us world’s first token i.e. Bitcoin way back in 2009. Today, Coinmarketcap lists over 1591 tokens varying form storing data, to getting access to computing power, to watching porn.
Tokenization will change the world and if there isn’t a token for an asset today, pretty soon there will be. The recent number of Initial Coin Offerings (ICOs), the enormous amount of money they’ve raised and the speed with which they did it (~$ 7.5Bn in 2017 alone), has set off the alarms for funding industries from Venture Capital firms to government bodies.
For us to be able to value tokens correctly we need to first be able to understand what they are and broadly classify them according to their purpose.
What are tokens anyway?
Blockchain is essentially a ledger which has accounts and balances represented by ‘tokens’. Every blockchain platform is powered by tokens, sometimes also referred to as “coins.” Bitcoin is a token, so are Litecoin, Dash, and other currencies that function over a blockchain. The token of every such blockchain represents ownership of the entity the blockchain is built for.
The Bitcoin token acts a store of value, Ethereum’s ether as fees to power the network, Siacoin has Sia token which acts as a way to access file storage and so on.
Types of tokens
There are multiple ways to differentiate tokens and classify them. From a monetary perspective of evaluating tokens, its best to evaluate them on the basis of their purpose i.e. what they can be used for. All tokens broadly they fall into one of the below 3 types:
Currency tokens aka ‘Cryptocurrencies’
Payments got it all started and bitcoin became the mother of all tokens. Currency tokens or ‘Cryptocurrencies’ are the simplest to understand as they solve one problem and one problem only i.e. to act simply as a medium of exchange of value.
Just like USD or INR or any other form of fiat they are really worth whatever people choose they are worth based on supply and demand. Cryptocurrencies have the potential to become money of the future more of which is explained here:
Utility tokens
Utility tokens are tokens you need to access a particular service or utility. The token ownership does not give you any specialized rights within the network, but it does give you access to the service, a finite amount of it, an amount which is determined by market forces. The best way to understand them is to think of them as paid ‘API keys’.
For example, when you buy an API key from Amazon Web Services for dollars, you can redeem that API key for time on Amazon’s cloud. The purchase of a token like Sia is similar, in that you can redeem Sia for storage space on the Siacoin network.
Utility tokens are ideally not designed as investments or mediums of exchange or stores of value. They typically start of as ways to fund projects of shared infrastructure that couldn’t be funded before. To enable such ecosystems to be built some tokens can be “pre-mined” while being sold in “crowd-sales” during tokens launches.
Security tokens
Security tokens are a digital representation of an underlying asset. A security token might represent shares in a company, a piece of land, ownership in a car, etc. These tokens might have special rights associated with them as dividend payout, voting rights, and much more. Digitizing physical assets makes the asset tradable and hence ‘code’able which is what makes security tokens interesting.
The birth of Ethereum opened the floodgates for security token creation. Before Ethereum, to launch a token you had to build your own blockchain. Tokens built on top Ethereum’s popular ERC-20 token standard today account for value ~3x that of Ethereum itself!
Evaluating tokens
The purpose of every token is different and as a result, evaluating methodologies for each token are different. Currency tokens would be evaluated more on the underlying technology, the community and token supply characteristics. On the other hand, utility tokens might be evaluated on the product, potential market, and probability of success. Broadly, a token evaluation framework would include looking at
- Type of token
- Stage of project
- Current value
- Expected growth
- Competition
- Potential impact
- Token Mechanics
In part 2 we will take a deeper look at evaluating tokens at an ICO stage.
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