The rise of initial coin offerings (ICOs) as a way for start-up businesses to raise capital has led to the proliferation of a whole new class of asset; digital tokens. Despite the significant attention they have gained over the past two years, a halo of mystery hangs over these new assets beyond the fact they are digital currencies.
But not all tokens are created equal and different ICOs issue different token types. For potential investors, understanding the differences and the rights specific tokens bestow is vital, not only to determine the value proposition of that investment but to also be aware of the regulatory and legal consequences that may be encountered.
Here we have put together the four main token types issued by ICOs, and what you need to know about them.
Utility tokens act as vouchers that can be exchanged for the goods or services sold on a particular platform. In short, they grant holders access to a network or service feature on a platform – without them, users are denied entry.
Distributed through ICOs, utility tokens enable projects to raise funds for development while providing holders access rights to the products or services subsequently developed. However, once startups spend the funds raised through their token sales, it is vital that these and the remaining tokens provide the goods and services for at least costs and, more, ensure the viability of the business.
Failure to do so would result in potential losses as the cash flows would not be able to fund the costs of providing the goods and services offered. As a result, a utility token’s long-term prospect and value is aligned to the popularity of the services and goods transactions they facilitate.
Equity or Security Tokens
When you buy an equity or security token, in effect you are buying partial ownership of the issuing company or project. As they entail ownership like stocks, these are the most sought-after tokens among potential investors.
That said, there is one major drawback. Because they are a security in a company they need to comply with the various securities laws prevailing worldwide. Failure to do so will jeopardise the business and by default the investors who hold these tokens.
Asset Tokens, like their utility counterparts, also give access to a product or asset. However, instead of acting as a voucher for a product sold on a platform, these tokens serve as substitutes for a physical asset; for example, commodities like gold and diamonds.
The value of asset tokens is therefore tied to the selected assets or portfolio of assets they represent. This means they will most likely need to comply with securities regulations in the way they are offered, sold and distributed because they meet the standard definition of a security.
As a result, an asset token’s value proposition will be significantly impacted by jurisdictional securities regulations that apply to the issuing company and potential investor.
These tokens reflect a user’s standing or reputation within a platform’s business. They specify the level of trust a user (or wallet) has achieved, allowing others to see their reputability.
Crucially, if these tokens are earned from the work of a community and the platform they are not deemed to be the result of pooling value. This would result in them being classified as a security token and regulations would be applied.
When developing the tokenisation of a business on a platform, careful consideration must be given to the features, privileges, and rights the token entails so as to ensure there is clear and fair governance.
It is advised that the token is not a security, but if it is, it must comply with the various security regulations so as to protect the participant or owner of the token.
The legal landscape relating to the selling and marketing of goods and services has become increasingly complex, and more so regarding sales to customers.
Countries across the world have enacted consumer protection legislation to some extent to safeguard investors when it comes to ICOs.
For example, the English Common Law, Acts of Parliament and EU derived regulations as well as legislation from the Federal Trade Commission (FTC) ensure ICOs and the tokens generated are above board.
As a potential investor evaluating a token, it is vital you understand the type of token being offered and asses its compliance within the regulatory and legal landscape to avoid potential criminal and civil liabilities.