Utility tokens vs. equity tokens: Key differences
Although crypto coins and tokens fall under the broader umbrella of cryptocurrencies, subtle technical differences between the two make each unique and warrant that investors understand these variances.
While crypto tokens and coins are largely the same from the end-user perspective, there are technical differences in how they are built on a blockchain that are important to understand.
Making matters more befuddling for new investors, crypto tokens can be classified into three types: utility tokens, security tokens or equity tokens. In the subsequent sections, we will focus on the differences between utility and equity tokens, and how these dissimilarities ought to drive decision-making when it comes to investment.
What is a utility token?
Commonly issued during an ICO, utility tokens provide token holders with privileged services and aren’t considered to be investments as they are speculative and act more like promotional tools for the issuing company.
Usually associated with initial coin offerings (ICOs), a utility token is a special type of cryptographic asset that is primarily aimed at garnering the funds necessary to develop a cryptocurrency project. Investors may purchase these utility tokens in different cryptocurrencies or even fiat currencies, and prices are generally static during the initial stages.
These utility tokens, once purchased, are stored in a crypto wallet associated with the buyer and can be used to access services provided by the blockchain project.
Moreover, utility tokens do not represent any ownership stake in the project being invested in and instead, allow the holder to buy or sell the underlying tokens on a preferential basis.
The value of utility tokens usually fluctuates, depending on the demand for the project and may generate profits for the token acquirer if the project ends up reaching its intended purpose with reasonable success.
Is Bitcoin a utility token?
Considered to be the most popular cryptocurrency and also the coin with the largest market capitalization, Bitcoin was designed to be a purely digital currency for peer-to-peer exchange.
Cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH) are encoded into the software protocols of their respective blockchains and have digital assets native to their ecosystem. Therefore, BTC is considered to be a cryptocurrency in its truest sense and is used to transfer monetary value on Bitcoin’s peer-to-peer network.
Crypto tokens, on the other hand, have a transaction behavior that is the result of being implemented by smart contracts instead of being built into the blockchain software, itself.
Similarly, many investors wonder if Ripple (XRP) is a utility token. XRP and Basic Attention Token (BAT) are basically ERC-20 tokens that run on the Ethereum network wherein XRP is used to facilitate Ripple’s enterprise-grade payment solutions, which are faster, transparent and more cost-effective than traditional financial services.
BAT is driving the Brave browser’s global private ad platform, which has 54 million monthly active users and 1.4 million verified creators, benefitting from arguably one of the most successful blockchain projects to date. Both are classic examples of utility tokens that have grown multiple folds in price terms since their ICOs due to the immense value they have created since their launch.
How different are security tokens from utility tokens?
Security tokens represent the ownership of the principal company and differ from utility tokens in how their value is derived. Being regulated by governmental agencies that provide oversight in financial markets, they are considered much safer and offer returns in proportion to the issuing entity’s financial performance.
Security tokens have the potential to end up being one of the most encouraging cases for blockchain technology yet. In contrast to utility tokens, which were discussed above, security tokens represent the ownership of a digital or even physical asset such as real estate or anything else that is tangible.
Representing a unique method for companies to raise capital on the cryptocurrency market, security tokens allow companies to sell stock in a digital form or as a tokenized equity and provide ownership opportunities for a large swathe of investors at a low entry point.
These tokens represent the convergence of the traditional financial industry and the revolutionary crypto market where investors can invest in non-crypto businesses while enjoying the benefits offered by cryptographic tokens.
Unlike utility tokens, however, security tokens are regulated by bodies such as the U.S. Securities and Exchange Commission since they represent real ownership of underlying assets.
Subsequently, security tokens are issued through the security token offering process and can represent a very small monetary value of the company or firm, making it possible for a more geographically dispersed population to own the underlying entity as compared to traditional equity market offerings.
What is an equity token and what are some popular examples of equity tokens?
Considered to be a subset of security tokens, equity tokens offer a multitude of benefits to their token holders, making them apt for crypto investors who would like to participate in the decision-making process of the issuing company.
Equity tokens represent equity in an underlying asset, which is usually the stock of a company, with all the terms and conditions recorded on the blockchain. Moreover, they are regulated by the securities law of the country in which the issuing company is based and which guarantees legal protection for its investors.
Equity tokens issued through the equity token offering process also offer their holders the benefit of voting transparently on the issuing company’s matters through the blockchain, thereby facilitating the investor community’s acquisition of control in proportion to their holdings.
An application of Ethereum-based smart contracts conforming to ERC-20 standards, equity tokens allow holders to become shareholders in the token-issuing company, and all money invested is linked with the company’s performance.
Token holders maintain the right to get a share of the profits in the form of dividends and the value of the token is usually not linked to its demand on the crypto market but rather to the performance of the issuing company.
Utility tokens vs. equity tokens
Investors familiar with the concept of equity investing will find equity tokens to be an extension of the same thought process as initial public offerings while those with a riskier appetite can venture into plonking their capital on the utility tokens in which they believe.
One glaring difference between utility and equity tokens is the fact that the former is not regulated as they provide access to a service rather than a specific investment in an asset or company as do equity tokens.
However, for those asking the question of whether utility tokens can be traded, the answer is that they are similar to equity tokens in this aspect and are available for trading on various exchanges.
To answer whether utility tokens are good investments though, any money put into a utility token needs to be weighed against the prospects of the service being offered by the issuing company and the potential rise in its demand to generate returns for token holders.
On the other hand, equity tokens are regulated and issued by existing firms that are already in business and provide token holders with voting rights that allow them to participate in the working of the company.
For novice crypto investors, it seems more prudent to invest in equity tokens as they are an extension of equity shares on the traditional stock market and are an easier concept around which to wrap oneself.
However, if you believe in the prospects of a blockchain project like XRP and want to gain an early mover advantage, it may be more beneficial to put your money on a utility token ICO and ride the demand wave to generate handsome returns in the process.
Do remember that utility tokens are not treated as a security and therefore, will have a higher risk involved when investing. Either way, it is important to read all the terms and conditions before investing money and understand the applicable fees that are levied on redemption or while trading these tokens on the various exchanges available in the crypto market.