In this article, I will give a short overview of some types of blockchain-based tokens, which are usually sold in Initial Coin Offerings (ICOs). The rights and benefits, that a token holder may gain, can be as different as day and night. Unfortunately, on the one hand, many ICO-teams forget to consider whether a token is the right solution to accomplish their goals and do not think about their true utility.
The rise of the “token economy” – what are ICOs and tokens?
We are currently seeing high growth in Initial Coin Offerings (ICOs). Tokens are vehicles that are usually sold during ICOs to raise funds by blockchain-based companies (or, where applicable, foundations) to raise funds. Hence, the term “token sale” is often used synonymously with ICO.
But how do ICOs work? In the words of UNIC (“Introduction to Digital Currencies“), “The new cryptocurrency created by the startup is sold to parties willing to invest in the project, in exchange usually for Bitcoin or Ethereum. (…) Investors usually receive a token which is listed and traded on private exchanges.” However, in contrast to an initial public offering (IPO), an ICO-token doesn’t necessarily offer shares or dividends. In most cases, the token represents a promise that its value will grow, leading to the investor potentially making a profit. To avoid confusion with the term “IPO,” the description “token sale” is often used.
What is often overlooked?
First, it’s worth remembering a key business concept – the better your business model, the better able you are to create tokens of real value. Hence, a good business model with a unique selling proposition has to be designed before the ICO. This business model must create value for a specific target group. At my company, net1.digital, we have a structured approach to checking your business idea and model. For example, we offer a “jump start” service for your blockchain-based idea/venture. This involves a thorough analysis, including checking the feasibility criteria based on the Business Model Canvas and Digital Innovation Board approaches.
Tokens as utility and investment construct
In the blockchain and crypto business, utility tokens are currently seen as the best kind of token to be sold in an ICO. A utility token has a specific use in your application. If you are thinking about creating utility tokens, you should challenge your concept and ask yourself the following questions (see The Token Handbook):
- Who will want to buy and hold this token?
- Why would people want to use it?
- Under what scenarios will people need this token?
- Can the same job be done better in a different way?
In general, if you want to create a utility token, you should be sure that the purpose of your token cannot be fulfilled more easily and cheaply without tokens.
A utility token has one clear advantage over other token classes, which is one reason behind the recent explosion of ICOs: in some circumstances and depending on the regional authority involved, token sales can circumvent official regulatory requirements governing traditional capital-raising processes like IPOs.
Tokens as pure investment vehicles
You cannot necessarily assume that your tokens will be seen as utility tokens. Sometimes, tokens are seen as funding or investment vehicles. And occasionally, ICO teams don’t think hard enough about the true function of their tokens, i.e., their use in the application. Regardless of whether you sell your tokens as a coin or as a share (see below), you must face the possibility that official authorities may require you to fulfill regulatory requirements for securities.
Tokens as pure share (equity)
Usually, a token itself is not designed to represent a security. Nevertheless, depending on how your ICO is structured, investment in your tokens can lead to a future share in your venture. Thus, a token could also be thought of as a type of security (aka an equity token) by official authorities such as the SEC (the Securities and Exchange Commission) in the USA or the Swiss FINMA (Financial Market Supervisory Authority). These are tokens that “represent shares in an entity similar to company stock or shares in a limited partnership and don’t have any additional utility beyond representing the value of the fund; the profits would depend on the promoter.” In this case, the regulatory standards for securities in your country might be applicable. Hence, you should clarify the regulatory requirements with your local authority. Sooner or later, you will have to fulfill them.
As we have seen in the China ban, it cannot be ruled out that, in the future, all types of ICOs might be subject to ICO-specific regulatory requirements or even security requirements. Depending on the country, ICOs might be (temporarily) banned, as we have seen for example in China, or subject to official regulatory oversight, as for example in the USA. However, Switzerland is a particularly friendly and welcoming environment for ICOs, especially the town of Zug, also known as “Crypto Valley.”
Overview of crypto assets
As previously explained, there are three classes of tokens: ‘utility tokens’, ‘investment tokens’ and ‘share tokens’. Share tokens are basically a subcategory of investment tokens. Depending on local regulations, an investment token might be a security or not. In addition, there are classic coins in the sense of cryptocurrencies (see below).
The lesson is clear: before you start raising money in an Initial Coin Offering, ask yourself what your business is about and what your token is for… If you have any questions, please do not hesitate to get in touch. My company, net1.digital, can also guide you through the whole process of your blockchain-based business, from idea to implementation. What’s more, our partners, a prestigious attorney’s office, are able to give you expert legal advice on all the matters discussed in this article.
Side topic: coin vs. token
According to The Token Handbook, a token is a contract. It represents rights and obligations, and it is a thing or does things – but a token is not a thing itself. Examples here include a passport or a dollar note (but not a dollar). In contrast, a coin is only a store of value, a medium of exchange and a unit of account. It acts as a means of payment (for transaction fees or something else in a system). Usually, it is tradable (through P2P or via a particular platform, e.g., an exchange like Kraken). One example of this is the cryptocurrency bitcoin.