The Beginner’s Guide to Utility Tokens

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When people discuss digital assets, they often talk about them all as cryptocurrency. But, while those various assets often have characteristics in common — and while it’s convenient to discuss them under the general umbrella of cryptocurrency — they aren’t all the same. Along with having two primary categories – coins and tokens – there are unique versions of each asset within those groups. Utility tokens are one example of this.

If you’re a newcomer to the crypto world and aren’t familiar with utility tokens, it’s helpful to learn more about how they fit into the broader crypto and investing landscapes. Here’s what you need to know to get started.

What Are Utility Tokens?

Tokens are a type of cryptocurrency. When most people think about cryptocurrency, they probably think about coins — things like Bitcoin, Ethereum, Dogecoin and others that represent the digital currency itself that you can use to make digital purchases. A utility token is a different class of cryptocurrency. Instead of serving as a coin, it’s a digital representation of a right to take certain actions within a crypto ecosystem or on a crypto platform. While they do have value, utility tokens don’t operate as currency in a traditional sense. Instead, they mainly provide you with access to products, services or actions.

Because you can use a token to take specific actions on a crypto platform, in a way it serves as a form of payment; you’re exchanging the token for the right to complete the action. In that regard, there’s a currency-style element to tokens. But, all of a token’s functionality is limited to its particular ecosystem.

Examples of Utility Tokens

Within the utility token landscape, there are several kinds of tokens. While they’re functionally the same – providing access to products or services – they operate a bitt differently, too. Here are some examples.

Basic Attention Token

The Basic Attention Token (BAT) exists within the Brave browser landscape, specifically within the advertising segment. By opting into ads, you can earn BAT. Then, you can use the BAT you acquire to tip content creators.

Functioning as an “oracle,” Chainlink (LINK) plays a critical role in the execution of certain smart contracts. The broader network gathers data from information providers, requiring each provider to stake collateral. That allows the LINK token to operate as an incentive.

How Do Utility Tokens Differ From Coins and Other Tokens?

Utility tokens differ from other digital assets in several ways. When it comes to coins vs. tokens, it’s critical to understand that coins are, for all intents and purposes, a form of currency. In many ways, they function like a country’s fiat currency – such as the dollar or the euro. They simply exist solely in the digital space, but you can spend them online like other currency types.

While tokens have value, they don’t function purely as currency like coins do. Instead, tokens have other kinds of functions. For instance, they may represent your right to a future product or a stake in a company, depending on the type. In some cases, tokens let you perform a specific kind of action within the larger system. A particular type of access right comes with a token. That isn’t something people get with coins.

Additionally, while coins are mined, tokens are all issued simultaneously upon a cryptocurrency’s release. Their initial distribution is determined by the team overseeing the particular crypto project.

However, each type of token can operate a bit differently, too. For example, security tokens give you an ownership stake in the company behind the crypto. In this way, security tokens aren’t that different from traditional stocks. They’re simply decentralized versions that are entirely digital.

Utility tokens are different. In most cases, they represent access rights to a specific product or service within the associated cryptocurrency’s broader ecosystem. Often, they can work as a payment mechanism. However, they usually only do that within the constraints of the ecosystem they’re in and not broadly, which can be the case with coins.

For instance, a utility token within a food delivery app may allow you to pay for a meal using the token. However, you can’t spend that token on a meal on any other platform; it only works in that regard inside that one app’s ecosystem.

NFTs are technically a specialized type of utility token. They represent a right to a particular piece of digital art, and that art may have value, but NFTs can’t be used as currency across ecosystems.

How Are Utility Tokens Regulated?

Security tokens are treated like traditional securities — financial instruments like stocks and bonds — in a legal sense. That isn’t the case with utility tokens. They aren’t viewed as an investment in the same way because they don’t meet certain requirements outlined by the Securities and Exchange Commission (SEC), a U.S. government agency that aims to prevent stock market manipulation.

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For instance, one aspect of the Howey Test — a mechanism the SEC uses to determine if an asset is a security — is the expectation of profit. Because you can purchase utility tokens solely to perform certain functions within a platform – such as buying a meal – there isn’t an inherent expectation of profit. That’s just one reason why utility tokens aren’t viewed as securities.

Instead, utility tokens are generally viewed as property in a legal sense. Usually, they’re taxed similarly to income. If you receive a utility token as a form of payment, it’s taxable as income. Additionally, if a utility token’s value shifts, it can result in taxable income or capital gains or losses, depending on how long you hold the token before using it.

In some cases, people view utility tokens as an option for safe crypto investing. While their value may not increase (or decrease) as much as coins, there may be some safety in the fact that you can spend them on specific goods and services. As long as you’d use something offered through the platform, there’s always an inherent degree of value to you in the token. However, if you have no interest in the ecosystem’s offerings, that doesn’t apply.

It’s important to note that the regulation of utility tokens may change over time. While they aren’t viewed as an investment now, that isn’t guaranteed to be the case in the long term. Additionally, regulations impacting the broader crypto landscape may also alter the treatment of utility tokens, so it’s critical to be mindful of new laws as they emerge.

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