Utility Tokens Vs. Security Tokens: What IСO Investors Actually Buy
ICO as a means of fund-raising is becoming more and more attractive for investors and startuppers. At the same time, investing in an ICO may involve risk, and it's obvious for anyone, who looks at the statistics of the independent rating agency ICORating for 2017. According to its annual report, companies raised more than $6 billion during ICOs. The ROI of last year's ICOs was 116,63%, but in fact, almost half of all the projects was unprofitable.
There were 800 ICOs in total in 2017, but less than half of them could attract $100 thousand. Notably, the most profitable projects were those that offered the use of blockchain technology in different spheres of life, which is natural. For example, Filecoin, a decentralized data storage service, and Tezos, a smart contracts and applications platform, collected the largest sums of money.
Unfortunately, the financial success of an ICO does not guarantee a profit for investors. For instance, Tezos has not been launched yet, although the token sale ended more than a year ago.
Apparently, ICO investors risk even more than those who prefer classical investing methods. To minimize risks, investors need to know in advance what he will get in return. It's not enough to believe in the project and its success: the investor has to be sure that the investment is expedient and economically justified.
What investors actually buy: types of tokens
The idea of ICO is based on the exchange of tokens for certain goods — products or services. A company can offer more than one type of token. Before making a purchase, an investor should know what they gets in return and what conditions there are.
It is important to note that there is no single and standardized classification of tokens. However, by analogy with more traditional assets, all ICO tokens can be divided into two groups: utility tokens and security tokens.
95% of ICO tokens are utility tokens. They are also called appcoins (application coins — coins, that can be paid inside of the platform as an internal currency). An investor buys useful tokens and gets access to certain goods or services of the company. Utility tokens are used to pay for internal purchases. Utility tokens are mainly based on Ethereum and smart contracts.
Here are several examples:
- Bancor — is a platform for developing and exchanging tokens. It's based on the Ethereum standard ERC20. Bancor offers users to exchange ERC20-based tokens without cryptocurrency exchanges as mediators, and this is the uniqueness of the project.
- EOS — is a platform for creating applications based on smart contracts. It was the first ICO lasting a year: from June 2017 to June 2018. Before the project was started, investors who put money in EOS (and other similar ICO) received literally nothing. During the ICO, tokens were backed by nothing, they didn't fulfill any goals, didn't have attributes and functionality. But in the future, they might bring profit to investors, since EOS, in fact, is a direct competitor of Ethereum.
During the presale stage, both ICOs collected several hundred thousand dollars of investment. At the same time, projects that offer utility tokens don't guarantee anything to their investors, because they are not regulated by law. Nevertheless, investors believe in the success of the project and know that after the launch of ICO, the tokens price will increase. Though, this price can be artificially overstated and not match the real value of the tokens.
The purchase of security tokens is similar to the traditional investment in stocks and funds. The investors who buy security tokens receive the right to get interest payments and dividends in the future, after the successful launch of the project. In fact, the investor becomes a company stockholder. Security tokens, just like stocks, can rise or fall in price depending on the success of the project.
The advantage of security tokens is that this type of virtual assets has the same properties as common stocks. If security tokens are officially registered, the same laws apply to them. Tokenholders can receive reports on value changes, which makes it impossible to manipulate their price level.
Security tokens are rarely sold during an ICO because of regulatory issues in different countries. Only 24% of the total number of ICOs in 2017 had an official legal status. One of these projects, Filecoin, became the leader in the amount of collected funds.
Filecoin is known as a project that raised more than $200 million of investment within the first half an hour of its ICO. Only accredited investors could participate there, as ICO was supported by SAFT — Simple Agreement for Future Tokens. This is a kind of analogue of SAFE — a simple agreement for future assets, the term used in venture capital investment.
With the help of SAFT, an investor buys securities that guarantee the ownership of future tokens that will be issued after the project is launched. Before the start of an ICO, a company must submit documents to the SEC — The United States Securities and Exchange Commission.
The absence of objections from the SEC guarantees an investor that their deposits will be returned if the project fails. But at the same time nothing can guarantee that the project founders will have enough money to repay investor deposits.
Either way, investing in ICOs is risky. If investors buy security tokens, they can not be sure that it will bring them a profit. However, the understanding of how the token price is formed and how much it corresponds to its real economic value can increase the chances of success.
You can read about this in the next article of the series of "How to invest in ICO".