Since the introduction of Bitcoin in 2009, we have witnessed an immense growth of the token economy and cryptocurrency market. But not all cryptocurrencies found on exchanges are created equally. Cryptocurrencies (or tokens) can vary widely with different utilities, use cases, and value offered to investors.
Tokens are mainly used as a payment method for services, as voting rights in ecosystems, or as digital assets. Besides their function as a medium of exchange (in the form of digital money) and a store of value, cryptocurrencies and tokens see a vast range of use cases beyond conventional financial transactions as the number of applications is increasing at unprecedented rates.
With the emergence of DeFi and Dapps the number of utility tokens has been growing exponentially, offering users access to multiple services on the blockchain. So what makes utility tokens different? Let's have a look.
Tokens are generally issued by companies using existing third-party blockchains such as the Ethereum blockchain. Strictly speaking, tokens are not cryptocurrencies like Bitcoin or ether but transferable units of value issued on top of a blockchain.
Tokens are usually divided by functionality into utility tokens and security tokens. Utility tokens serve a specific utility and typically have a comprehensive functionality within a protocol or platform/app. Utility tokens can provide value to investors in different ways, but basically, they give users access to a product or service and serve as a medium of exchange within an ecosystem. Therefore, utility tokens are not created as an investment opportunity in the original sense.
As opposed to security tokens, utility tokens do not represent a stake in an external asset or enterprise. Rather than granting a tangible benefit for an investor such as access to an ecosystem, a security token can represent a share in the company issuing the token, a loan with fixed income (similar to bonds in traditional financial markets), or a stake in an asset, like real estate or commodities. They are regulated just like securities you'd find in more traditional markets.
arguably the most obvious utility for a token is a means of payment for gas fees on the blockchain. This utility is implemented for most layer 1 and 2 protocols' tokens, like BTC, ETH, MATIC, ADA, or VLX. Aside from that, tokens of decentralized applications built on top of an existing blockchain give holders similar utility to pay for internal products and services. For example, tokens like SAND and AXIE are the utility tokens used throughout in-game ecosystems as the basis for transactions and interactions.
With the mainstream adoption of cryptocurrencies, we will witness more opportunities to use tokens to pay for products or services not only in the crypto and blockchain ecosystem but as well in the offline world. For example, El Salvador adopted Bitcoin as a legal tender back in September 2021, allowing users to pay with BTC for nearly everything, from real estate to fast food.
Preferential treatment - Utility token can offer some bonuses, upgrades, and various discounts for its users. One of the prominent examples is a BNB token that gives users a discount on transaction costs on Binance exchange if they choose to pay trading fees in BNB.
Yield Farming utility comes with Decentralized Exchanges (DEXs). It allows users to earn tokens while supporting the exchange with liquidity. In order to participate in farms, users should stake two tokens to get Liquidity Pool (LP) Tokens, which they then stake in the farm to earn rewards. Although farming is a great way to make passive revenue, by keeping your position in different tokens, it is important to remember that this benefit comes with the risk of impermanent loss due to market fluctuation and arbitrage.
yet another way to generate passive income for token holders. As opposed to farming, staking doesn't require paired tokens, implying less risk to the investor. Holders only need to stake one token to start earning other tokens or more of the same token. For example, Pancake Swap allows users to stake CAKE to earn tokens of other projects.
By implementing a governance utility, tokens can provide owners with the rights to shape the future of the protocol or Dapp. For example, Maker (MKR) is the governance token for the DAI Credit System. MKR holders have the important responsibility of making decisions around the risk that will impact the system's future. AAVE, for instance, offers users the privilege to vote on grants for projects that are being built within the Aave network. A simple "Yay" or "Nay" while connecting your crypto wallet with a few Aave tokens is an example of how a voting system is created on the network. Another example is CAKE - a native token for Pancake Swap DEX, that on top of many other things, gives holders the ability to vote on proposals relating to the PancakeSwap ecosystem.
The innovation doesn't stay still, and we believe we'll see more interesting and valuable utilities coming. Furthermore, the opportunities and use cases NFTs open are immense, and we will cover them in the future blog post.
Despite great utility features and use cases, many tokens still suffer from a lack of liquidity. At flovtec, we provide innovative market-making solutions for any type of token to help them succeed in the digital asset ecosystem.