This is part three of a six-part Welcome to Crypto series, which will cover everything from the advantages of digital assets and how to buy crypto to how to read cryptocurrency price charts, and why they matter.
Catch up:
Part 1: The Benefits of Cryptocurrency and Blockchain Technology
Part 2: How Does Cryptocurrency Have Value, and Why Should I Care?
Introduction
In the race for cryptocurrency mass adoption, the field is crowded with thousands of projects seeking to apply blockchain technology to an array of business and consumer needs. In just the last year, the crypto industry’s market cap has risen substantially. And, as if to underscore cryptocurrency’s nascent potential, Facebook’s announcement in June 2019 of its planned stablecoin, Libra, piqued the interest of many, including naysayers, who previously wanted nothing to do with digital currency.
However, as Facebook quickly discovered, its announcement begged more questions than it answered. The existing crypto community and regulatory bodies were quick to draw distinctions between the various cryptocurrency types based on their uses. As a result, much of the public is left struggling to grasp not only how the use cases relate to their lives, but also the terminology around usage. For example, people heard cryptocurrencies referred to as both “coins” and “tokens” for the first time. Those terms might seem interchangeable to newcomers, but there’s a clear distinction between the two, and it lies in the manner in which each is used: Coins, including MakerDAO’s popular Dai stablecoin, which is backed by a surplus of collateral, serve currency functions, whereas tokens leverage crypto technology to serve a variety of other user needs across industries.
A categorization system has materialized to explain the different types of cryptocurrency and help people navigate the landscape. A complete understanding of crypto begins with a review of the most prevalent token types:
- Platform tokens
- Security tokens
- Transactional tokens
- Utility tokens
- Governance tokens
Cryptocurrency tokens are fungible digital assets that can be used as mediums of exchange (traded) inside of the issuing blockchain project’s ecosystem. They are best described by how they serve the end user. Think of tokens as the foods that nourish blockchain-based ecosystems.
Each token type provides unique features based on usage. However, a token can fit into more than one category, so these groups are not mutually exclusive.
1. Platform Tokens
Platform tokens utilize blockchain infrastructures to deliver decentralized applications (dapps) for different uses. For example, while Dai is categorized as a stablecoin because it is soft-pegged to the US Dollar and its pricing maintained through mechanisms built into smart contracts, it can also be classified as a platform token because it is built on the widely used Ethereum blockchain.
Platform tokens benefit from the blockchains they build upon, gaining enhanced security and the ability to support transactional activity. Platform tokens run the gamut of use cases, from serving gaming and digital collectibles (CryptoKitties!) platforms to global advertising and marketplace industries.
2. Security Tokens
The term “security token” emerged as a result of rising regulatory concerns. Regulatory authorities, such as the U.S. Securities and Exchange Commission, sought to specify cryptocurrencies using terminology that didn’t wrestle with existing legal definitions.
Generally, a security is an instrument issued by a company, trust, government, or other legal entity that memorializes an ownership interest and provides evidence of a debt, a right to a share of earnings, a right in property distribution, or other similar legal rights. Types of securities include, among others, bonds, debentures, notes, options, shares, and warrants, and may be traded amongst investors or otherwise freely transferable. While not yet ubiquitous, security tokens are tokens that serve as direct, on-chain representations of real-world securities or tokens that are on-chain instruments serving a similar purpose for blockchain projects and/or digital assets.
Security tokens can represent property interests. For example, investors on the Meridio platform can seamlessly trade tokens representing real estate shares and pay in Dai, while Fluidity Factora allows people to invest in a Brooklyn, New York, property by paying with Dai.
In a case where a token represents ownership of an off-chain asset, such as real estate, equipment, payable invoices, or a business, similar to a share of stock, the security token’s value is directly tied to the asset’s valuation; the more valuable the asset, the more valuable the token.
3. Transactional Tokens
Transactional tokens are used to transact—they serve as units of account and are exchanged for goods and services. These tokens often function like traditional currencies, but in some cases, provide additional benefits. For example, with decentralized cryptocurrencies, such as Bitcoin and Dai, it is possible for users to execute transactions without a traditional intermediary or central authority, such as a bank or payment gateway. In addition to its function as a currency, Dai offers transactional performance to other networks. For example, POA Network created xDai, a Dai-like transactional token that lives on a sidechain, allowing for fast, inexpensive transactions.
Not all transactional tokens are currencies. Global supply chains and other industries utilize transactional tokens to apply the immutable nature of the blockchain and the flexibility of smart contracts to their operations.
4. Utility Tokens
Utility tokens are integrated into an existing protocol on the blockchain and used to access the services of that protocol. They are not created for direct investment like security tokens, but can be used for payment of services within their specific ecosystems. The relationship between a platform and a utility token is synergistic, as the platform provides security for the utility token while the token provides the network activity necessary to strengthen the platform’s economy. For example, Dai is integrated into Axie Infinity, a digital-pet universe with a player-owned economy, providing players with a stable in-game currency. Other projects, such as Cryptocup, leverage Dai stability to provide a better experience for users.
5. Governance Tokens
As decentralized protocols continue to proliferate and evolve, the need to refine the decision-making processes around them is critical. On-chain governance allows all stakeholders to collaborate, debate, and vote on how to manage a system. Governance tokens fuel blockchain-based voting systems, as they are often used to signal support for proposed changes and to vote on new proposals. In the Maker Protocol, the governance token is MKR.
The world of cryptocurrencies is vast and, most importantly, still evolving. To summarize, here are the main token types:
- Platform tokens support dapps built on the blockchain.
- Security tokens represent legal ownership of a physical or digital asset.
- Transactional tokens serve as units of account and are exchanged for goods and services.
- Utility tokens are integrated into an existing protocol and used to access the services of that protocol.
- Governance tokens fuel blockchain-based voting systems.
All of the different types of cryptocurrency tokens explained above serve specific purposes, and the uses for some, including the versatile Dai stablecoin, can even overlap. Defining each type is an important step toward offering a deeper understanding of how blockchain technology is used by organizations such as Maker to help individuals and businesses realize the advantages of digital money without experiencing volatility.
To learn more about Dai, visit the Maker website and join the dialogue in the MakerDAO Forum.
Next up in the six-part Welcome to Crypto series: A Guide to Crypto Wallet Types
DISCLAIMER
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. Charts, graphs and references to any digital assets are for informational and illustrative purposes only.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any purchase decision. The content speaks only as of the date indicated.
