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Tokenomics: Discover Five Types of Digital Tokens

Source: iStock/BrendanHunter

The cryptocurrency market today is no longer only composed of digital currencies such as bitcoin that allow anyone in the world with an Internet connection to make peer-to-peer payments. Instead, more and more digital assets with different functionalities and purposes are introduced as the booming initial coin offering market is allowing blockchain startups to issue a wide range of different digital tokens.

In this guide, you will discover the five digital tokens that are mostly commonly found in the digital asset market.

Digital Currencies

Digital currencies are the most well-known type of digital token. A cryptocurrency, also known as digital currency, currency tokens or digital coins, are currencies that runs on a blockchain. The blockchain is a decentralized ledger that uses complex mathematical computations to verify transactions and uses cryptography to secure the network. Hence, they are commonly refers to as cryptocurrencies.

Due to the peer-to-peer nature of the distributed ledger technology, cryptocurrencies like bitcoin and litecoin, do not have central authorities that govern their issuance and use. In other words, no intermediaries such as a bank or a payments provider is needed when making online payments using a cryptocurrency.

The most popular digital currency by far is bitcoin, which was launched in January 2009 as the first decentralized blockchain-based cryptocurrency. Since then, many alternative coins (altcoin) have been created. The most notably digital currencies next to bitcoin are litecoin (LTC) and Dash (DASH).

Other example of digital currencies include privacy-focused digital currencies such as Monero (XMR), Zcash (CEZ) and PIVX (PIVX), which allow users to make financial transactions online with varying degrees on anonymity and transactional privacy.

Utility Tokens

Utility tokens give a user the right to interact and transact within the platform that issues the token. These tokens are usually purchased when a company holds an initial coin offering (ICO). Utility tokens effectively allow the user to use the product or service being offered by the company. Some utility tokens also give the holders the right to make decisions within the ecosystem through voting rights.

These tokens are also referred to as app coins or user coins. In addition to buying them during a token sale, users can also acquire them by participating in the ecosystem through pre-defined ways. To further understand them, these tokens can be likened to paid APIs ( application programming interface).

An example of a utility token is the Storj token. Storj is a decentralized data storage platform and to access the platform, users must acquire the Storj token. The token is used in a number of ways throughout the ecosystem, such as a payment for performing tasks like sharing disk space as well as an incentivization tool.

Tokenized Securities

Following the 2017 investigation by the US Securities and Exchange Commission (SEC) on the tokens offered by the DAO, it was concluded that token sales were considered securities if they met certain criteria. This regulation resulted in the creation of a different form of digital token, now referred to as tokenized securities.

A tokenized security is a portion of a company that a buyer purchases during a token sale. They are also called security tokens or equity tokens. Unlike utility tokens that are used within the ecosystem, equity tokens constitute a share in the company and thus give the holder rights to the profits the company makes. In other words, tokenized securities provide investors with digital shares in a company.

The distinction between utility tokens and tokenized securities is a based on whether the tokens pass the Howey test. This is a series of questions, created after the landmark case SEC v. Howey Co., which determines if the SEC has jurisdiction over a transaction or not.

An example of an equity token is the tokens from tZero, a company that is part of publicly-traded online retailer Overstock inc. The token sale for tZero is aimed to fund the development of Overstock’s planned regulated digital token trading platform.

Due to the somewhat restrictive regulatory status, many startups holding token sales are looking to avoid the classification of tokenized securities as it increases the legal costs of conducting the crowdfunding campaign. This is also why most startups are currently issued utility tokens during their token generation events.

Asset-Backed Tokens

An asset-backed token is a digital token that represents a physical asset. These tokens are useful as they allow for the digitizing of traditional assets such as commodities. Examples of startups working on asset-backed tokens would be OneGram and Goldmint who are using blockchain technology to tokenize gold.

While these tokens are a novel way to use the blockchain, they are not the most popular tokens because their values are linked to traditional physical assets and thus do not provide the same upside potential for investors that other digital tokens possess.

However, used with the right assets, they can introduce a certain level of ease of use for physical assets that are difficult to purchase or store such as gold, silver and other commodities. Hence, the asset-backed token market will likely grow to a substantial size if major players in the commodity markets will become comfortable enough to adopt them.

Reward Tokens

Reward tokens, which can also be referred to as reputation tokens, are tokens that symbolise the users standing within an ecosystem. These are usually earned or accumulated over a period of time as the user positively participates within the network or on the platform.

These tokens are not necessarily useful from an investment point of view. This is because it is difficult to ascertain the value of reputation tokens. They are better viewed as a sign of an achievement within the network and may play a role in the trust others have with the user. Having said that, some reward tokens, such as Steem (STEEM) have witnessed a substantial increase in value since their inception.

On the blockchain based social media platform Steemit it is possible to earn reputation tokens such as Steem Dollars (SBD) and Steem Power. A user can accumulate them by contributing content that receives upvotes by other users and for upvoting other users’ content. The more one participates, the more reward tokens can be acquired. This incentivises the user to stay active on the platform. Both Steem Dollars and Steem Power can be turned into Steem (STEEM), which is the Steem blockchain’s native cryptocurrency, and can be traded on most major digital currency exchanges.

The variety in cryptocurrencies is one of the reasons why this asset class has become so popular and is being increasingly eyed by professional investors. The available choice in tokens mean that there is something for everyone, whether the investor prefers a more stable asset-backed investment, wants to buy into the growth of a particular decentralized network or believes that digital currencies are the future of payments.

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