Bitcoin was the coin that introduced us to the world of blockchain technology, the applied value of which is represented by thousands of different cryptocurrencies today. Back in 2010, it was the only trust-less, peer-to-peer currency transaction system in the world. Eventually, other types of coins came into existence. These were called ‘alt coins’ since they were created as alternatives to Bitcoin.
The innovation of cryptocurrencies did not stop with alt coins. With time, many new and different categories of cryptocurrencies were invented to support different applications. The creation and growth of Ethereum gave birth to the term “token”, which soon became a universal term for all currencies developed on the Ethereum blockchain, and later for all tokens developed as “layer twos” on preexisting “layer one” blockchains. While Ethereum is the most popular blockchain (layer one), there are many dozens of independent, autonomous blockchains out there today. Based on the applications and functions of different tokens on different blockchains, they were further divided into various categories as explained below.
Types of Tokens (or ‘alt coins’)
1a. Utility Tokens
These tokens are designed to be used for a particular purpose, usually within the ecosystem (i.e. application/platform) for which they are developed. The most common use of a utility token is as a payment option for token trades, swaps, or exchanges within the platform.
Utility tokens are released by a company to provide their users with a way of paying for a new company product or service, often developed on the blockchain platform the company has built their token on. It also serves as an investment opportunity for people optimistic about the longterm prospects of what the company is building. It is usually a good idea to buy utility tokens during the ICO sale, since the tokens during the ICO are offered at a significantly lower price than the market rate. Alternatively, some people wait a few months after ICO sales to buy tokens, since prices sometimes drop after the initial ICO spike. Many utility tokens can be compared to stocks on the stock market, in the sense that they often represent blockchain-based startup companies as opposed to publicly traded traditional companies.
1b. Subcategories of Utility Tokens
Some common subcategories of utility tokens are DeFi (decentralized finance) tokens, Privacy tokens, Metaverse tokens, Gaming (play-to-earn blockchain game) tokens, Platform and/or Exchange tokens, and many more!
Governance tokens can also be simultaneously be considered utility tokens, depending on the type of DAO community they represent, and whether or not there is an underlying utility (e.g. blockchain protocol or smart contract) proprietary to the DAO. But even when they aren’t utility tokens per se…
2. Governance Tokens
…Governance tokens are still quite similar to utility tokens, except instead of representing the value of a blockchain startup that has created some sort of innovation or solution to a problem in crypto, they represent the value of a tangible community: Namely a DAO (decentralized autonomous organization) community.
DAOs can be formed to represent the interests of a variety of communities and special interests, from non-profit charities, to for-profit member-based companies, to local communities of people united over a common interest, hobby, or pursuit. Really, any community of people can create some flavor of DAO on a blockchain, and develop structured rules that govern the community and serve its interests. When DAOs are created, governance tokens are minted and distributed to provide equity and financial ownership to members of the community.
Some utility tokens (e.g. UNI) also function as DAO governance tokens, because the companies that launched them also incorporated as a DAO, and wanted their utility tokens to simultaneously be used by their member communities.
3. Security/Equity Tokens
Security tokens work in the same manner as traditional securities. Also called equity tokens, these act as a stock or share of the company, which is given to the buyer once the initial coin offering ends. By purchasing security tokens of a company/project, you get certain rights along with sharing in the company stocks.
Security tokens are different than utility tokens in that they are limited by specific federal laws and rules of stock trading. Equity tokens, by nature, can also be accessed outside of the platform on which they are developed. The value of security tokens may rise or fall according to the project’s performance, similar to stocks, which is not always the case with utility tokens. There is some overlap, though, in the sense that some utility tokens can be considered security tokens.
Speaking of overlap, NFTs (or ‘non-fungible tokens’) are also sometimes considered to be securities. NFTs are essentially tokens that are wholly unique (non-fungible), cannot be fractionalized or subdivided (unlike other tokens), and are often represented by some form of digital media, which can be a picture, PDF, GIF, video, or audio file.
Today most NFTs are treated as digital collectibles and/or tickets to private (and often very expensive) memberships or organizations. In the future however, NFTs will probably have a variety of practical uses. Some possible examples include tokenized deeds, titles, certificates, diplomas, proofs of sale or purchase, wills, proofs of subscription, and much more.
The benefit of using NFTs to represent these things is that they are practically impossible to forge, due to blockchain immutability. The limitation today is that NFT transactions on blockchains can become expensive or slow to process. However, this is an issue that may be resolved by up and coming blockchains, many of which are created to innovate and fix limitations like these.
5. Reward Tokens
These are special tokens that are designed to act as a reputation token for a specific blockchain application. They incentivize more people to join communities and/or invest in utility tokens or NFTs, by providing people with a reward incentive. Many DAOs, NFT collections, crypto gaming ecosystems, and metaverse ecosystems commonly leverage Reward tokens for their communities and/or investors.
A reward token doesn’t always have real-world value, meaning you can’t buy or sell certain reward tokens on an exchange, or even send them to a crypto wallet. Often these tokens simply provide users special perks or privileges within the specific crypto community or ecosystem that gifted them.
6. Asset Tokens
Tokens that are backed by a real asset, such as gold, real estate or bonds, are called Asset tokens. These tokens represent the value of real-world assets and can be used for buying or selling the assets that they back, without having to physically handle them. This makes possible the trading of physical assets (e.g. gold, silver, etc.) on digital platforms.
7a. Currency Tokens
A currency token acts the same way as a real currency and is used for the same purpose: buying, selling, and exchanging currency. A classic example is Bitcoin, which is a type of digital currency that can be used for transactions with online/offline merchants who accept these coins. Currency tokens can also be traded for other cryptocurrencies and fiat currencies and can be sent to other users through a digital wallet.
Many tokens that can be classified as ‘currency tokens’ can also be classified as other categories (e.g. utility tokens, securities, etc.)
7b. Stable Coins
Stable coins are a subcategory of currency tokens. These are special tokens that are pegged to the value of an existing real-world currency (e.g. USD, the Euro, the Pound, etc.) Stable coins reliably maintain the value of the currencies they’re pegged to when their treasuries are sufficiently backed by reserve amounts of that currency, combined with other tangible assets (such as gold). This helps guarantee their longterm value for users. Algorithm-based stable coins (such as UST, of the Terra/Luna ecosystem) are less safe, as evidenced by recent events.
Now that you know the different types of cryptocurrencies and their uses, you can make a better decision evaluating tokens, and choosing when and what to invest in.