Types of tokens. The four mistakes beginner crypto-investors make.
The growing hype around ICOs and searches for the projects able to generate 100x return motivated ICOscoring team to give some clarifications on different types of tokens, which is often one of the essential factors to analyze when choosing the right project to invest.
After investing in more than 30 ICOs, our team can clearly state that any top project that organizes ICO might lose investment attractiveness for 3 reasons:
1) the issued token does not add value to the project
2) the token price growth does not have the economic rationale
3) the token price is overvalued
In this article, we will provide a hands-on guide to different types of tokens and their role in projects. Also, we will try to describe the most frequent traps the projects try to hinder from investors.
Quite often, unqualified investors do not fully understand the economy of the project, send their BTC/ETH and get tokens that do not add value to the invested project or, sometimes even do not fit into the business model. Moreover, these tokens usually do not give any voting power. In this case, the only winners are the founders, equity investors, and early buyers, who bought tokens with high discount rates (that sometimes can reach 80%).
While the rationale behind introducing tokens for a particular business model might be debatable, the question of defining the type of token and its price seems more fundamental and have more explanations. Let us discuss it in more detail.
Types of tokens
At the moment, there is no unified classification for tokens. However, there are movements towards resolving this problem from SEC in the USA and FINMA in Switzerland.
Both of the organizations divide tokens into two broad categories:
- security tokens (this type is to some extent similar to securities)
- utility tokens (this type gives its holders the access to services provided by the project).
Another category that can be emphasized might be called “real cryptocurrencies” or Payment tokens — this type has its own Blockchain and is often considered as a mean of payment. However, there is one big difference between SEC and FINMA: while SEC focuses on comparing tokens with securities, FINMA is focused on the economic functions of tokens. Each type of token has key features.
Security token (SEC) / Asset token (FINMA)
This category of tokens represents assets such as participation in real physical underlyings, companies, or earnings streams, or an entitlement to dividends or interest payments. In terms of their economic function, the tokens are analogous to equities, bonds or derivatives.
Utility token (SEC) / Utility token (FINMA)
This category provides access to the goods & services that the project will launch in the future. Also, they can be used as a type of discount or premium access to the goods & services of the project.
Cryptocurrencies (SEC)/Payment tokens(FINMA)
Usually, the tokens of this category have no further functions or links to other development projects. Speaking broadly, cryptocurrencies purpose is to be items of inherent value (similar, for instance, to cash or gold) that are designed to enable purchases, sales, and other financial transactions. They are intended to provide many of the same functions as long-established currencies such as the U.S. dollar, euro or Japanese yen but do not have the backing of a government or other body.
Depending on the type of token, organizers and participants of an ICO might have different rights and responsibilities, which are briefly described in the table below.
If utility token does not add value to the functioning of the product and is only important for investment purposes, then it can be considered as a security token. Utility tokens are used in more than 95% of all the projects and sometimes they are given completely absurd functions. This is an implication of the legal restrictions.
It is worth noticing that the safest type of token for investors is security token. However, this type of token makes ICO more complicated and requires KYC/AML procedures. For instance, FINMA considers these tokens as a type of security and applies the same rules to them as for other securities (stocks, bonds, etc).
This classification, however, is not exhaustive. The type of token might be amended throughout the project development, or because of SAFT-agreements. Ziliqa, Seele, and Credits all issued ERC-20 tokens in the early stages of development and later aim to substitute them for own cryptocurrencies.
The four most common mistakes beginner crypto-investors make:
1. Utility tokens are not considered as investment instruments because of their nature. Nevertheless, many investors buy utility tokens, hoping that the price will go up because of growing demand for the goods & services the project aims to provide. However, the price growth of this tokens often has speculative nature and is not bankable.
2. Choosing tokens for which the price does not correspond to the price of the provided functionality. For instance, if token provides 1GB of cloud storage and costs 5 USD, while the same 1GB of cloud storage can be purchased on a traditional service for 1 USD.
3. Buying tokens without taking into consideration the fact the project may issue different types of tokens. For example, Kairos has two different types of tokens: security and utility. This variety can make the investment decision more difficult.
4. Buying tokens which do not have any value generating mechanisms in their economy or external growth drivers.
Three takeaways
1. It is necessary to analyze the type of token and the economy behind it when making investment decisions.
2. It is a must to always remember that the price of token is based on the basic principles of economics, such as law of demand and fair value
3. It is always advisable to understand the base value of token and its current and potential price in case all the targets are reached.
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