Token Types Explained

Most people know that the cryptocurrency craze first started in 2009 with the launch of Bitcoin. It was largely ignored by most and misunderstood by many. It wasn’t until those early investors were made into millionaires overnight that the rest of the world decided to pay attention to the possibilities of cryptocurrencies. The increased profile led to copies of the popular Bitcoin to be developed, but the smart contracts they utilised were based on a restrictive coding language.

It wasn’t until the introduction of Ethereum in 2014 and its modified smart contacts that the true possibilities were realised. Ethereum has been hailed as cryptocurrency 2.0 and prepared the ground for the explosion of cryptocurrencies that we are experiencing today. Moving away from the highly restrictive language of the Bitcoin smart contracts, Ethereum was built on a language that could be easily adapted and allowed programmers to write their own contracts.

A smart contract is essentially a self-executing contract that could one day replace much of the work that present-day lawyers are tasked with. Smart contracts allow value to be passed from one person to another automatically based on a series of terms that were mutually agreed when first issuing the contract.

As cryptocurrencies are assigned value, governments and regulatory bodies are naturally concerned with how this is managed. After all, a coin that retains value against real estate, for example, but that isn’t regulated by any financial authority, could easily be put to use in money laundering operations.

So, how do governments and regulatory bodies decide what needs to be regulated? At the moment, there is much ambiguity about the categories and the requirements for each. For example, while the Swiss Financial Market Supervisory Authority (FINMA) recognises three classifications (payment tokens, utility tokens and asset tokens), the U.S. Securities and Exchange Commission (SEC) only recognises two (utility tokens and security tokens).

While the terminology might vary, it is becoming clear that there are three distinct categories with more subcategories. It is widely accepted that tokens can be divided into the following groups:

1. Utility Token

2. Security Token

3. Payment Token

Utility tokens are broadly defined as app tokens or app coins. They can normally be exchanged for goods and services but only within their own “ecosystem”, which is a predefined area of reach. Security tokens are intended to retain and appreciate in value, they may be backed by physical assets like real estate or precious metals and they are also considered investments. A payment token works as the name suggests, and can be used as payment for goods and services.

Since the definitions vary so wildly, investors must be wary of which coins they choose to support. Many investors are only interested in securities, as these will retain or appreciate in value. However, it isn’t immediately clear what is and what isn’t a security.

For companies launching their own tokens, the process becomes even more complicated. Choose the wrong category and you could face being banned from a particular exchange. An example of strategic choice can be seen with Silent. Although it would be easier to be categorised by authorities when you issue a utility token, since the funds generated from the token sale will be used as investments into methanol production plants, it functions as a virtual share of the Silent company. And as Silent is investing the funds into a factory, the token is a security token which is backed by the assets of the company.

Ultimately, the test for what is a security token and what is a utility comes down to a legal debate, and this varies wildly between jurisdictions. Therefore, companies launching their own ICO are paying very close attention to comply with regulatory requirements in the country of issuing.

Investors as well must have absolute clarity on what they can gain from their crypto investments. The base for future gain is to ensure that the tokens are legally compliant with current and future legal frameworks, both in the country where the token is issued, as well in the country of the investor’s residence.