ICOs & Token Types for Dummies: An buyers guide to crypto-tokens.

Credit: fdecomite

How do I value (ICO X)

We get a lot of requests for advice about the current ICOs. People ask us what they should buy and what they shouldn’t, and mostly whether a token will go “to the moon”.

We get it — you want a return on investment. Yet we think people are asking about this from the wrong perspective. If you are treating a token purchase as an investment then you should know a bit about what you are getting into. Not all tokens are made equal, not all are honestly represented, and very few organizations are being clear about what their token really is.

We don’t give investment advice. But we still want to help, so we decided to create a quick guide to different token types. Many tokens can fit in multiple categories.

Why you need to know this

If you don’t understand what type of token you are dealing with, it’s impossible to evaluate the potential long term value. Short term value for all tokens is driven by only one thing: hype. The only way to know if that hype is based on something deeper than slick marketing is to look under the hood.

Currency tokens

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The token type that started it all — Cryptocurrency. Bitcoin is of course the mother of all of these tokens. They are typically the easiest to use and understand as they are simply a medium of value exchange. Just like USD or any other form of fiat they are really worth whatever people choose they are worth based on supply and demand. Unlike fiat currencies, no governments forces people to use cryptocurrency (so far) meaning that all currency value is purely based on speculation and user choice versus with supply. Bitcoin’s value continues to increase as demand goes up but supply is constrained by the bitcoin codebase. Ethereum’s value has shot up because of heavy use but it is far less constrained.

The difficulty with any cryptocurrency entering this space is generating demand. It’s a chicken and egg problem — to have value and liquidity a currency requires lots of users. To get lots of users a currency needs value and high liquidity. It took years for bitcoin and ethereum to break through, and we expect future currencies to have an even more difficult time.

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Utility tokens

Ethereum was the first major utility token. A utility token allows you to do things. In the case of Ether, those things were running smart contracts and code on the global blockchain. Ethereum is also a currency token, as it is used to exchange value. In this case, Ethereum used its utility value to punch through the chicken and egg problem that all currency tokens face.

If there were a “car token”, it might be a utility token. The question would be-is the token the car, how much horsepower the car gets, or whether you are allowed to drive? The first would be an asset token (below) but the rest would be utility tokens.

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Utility tokens are also sometimes called “Network Access Tokens”. The token gives you access to something the network allows you to do. This could be something like PrimalBase where the token gives you access to a coworking space (also somewhat of an asset token, described below).

Asset tokens

Asset represent some sort of (generally physical) asset or product. For instance, take the example of a “car token” that represents ownership of a car. Or it could represent the number of days you are allowed to use the car — only 365 in existence! Asset tokens are one of the largest areas of growth because they enable true distributed, P2P ecosystems on the blockchain. On the other hand, if they are represented honestly they are not as popular with investors. After all, all 365 “car tokens” in our example are not going to be worth much more than the actual car — Maybe less! And as the underlying asset depreciates, so would the token.

The escape here is to tokenize an asset that is expected to rise in value. To this end, there are a number of initiatives to tokenize traditional asset classes like Gold. Take a look at Goldmint. Coming up with a creative asset class that has real growth potential makes an asset token a good choice.

Equity tokens

Everyone is trying to avoid being an equity token because of the SEC, yet this is the type of token most people would probably most like to buy. An equity token implies ownership and control. Somewhat like a traditional stock, an equity token buys you into some level of ownership of an organization and it’s success. To some extent, all tokens could be seen as having some equity like properties. It should be noted that Equity and Security are two different things. You can have a token that implies no equity at all but is still a security.

Token Tower?

The Ethereum based DAO was the first major token that was explicitly an Equity token (and the SEC officially agrees). Owners of DAO tokens had control over the behavior of the organization.

The rules around being “an equity” are complex. Essentially, if the token gets you a reward off the actions of others with you as a distant owner — it might be an equity. If the token involves making money exclusively off the actions of others — it might be an equity. Protip: consult a lawyer.

Extending the “car token” example, an equity car token might be a token that you hold to get a percentage of the money the driver makes working for uber through co-ownership of the car.

It’s our opinion that a good equity token would be better than most stock offerings, as there are lots of corporate tricks and rules to be exploited, things that could be avoided in part by good smart contract designs.

Reputation and Reward Tokens

These tokens are given as a marker of reputation or as rewards. Both are ways of specifying on a blockchain that some user or wallet did something special or is someone special. Some of these tokens may not be trade-able. Unlike other token types where liquidity is highly valuable this pattern may be reversed. The value of a reputation token is that you can trust that the person bearing it is who they say they are.

Photo by Kris Kerr on Unsplash

The value of these token types is the hardest to evaluate. If reputation or symbolic rewards are part of a token system then it requires a lot more time to evaluate. This isn’t to discount these tokens however — the real life example of a reward token would be something like an Oscar or the Nobel Prize. They are just symbols — the work that led to them had already been done — but the meaning and value for the person holding them and their career is immense.

Our Advice

Caveat Emptor. Crypto tokens are a new and ever changing world. But they aren’t magic. The rules of supply, demand, and utility still apply. We’re in a speculative bubble which means there is tons of money to be made but also to be lost. Like the dotcom bubble, the big winners are the ones who buy not on hype but on a clear understanding of the underlying business and economic models represented by these tokens. Choose well and it may be like buying $1000 in apple stock in the 80s.

Know what you are getting into, understand how it is meant to work. Do you agree? If you can’t figure out how it works using the categories above try asking on slack or telegram or whatever other medium the token issuer makes available. If they can’t answer that question, it’s a red flag.