If you are a potential ICO investor looking into the crypto market, you need to understand the different kinds of tokens and how they work. The crypto market can be a confusing place, and it is not always easy to know which options are best for you.
As you start exploring the world of initial coin offerings (ICOs) and other aspects of these investments, you will likely encounter two specific types of tokens — asset-backed, or equity tokens (sometimes also called security tokens), and utility tokens. So how do each of these tokens work, and what are the pros and cons of each one?
As the name implies, asset-backed tokens are backed up by ownership in a hard asset. For that reason, they are often referred to as equity tokens. You can think of asset-backed tokens as the digital equivalent of a stock or bond. Although they are not really stocks nor bonds, asset-backed tokens represent real ownership in an asset.
A company planning to raise funds can issue shares in the form of equity tokens, allowing early investors to profit if the company does well. Conversely, a lender could issue asset-backed tokens that represent the debts owed by a particular company. This can make the buying and selling of associated loans easier.
The benefits of asset-backed tokens are clear enough, at least for potential investors. When they buy an asset-backed token, investors are buying ownership of the company, providing them with the benefits that ownership entails. And investors could benefit from the success of the company.
Utility tokens work differently, and they have their own advantages and drawbacks. These tokens are sometimes called user tokens, and they provide buyers with future access to a specific type of product or service. You can think of utility tokens as a sort of crowdfunding model, one where interested parties buy in and share in the proceeds later on.
If you have ever put up cash for a crowdfunded product and later received that product in the mail, you already understand how utility tokens work. This type of token gives startups direct access to the capital they need, so they can manufacture their products or services.
Unlike asset-backed tokens, which are ready-made for investment, utility tokens work quite differently. Utility tokens are not designed to be an investment — rather they provide future access to the company’s products or services. But even though utility tokens are not designed as direct investments, many ICO companies are using them in hopes that the value of the token will increase.
That bet on the price increase of utility tokens could be a good one, especially given the recent run-up in the price of some. At the same time, there is no guarantee that this will happen, and that uncertainty is one of the main drawbacks of the utility token model.
In the end, the choice of asset-backed vs. utility token is a highly personal one, both for would-be investors and for companies contemplating a future ICO. Both of these funding models have their advantages, and both have some potential drawbacks.
The main difference between asset-backed tokens and utility tokens is how they are backed up. While utility tokens entitle buyers to a future product or service, asset-backed tokens represent actual ownership rights, with all the advantages that entail. Both utility tokens and asset-backed tokens can, and likely will, fluctuate in value after their issuance, and those swings could be wild. In the end, investors will need to weigh the potential advantage of ownership rights, those provided by asset-backed tokens, against the right to future products and services that utility tokens provide.