Utility tokens are linked to specific projects or products and serve as an incentive to investors. Asset-backed tokens are backed by a digital asset.
Both types of tokens are linked to cryptocurrencies somewhat but serve different purposes for issuers and users.
Let us discuss what are utility tokens and asset-backed tokens and some key differences between them.
What is a Utility Token?
A utility token is a special-purpose token that is issued within an ecosystem or specifically for a project. It is a type of crypto token and is often associated with initial coin offerings (ICOs).
Like other tokens, these tokens also allow users to perform certain tasks or enjoy access to certain features of an ecosystem for which they are issued.
Utility tokens are issued for a fixed number as pre-mined tokens and are distributed as and when needed by the issuer. These are not mineable like other cryptocurrencies.
How Does a Utility Token Work?
Utility tokens can be built on any blockchain technology that supports smart contracts. For its wider application, most utility tokens are built using Ethereum tokens known as ERC-20.
Companies issue utility tokens to attract investors usually. This refers to startups or issuing a new product/service by an existing company.
Utility tokens offer special access or financial incentive to investors. Thus, if the newly launched project is successful, these tokens gain value, and investors receive a higher return on investment.
However, unlike security tokens, utility tokens do not represent ownership stakes in a company. This is the reason why utility tokens are considered a riskier investment.
Utility tokens serve different purposes for issuers and investors.
- These tokens offer decentralized storage.
- Users get special rights to use a product or service and may gain monetary value if the project is successful.
- These tokens can also serve as a mode of payment or currency for the issuer.
- Issuers use utility tokens to offer discounts, bonuses, and incentives for employees and customers.
- These can be combined with other tokens and protocols for increased productivity.
For these features, issuers use utility tokens as a means to attract investors in initial coin offerings commonly. Issuers receive initial investment to develop a new product/service and if successful investors enjoy different perks.
Special Considerations with Utility Tokens
Utility tokens face several challenges as compared to other tokens and cryptocurrencies.
First of all, utility tokens are not tightly regulated. Therefore, these are prone to fraud and scamming by issuers and face a lack of trust from investors.
Then, these tokens do not provide voting rights to investors and they do not take part in the decision-making process for which they provide capital. It further decreases the stakes of the investors.
Then, utility tokens derive value from a project or product. It means if the newly launched product/service fails, the utility token attached to it does not offer a real incentive.
Utility tokens do not appreciate other than the success of the project. It further increases the risk profile of these tokens.
Examples of Utility Tokens
Here are a few well-known utility tokens.
Smooth Love Potion (SLP)
- The SLP token is issued by Axie Infinity, a popular play-to-earn game.
- Users gain access to exclusive features of the game by purchasing and earning SLPs.
- SLPs do not offer any incentive or monetary value out of the Axie Infinity game though.
Basic Attention Token (BAT)
- BAT works with the Brave browser for user tracking and browsing behavior tracking metrics.
- It can also be used as a mode of payment for advertising revenue on the browser.
- Users of Brave browser can also make money through advertisements and get paid through the BAT token.
Binance Coin
- It is the native token of the Binance ecosystem which comprises Binance Beacon and Smart chain.
- Investors holding Binance coins can enjoy up to 25% discount on trading fees and other costs on the Binance network.
- It can also be used for different types of payments on two blockchains of the Binance network.
Cronos (CRO)
- It is built on the Cryptos Blockchain and developed by crypto.com.
- It can be used to convert cryptocurrencies to fiat currencies at discounted prices.
- It also helps merchants to accept payments in cryptocurrencies.
What is an Asset-Backed Token?
An asset-backed token is a cryptocurrency token backed by a real-world asset as the name suggests. It is also commonly referred to as a security token.
Precisely, asset-backed tokens can be categorized as a subset of security tokens as well. These tokens give holders special privileges like ownership and voting rights.
These digital tokens derive their values from external assets that are also traded in the market. It means these tokens represent a digital form of financial securities (derivatives) of the traditional stock markets.
Security tokens or asset-backed tokens represent ownership of an asset or investment. Thus, their value is affected by a change in the value of that asset or investment.
How Does an Asset-Backed Token?
The simplest way to understand asset-backed tokens is to know how they derive value from real-world assets.
These assets can be shares of a company, commodities, real estate assets, precious metals, diamonds, gold, etc. A change in the value of these assets will result in a change in the value of an asset-backed token.
It is the same concept that runs financial securities in the traditional markets. Security or asset-backed tokens represent fractional ownership in real-world assets.
The concept of fractional ownership or representation of a real-world asset is an attractive aspect for investors along with some other key factors.
A key factor favoring security tokens is they are highly regulated. In most jurisdictions, these tokens are legalized and regulated like traditional financial securities. As a result, investors feel a better sense of security.
Other factors attracting investors to asset-backed tokens are automation, transparency, and enhanced security. fractional ownership means more accessibility for retail investors as well.
In short, asset-backed tokens are becoming more popular among retail investors as they see an increasing demand and value from these tokens as compared to other cryptocurrency assets.
Special Considerations with Asset-Backed Tokens
Asset-backed tokens run on smart contract-enabled blockchains like Ethereum. Fractional ownership is another great advantage of these tokens.
Thus, these tokens become popular and attractive to retail investors. It increases the liquidity of these tokens and makes buying and selling easier.
Unlike other investments, these tokens do not rely on movements in fiat currencies like the USD which makes them immune from inflation.
Many experts argue that the securitization of cryptocurrencies and tokens will enable more blockchain-oriented ecosystems.
Since asset-backed tokens qualify as securities, they are highly regulated as well. They go through different types of regulations like regulation D, regulation A+, and Regulation S.
An important to mention here is that asset-backed or security tokens are less volatile as compared to other crypto assets. Traders looking for quick trading gains through day trading practices may not like this aspect though.
However, as these tokens grow in popularity, we’ll see an increasingly upward demand trend and more trading of these tokens which will bring a higher degree of uncertainty and volatility to security tokens at some stage.
Examples of Asset-Backed Tokens
There are a few successful examples of asset-backed tokens so far and some failures too.
A popular asset-backed token is Tether (USDT). It derives its value from the world’s most popular currency USD. Tether also comes with other features like a high level of security and backing of other assets.
Similarly, DIAM is a popular security token that is backed by diamonds. It is issued by diamDEXX and it offers retail investors a chance to invest in diamonds through digital tokens.
AABB gold token combines the investing benefits of cryptocurrency and gold for investors. AABBG is backed by the current spot price of gold making it less volatile than other gold-backed securities.
Utility Tokens Vs Asset-Backed Tokens – Key Differences and Similarities
Let us now summarize some key differences and similarities between utility tokens and asset-backed tokens.
- Utility tokens do not represent ownership stakes of the issuer company while asset-backed or security tokens do.
- Asset-backed tokens derive value from an asset like derivative security in traditional trading while utility tokens do not.
- The primary purpose of asset-backed tokens is to offer an investment incentive to investors while it is the secondary purpose of a utility token.
- Asset-backed or security tokens are highly regulated while utility tokens are not regulated strictly.
- Due to a higher level of regulation and participation by investors, asset-backed tokens are considered less risky as compared to utility tokens.
- Utility tokens do not appreciate independently as their success is tied to the success of the project they are linked to. Asset-backed tokens also depend on the success of the asset they are linked to.
