What is an ICO Token?

Tokens 101

What is an ICO Token?

In the context of cryptocurrency, “coin” and “token” are sometimes, inaccurately, used interchangeably. Despite some overlap, they have very distinct functions. Coins are a digital currency and hold value like traditional money. They are often built on a native blockchain — like Bitcoin or Ethereum — and widely accepted as a medium of exchange. Coins can be held in wallets, used to purchase goods and services and also be exchanged for fiat currencies.

Tokens, on the other hand, have a broader application in blockchain infrastructure. They can in some cases function as shares or rights to an asset; they can also serve as a form of payment or reward. They do not carry inherent value like a coin, however, and do not guarantee ownership in a project.

An ICO token specifically refers to the form of currency generated in the process of a company tokenizing a blockchain-based project during its initial offering. Those tokens can be classified in a number of ways based on blockchain standard and specific function with regard to a project.

ERC-20 tokens

ERC-20 (Ethereum Request for Comment-20), most simply, is a standard that defines the rules for all tokens that function off of Ethereum blockchain technology. Because Ethereum’s blockchain has proven to be a hospitable place for hundreds of thousands of DApps (decentralized apps) to build, having the guiding principles of ERC-20 means both that developers do not need to create their tokens from scratch, and also that they can predict and anticipate how their tokens will function. Essentially, all ERC-20-based tokens subscribe to a universal standard, using the same language and meeting the same criteria.

It’s easier for smart contracts to be executed among various applications and Ethereum-based tokens that all meet the ERC-20 standard. For analogy, consider how Android users and iPhone users communicate with each other —while the phones and operating systems themselves vary, there are principles that allow them to be compatible r so that people can text each other, share photos, and, most importantly, send emojis regardless of which phone they’re using.

ERC-20 functions through six guiding principles that govern token transfer, data access, recognition of different crypto wallet functions and more. These principles have been widely praised as smart contracts become a more fundamental part of newly created DApps, and tokens built on ERC-20 may be more appealing to potential investors. However, ERC-20 has also had serious implementation issues in the past that have resulted in the unintentional destruction of tokens (estimated at worth more than $3 million). New standards have been proposed, but have not yet been fully vetted or implemented. In the meantime, the popularity of ERC-20 seems only to have increased, with more than 161,341 ERC-20 compatible tokens currently in circulation.

Why do ICOs use tokens?

Since 2013, Initial Coin Offerings, or ICOs, have become a popular way to raise capital to fund the development of new cryptocurrencies, blockchain platforms and other decentralized networks. Similar to the IPO process, though unregulated, ICO founders offer tokens instead of shares as a “reward” to investors. Many of these tokens are generated according to the ERC-20 standard, but an ICO token need not be an ERC-20 token. Launching an ERC-20 token will, however, require a token sale in the form of an ICO.

In what is generally termed a pre-sale, investors have the option of buying ICO tokens at a discounted price, usually by way of Bitcoin, Ether or another coin or currency. Depending on the terms of the ICO and token structure, the tokens may be used to purchase a newly launched coin, or other products and services, participate in a blockchain-based ecosystem and may even allow the investor to receive dividends. Importantly, however, tokens do not guarantee ownership in any project. Providing ICO tokens is a way for entrepreneurs to crowdfund risky projects and reward their investors without having to promise them monetary value in exchange.

Companies imbue tokens with value and scarcity by only generating a certain number of ICO tokens that will be distributed to the public, to the company, held in reserves and otherwise allocated. They also tether the price of the token to an existing currency. If the company raises adequate funds in its ICO, these tokens can be later traded on exchanges. The tokens also have specific functions within the blockchain ecosystem developed by the company. For instance, if a company builds a decentralized platform dedicated to democratizing content creation, tokens may be awarded to those who consistently contribute high quality content.

What’s a utility token?

As discussed, ICO tokens can have different functions, and are usually divided into two categories: security tokens and utility tokens. Utility tokens act as a kind of guarantee that an investor will receive a coin, product or service once the project has launched — but it does not confer equity ownership of the issuing entity, nor does it entitle the investor to dividends. (ICO tokens that do confer equity ownership are considered security tokens and are subject to SEC regulations.)

This distinction is critical as the vast majority of cryptocurrency founders are highly averse to regulation, particularly from the SEC and similar entities. When Ethereum sold Ether during its  ICO, it was priced at approximately 2,000 ETH : 1 Bitcoin (at the time, around $0.30 per ETH). The founder, Vitalik Buterin, stated clearly in the terms of sale that “Ether is a product, NOT a security or investment offering.”

“Ether is simply a token useful for paying transaction fees or building or purchasing decentralized application services on the Ethereum platform; it does not give you voting rights over anything, and we make no guarantees of its future value,” he said. Buterin made it abundantly clear that the purchase of Ether was intended to distribute utility tokens — tokens with some kind of “utility” on the platform — not security tokens, to Ethereum investors.

The Howey Test has been used since 1946 in the United States to distinguish between securities and other assets, but there is controversy around how the test applies to crypto as some analysts believe that both security and utility tokens fall under the definition of securities. While a change in the classification of utility tokens could create a seismic shift in the cryptocurrency community, it is also likely that, just as it has done for the better part of a decade, the community will continue to skirt efforts at regulation and continue to launch ICOs.

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