Utility tokens are a different type of cryptocurrency. Unlike coins and security tokens, utility tokens provide users with a variety of functions on blockchains and decentralized applications(dApps). As smart contract blockchains like Ethereum continue to grow in popularity, more blockchain developers are creating unique utility tokens for their Web3 applications.
Now that more cryptocurrencies are available on exchanges, many investors are wondering, “What is a utility token?” Why is it so important to separate utility tokens from other sorts of tokens? Is it legal to separate utility tokens from other crypto projects?
What is a Utility Token?
A utility token is a coin on a smart contract blockchain that performs a specific purpose in the ecosystem of a cryptocurrency project. Unlike Bitcoin (BTC), utility tokens are not intended to be a real-world means of trade. A utility token, on the other hand, has only one use case inside its specific smart contract protocol.
Most utility tokens are not created through mining like Bitcoin or Litecoin. Web3 project leaders, on the other hand, “pre-mine” their utility tokens and distribute them to team members, early investors, and the general public.
Any cryptocurrency project can offer utility tokens on a smart contract blockchain to provide users access to exclusive features. Utility tokens, for example, can be used to buy in-game items in metaverse games like Axie Infinity. Some utility tokens, such as Uniswap’s UNI, may provide holders voting rights on a dApp.
The idea is that utility tokens only serve a purpose within their own ecosystems. While utility tokens have a monetary value on the open crypto market, they are not intended to be a means of exchange, an inflation hedge, or a long-term store of wealth. Instead, developers build utility tokens to stimulate growth and engagement or to acquire funds for their dApps.
How Do Utility Tokens Work?
Utility tokens are not the same as security tokens. Security tokens comprise corporate ownership rights, similar to a type of decentralized digital share used for investing. In contrast, utility tokens can only be utilized within their own blockchain ecosystem to acquire access to the company’s products and services.
You can only swap tokens or execute operations on a specific decentralized exchange (DEX) token. These DEX tokens might be distributed as a reward for platform users or as interest for those who lend cash to borrowers through the platform.
For example, Brave’s Basic Attention Token (BAT) is a utility token that can only be issued through the Brave browser or through programs that have an integrated BAT wallet, such as Twitter. Utility tokens are typically useless outside of the network for which they are designed.
With the global expansion of blockchain networks, utility tokens are increasingly being used to generate cash for companies via ICOs, as they can be traded in exchange for other digital assets.
The ERC-20 token standard is one of the most often utilized for utility tokens, particularly among companies that create DApps on the Ethereum blockchain (since they will ultimately go through an ICO period utilizing these tokens).
Utility tokens can also be used as rewards inside the ecosystem to encourage a certain action. Tokens, for example, can be granted to customers who contribute consumption data in order to develop and fine-tune existing blockchain technology.
Despite the utility of these network-specific tokens, which led to their widespread adoption during ICOs in 2017-18, their lack of regulation resulted in fraudulent cases: many crypto ventures were unable to deliver on their unrealistic claims of big returns for investors.
Uses of Utility Tokens
There are dozens of possible use cases of utility tokens. A few common ways people use utility tokens include:
Utility tokens allow users to vote on prospective dApp development suggestions. If a utility token grants this privilege, it is technically referred to as a “governance token.” While each dApp has its own set of blockchain governance rules, one of these coins generally represents one vote.
Many blockchain-based games have utility tokens that may be used to purchase in-game products such as NFTs (non-fungible tokens). Furthermore, these utility tokens are frequently used as a reward system in play-to-earn games such as “Axie Infinity.”
Crypto Exchange Benefits
Utility tokens might be used as a built-in tipping system in a dApp. This function may impact the ranking of comments or videos on the main page of a social media dApp in addition to paying content providers.
People must pay transaction costs using the native utility coin of a smart contract blockchain. People who wish to utilize a dApp on Polygon, for example, must use the MATIC token to confirm transactions.
ICO vs Utility Tokens: Similarities
Utility tokens were not possible prior to the launch of the Ethereum (ETH) blockchain in 2015. Ethereum was the first project to include smart contracts, which are written commands that employ “if/then” expressions to do automated activities on a blockchain. Utility tokens are all stored on smart contract blockchains, and many of these cryptocurrencies adhere to Ethereum token specifications such as ERC-20.
While utility tokens existed before to the 2017 bull run, they rose to popularity during the “ICO mania” of 2017-2018. Hundreds of new Web3 enterprises began providing initial coin offers (ICOs) to investors as a method to acquire funding during this time period.
Many of these ICOs claimed to be offering “utility tokens” to early investors. However, the majority of these software startups had no intention of offering use to token holders. Indeed, developers frequently utilized the term “utility token” to avoid punishment from the US Securities and Exchange Commission (SEC).
As regulators became aware of the numerous ICO frauds, they began to establish more clear differences between a utility token and a security token. To qualify as a utility token, a cryptocurrency must have a realistic use case that goes beyond just speculation. Valid utility tokens cannot also be linked to a stake in a corporation or a third-party venture.
A security token, on the other hand, represents partial ownership in a third-party firm. A security token would be, for example, a token that monitors the price of Amazon’s shares. There are also new trading platforms that provide security tokens that reflect a portion of real estate ownership.
Because security tokens are considered “securities,” they must be registered with the SEC. Utility tokens, on the other hand, do not require SEC permission to be listed on crypto exchanges.
Governance Token vs. Utility Token
A governance token is a utility token that enables investors to vote on dApp developments. Developers often post proposed enhancements in a smart contract and allow the community to vote by staking their governance tokens. When the voting session is over, the smart contract automatically counts the votes and logs the results on the blockchain.
Governance tokens, aside from voting powers, have all of the characteristics of other utility tokens. Indeed, most governance tokens have several non-governance-related applications in DeFi. People who own Uniswap’s UNI tokens, for example, can place them in a liquidity pool and receive a percentage of transaction fees.
Utility tokens are all governance tokens, however not all governance tokens are utility tokens. If a utility token does not provide holders with a vote, in blockchain governance, it’s not a governance token.
Examples of Utility Tokens
Many cryptocurrency projects have used utility tokens in some capacity, whether to generate funding or to incentivize particular transactions on the platform. For example, a non-fungible token (NFT) might be used as a utility token to ease transactions on the Ethereum network.
The following are some further instances of popular utility tokens and their use on various networks.
As a decentralized storage network that allows indefinite storage of data, Arweave uses the AR token to incentivize miners to help store the massive amount of network data.
Basic Attention Token (BAT)
BAT is used to reward both content authors and viewers who choose to watch adverts. This allows the platform to make advertising money without tracking user activity. BAT is often distributed secretly and securely, either via the Brave browser or via Twitter.
The Binance Coin (BNB)
BNB, the Binance network’s native currency, is both a coin and a token. When users trade with BNB, they receive a 25% reduction on trading expenses.
Chainlink, an arbitrator that gives real-time data from an external source to blockchains, may be implemented into several blockchains. It gives out ERC-20 tokens (LINK) to people that provide correct, up-to-date data to input into several blockchains. This is very beneficial for smart contracts to track pricing data.
ZIL is the native token used on the Zilliqa platform to enable affordable, secure DApp creation for developers, whether for financial services or NFT marketplaces. ZIL can also be used for transactions in gaming and digital advertising.
While utility tokens can be purchased by investors for price speculation, this is not the aim of these cryptocurrencies. Utility tokens are intended for usage on certain protocols. Utility tokens should always serve a purpose in their evolving Web3 environment, from gaming and voting to tipping and transaction fees.