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What are Tokens?

Token definition 


A token is a unit of value issued by an organisation, accepted by a community, and supported by an existing blockchain. In simple words, the token is a representation of something in a particular ecosystem, a piece of data that serves as a representation of a fact or right. The token can represent something tangible (physical) or intangible (non-physical, i.e., a service) within its ecosystem.  

Although tokens may seem to be a new concept in the digital context, they have been with us in a physical form for a long time, going back to the time of the Roman Empire. Coin-like objects from that period have been interpreted as an early form of token. Bringing contemporary examples, a dollar note representing its corresponding value, or a driving license card is a physical token representing the fact that you have been taught how to drive a car and are permitted to do so. A digital token would represent that license in the digital world.  

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Just like in the physical world, we also need to distinguish between two overarching token categories in the digital world: Fungible and Non-Fungible Token. Fungible goods are goods or items that can be interchangeable, e.g., one sack of rice which can be replaced by another sack of rice. In the digital world, one Bitcoin can be replaced by another Bitcoin. Both goods and items are therefore fungible. Non-fungible goods, items, or tokens, on the other hand, are those that are not interchangeable due to their unique character.

For example, the Mona Lisa, or the one jumper that you have knitted yourself or bought, now has many memories attached to it and is therefore unique, only exists once. These are non-fungible items. Digital non-fungible tokens now allow for securing ownership of such non-fungible digital assets, price and trade them. 

 

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The examples of digital tokens can be countless: the certificate of course completion verified via blockchain, which confirms that you finished the course and passed the test or a digital art piece from the Bored Apes collection.  

While essentially all tokens are either fungible or non-fungible, there are multiple different types of tokens, which can be categorised into utility, payment, and security token – a framework spearheaded by the Swiss Financial Market Supervisory Authority (FINMA):  

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Security tokens are created to represent legal ownership of another asset, which must be verified on the blockchain. Security tokens are simply securities in a tokenized form – typically a share of a business, but also for real estate and other alternative assets. Unlike utility tokens, security tokens don’t have any utility attached to them.  

To determine if the token is a security or utility token, regulators often use the Howey Test (which is originated in the US, but other countries follow a similar rule). This test aims to check if a transaction is considered an “investment contract” and hence a security. If the token passes the Howey Test, it is categorized as a security token and subject to securities law.  
 
Security tokens have the potential to replace or at least complement other securities, such as stocks, bonds, or alternative investments such as funds or Actively Managed Certificates (AMC). However, the way they are regulated makes it very difficult to implement them than other tokens. Security tokens are subject to greater regulatory scrutiny than utility tokens from the US Securities and Exchange Commission. They require full SEC approval to be sold in public offerings to non-accredited investors or traded in the primary or secondary market. 
 
According to reports, the security tokens market capitalisation in November 2021 stood only at $1,1 billion. But the global security token market could reach $3 billion by 2025, growing at 56.9%, compounded annually. [1], [2]

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Utility tokens have a value tied to the ownership and therefore ‘can do something’. In contrast security tokens don’t do anything besides representing and storing value and giving the possibility to trade them. The easiest way to describe a utility token is that it’s the token backed up by a project. Utility tokens are released by a company to provide its users with a mechanism to pay for a new digital product of the company or service, often combined with a discount or benefit.  
 
An example of a utility token is BAT (Basic Attention Token), backed by the Brave browser project, a new internet browser similar to Chrome but claiming to be even faster. In exchange for your attention, you can accumulate tokens for browsing and earn 70% of the revenue that Brave receives from advertisers. Another example of the utility token is VRA (Verasity) that can be used in the Verasity ecosystem for different applications: esport, gaming, digital content, and AdTech industries, e.g., you can earn VRA as staking rewards or for engagement on the ad network, as well as use VRA for participation on VeraEsports.  


A special scope of application within utility tokens is so-called governance tokens. Governance tokens represent voting power on a blockchain project. They also allow their holders to stake, take out loans, and earn money by yield farming, e.g., used by DeFi protocols to govern the decentralised network. 

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Payment tokens are a unit of value that serves as a means of payment. Examples of pure payment tokens with the largest market capitalisation are the stablecoins USDC or USDT. 

Interestingly, a token is not restricted only to a particular role and could address various roles in its native ecosystem. The example here can be a BNB token that has its application on the Binance exchange platform - it fulfills the role of the utility token as it gives you the right to vote on new token listings, but also the role of the payment token as you can pay fees on the platform using BNB. Tokens with multiple ‘use cases’ are so-called hybrid tokens. [3]

Learn more about tokens.

 

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