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What are Utility Tokens?

Last updated 29th Jan 2023
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Most cryptocurrencies can be divided into two groups: coins and tokens. The sole purpose of a coin is to transfer money. Examples of currencies are Litecoin (LTC) and Bitcoin (BTC). On the other hand, tokens belong to a completely different class of cryptocurrencies; one popular type is utility tokens.

Utility tokens are exclusive to their respective blockchains and allow users to perform specific tasks on a particular blockchain network or decentralized application. These tokens are not mineable cryptocurrencies. Instead, they are usually mined in advance, and the team behind the project will later decide how to distribute the tokens.

How Do Utility Tokens Work?

Security tokens and utility tokens work in different ways. Instead, security tokens consist of corporate ownership rights, similar to a decentralized version of digital shares used for investment.

A security token reflects a share in the company issuing it rather than providing an investment with a practical benefit such as access to an ecosystem. Investors buy these tokens in the hopes of making a profit. Security tokens leverage the efficiency and speed of blockchain technology and benefit from government regulations that promote fraud prevention.

In contrast, utility tokens can only be used within the company's blockchain ecosystem to access its products and services.

Only those who own a token for a particular decentralized exchange (DEX) can exchange tokens or perform other actions on that DEX. For example, these DEX tokens could be issued to platform users as a perk or interest for those who lend money to platform-based borrowers.

With the growth of blockchain networks worldwide, utility tokens are often used to raise startup capital through ICOs, as they can be sold in exchange for other digital assets. The ERC-20 token standard is one of the most widely used utility tokens, especially among companies developing DApps on the Ethereum blockchain (as they will eventually go through an ICO stage using these tokens).

Utility Token Examples

Numerous cryptocurrency projects choose to employ a utility token. Here are a few well-known examples of utility tokens. It is worth noting that the Ethereum network is used by most of these tokens.

Basic Attention Token (BAT)

As mentioned above, the Brave browser is compatible with the BAT token. The Basic Attention Token allows the requirement of ongoing tracking of user activity to be replaced with a new, less invasive advertising revenue model.

This model allows Brave users to receive payment in the form of BAT when they choose to see ads. Users can then tip content providers on their websites or Twitter using their earned BAT.

Binance Coin (BNB)

BNB is a type of exchange token. Users who hold BNB on Binance's platform receive a 25% discount on trading fees. The fees are deducted from the trader's BNB balance and are not charged on the traded cryptocurrency.

Zilliqa (ZIL)

Zilliqa is a platform for the development of decentralized applications. The goal for developers is to increase the affordability and security of apps. In addition, ZIL tokens can be used for digital advertising and games.

Aurora (AOA)

Aurora is a decentralized cryptocurrency banking platform that runs on smart contracts. The AOA token is a stablecoin backed by debt and cryptocurrency reserves and also has a DEX.

Challenges of Using Utility Tokens

Using utility tokens comes with technological and market issues, as well as regulatory difficulties.

Utility tokens, like most cryptocurrencies, can be used as a platform for financial speculation. However, depending on the function of the token, this can lead to problems. For example, it can be difficult for users to estimate how many tokens they need if they require a certain number of tokens to perform a certain action on a network, and the dollar value of the token changes significantly.

Some utility tokens are stablecoins, i.e., coins that have a 1:1 relationship to another asset, usually a fiat currency such as the US dollar, partly for this reason.

Security Tokens Vs. Utility Tokens

Any user can employ utility tokens to pay for a specific product or service, while security tokens are a type of investment. Furthermore, the following characteristics allow us to distinguish between the two:

Purpose

A security token is a type of investment contract that symbolizes verified legal ownership of a tangible or digital asset. For example, utility tokens of a blockchain-based project are used to fund Initial Coin Offerings and build an internal economy. In addition, the owner of a utility token has some voting rights within the ecosystem.

Potential Fraud

Due to their strict regulation, security tokens have virtually no risk of being scammed. However, because utility tokens are so poorly regulated, fraudsters often produce fake ICOs and tokens to make quick cash.

Regulations in Effect

Because utility tokens are largely unregulated, developing regulations for the ICO is extremely difficult. In contrast, the company and the investor in a security token must pass a Howey test.

What meets the criteria for an "investment contract" and is consequently covered by US securities laws is determined by the Howey Test.

The Future of Utility Tokens

Utility tokens are any cryptocurrency tokens that you can issue with a particular decentralized application or crypto ecosystem to perform certain actions.

Most utility tokens are based on an established blockchain, and the applications they are used for are developed using smart contracts built on the blockchain, while the token itself is built on top of the blockchain.

The development of open banking is still in its infancy globally. Blockchain-based services and security tokens are expected to impact the future significantly. However, there currently needs to be more agreement on the regulation of cryptographic tokens.

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Emma Dwyer

Emma Dwyer

Emma is a law graduate with seven years of experience working in financial services. She has been writing in the cryptocurrency and blockchain tech space for two years now. Recently she worked as a Managing Editor and Head of Content for different crypto publications.