Tokenization, Explained

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3.

In short: It’s on a blockchain.

But let’s dive a little deeper and see what “token” even means in our case. Of course, as with many other crypto-related terms, there is no single, agreed-upon definition.

At the most basic level, a token is a representation of a particular asset or utility. Sound too abstract? Let’s outline three types of tokens you might come across on a regular basis and break them down:

Currency tokens

These are the most obvious ones. Just think of classic cryptocurrencies. Bitcoin.

Currency tokens are built on their own independent blockchains. They are not based on assets — instead, their value is directly linked to the very mechanism that distributes them.

As per their name, currency tokens’ purpose is to be traded, spent and received. Just like conventional currencies. Paying for Frappuccinos with bitcoin? This is an example of currency tokens at their finest.

Utility tokens

This one is a bit trickier, so bear with me on this.

Utility tokens give you future access to a given product or service, while the money you paid for them allows startups to raise enough capital to actually develop this product.

A prime example here would be the Basic Attention Token (BAT) — a tool for the enhancement of digital advertising. Advertisers buy ads with BAT tokens, which are then distributed among both publishers and browser users as compensation for both hosting ads and viewing them, respectively.

Utility tokens are not supposed to be investments by design; however, people often treat them that way and buy these tokens with the hope that their value will increase along with the demand for the company’s product or service.

Security tokens

Security tokens, in turn, represent a straightforward investment. Defining this type of tokens is surprisingly simple, especially if you refer to the Howey Test, which the United States Securities and Exchange Commission (SEC) has been using since 1946 and, oddly enough, still applies to cryptocurrencies as well.

When you see a token, ask the following questions: Is it being sold as an investment? Are profits expected? Will those profits depend solely on the efforts of the promoter who is putting the deal together or another third party? If you answered “yes” to all three, then you’re dealing with a security token.

Remember our COW token? Let’s apply the Howey Test here.

It is being sold as an investment opportunity. Investors do rely on you, as the farm’s owner, to keep it profitable and ideally not run it into the ground. Are profits expected to be made? Sure, why else would investors buy a token named COW?

To sum up, security tokens can represent any asset that is tradable and fungible. They are not backed by white papers with lengthy technical explanations — security tokens are essentially shares that live on a preexisting blockchain.