What Is a Utility Token? A Comprehensive Guide w/ Examples

Blockchain and digital currencies are an innovative space where many concepts emerged over time to create a complex and intertwined system. Long gone are the days when Bitcoin was the only cryptocurrency with the purpose of storing and transferring value. Nowadays, we have revolutionary, multi-purpose instruments such as security and utility tokens.

As their name suggests, utility tokens offer some sort of benefit beyond speculative value or add applicability to digital assets. But what exactly is this utility, and how do projects and users benefit from these tokens?

In this article, we’ll explore all the intricacies surrounding utility tokens, from their inception and issuance to use cases. Let’s get started!

What Is a Utility Token?

A utility token is a type of cryptocurrency designed to give a holder access to a blockchain service or product. It stands in contrast to security tokens, which are digital counterparts to securities in traditional finance and thus susceptible to regulatory scrutiny.

Furthermore, utility tokens are not to be confused with crypto coins. While the terms “coins” and “tokens” are often used interchangeably in the cryptosphere, and they are both considered cryptocurrencies, there are stark differences between the two.

Coins are comparable to fiat currencies, like USD and EUR. They exist on their own blockchains and are mainly used as payment instruments or to store value. The most popular coin is Bitcoin.

On the other hand, utility tokens are issued on preestablished blockchains, and they are tied to specific projects. In most cases, project creators distribute these tokens as a means of raising capital for further development. The holders can then use these tokens to pay for fees and services related to the project.

One of the most common methods of issuing utility tokens is through an initial coin offering (ICO). ICOs saw a huge surge in popularity in 2017, in large part due to the fact that they aren’t regulated. However, that resulted in a large number of scams and frauds, drawing investors away from ICOs.

Still, the convenience of the utility token offering and the advantages of these cryptocurrencies make them vital parts of the DeFi landscape. That’s why many projects and token issuers continue to work on self-regulation in an effort to reclaim investors' trust.

Utility Tokens Use Cases & Applications

Utility tokens have many use cases, and one of their key benefits is their versatility. Here are some of the ways these tokens can be used by their holders:

• Service access. Utility tokens can be used much like physical tokens can grant access to arcade games. Holders can use them as payment for blockchain-backed services provided by related projects. For instance, Filecoin is a decentralized storage network where you can obtain storage space with Filecoin tokens.
• Transaction fees. Decentralized networks focused on data and value exchange often require computational power and electricity to operate. In these cases, network participants who want to transact can use utility tokens to pay transaction fees, compensating miners and validators for their work.
• Project participation and governance. Some project owners allow the community to participate in project development. Those who hold a certain amount of utility tokens gain voting power that allows them to decide on proposals or suggest some themselves. The voting power often directly correlates to the number of utility tokens held.
• Rewards and incentives. Many projects use utility tokens to reward network participants and facilitate their involvement. These rewards range from compensation for viewing ads to rewards for providing liquidity.
• Virtual goods. Video games and blockchain metaverses can offer various assets, such as goods, equipment, plots of land, and more, in exchange for utility tokens. The tokens can further be used to facilitate the digital economy within these ecosystems.

Utility Token vs. Security Token

While utility tokens and security tokens both belong to the same category of crypto assets, they are two distinct types of digital assets. There are vast differences regarding their regulation and use cases.

The biggest clue is in the name. Utility tokens are created to have utility and grant holders access to products or services, while security tokens represent a blockchain version of traditional securities.

As a result, utility tokens gain value from the product or service that they are connected to. Their number is limited, thus promoting scarcity. If the quality of the product or service increases and the demand goes up, so will the value of the token.

On the other hand, security tokens are regarded as investment vehicles. Similarly to stocks, bonds, and other investment assets in traditional finance, security tokens are generally bought under the promise of lucrative dividends and future profits.

TradFi securities are subject to regulation, which is meant to protect both the companies and investors. While the world of DeFi aims to escape the confines of traditional regulation, it is still necessary to prevent large-scale fraud.

That’s why the U.S. Securities and Exchange Commission (SEC) continuously monitors tokens and uses the Howey Test to determine whether they are utility or security tokens. Ultimately, security tokens are supervised by government entities and required to adhere to robust legal frameworks.

Utility Token Examples

Let’s check out some of the most popular examples of utility tokens:

• Ether (ETH) is the world’s biggest and most popular altcoin and probably one of the best examples of how utility tokens work. While ETH is technically a coin, since it’s a native cryptocurrency on the Ethereum network, it has many use cases. ETH is used to pay for transaction fees, and developers use it to run EVM-compatible dApps on the network.
• Filecoin (FIL) network aims to decentralize digital storage. Network participants can use the FIL token to purchase storage, or they can sell it to obtain these tokens. Stored data can include everything from public and private datasets, video content, websites, podcasts, applications, company files, contracts, and more.
• Basic Attention Token (BAT) is awarded to the users of the Brave web browser. Brave is a Chromium-based Web2 browser that anyone can download, regardless of their cryptocurrency affinities. The browser allows its users to view ads and receive BAT tokens. The system is designed to compensate users for their attention.
• Golem (GLM) is a decentralized network created for sharing computing power. It’s a blockchain-based market where participants can use GLM tokens to purchase the computing power needed for their effort. On the other hand, users can rent out their idle computing power to earn GLM utility tokens in return.

4 Benefits of Utility Tokens

Here are some of the key benefits of utility tokens:

1. Improved community engagement. Projects that feature useful utility tokens generally see an increase in user interaction. For instance, token rewards can incentivize people to participate in the network’s operation more often. This engagement can result in the creation of tight-knit communities, which can be vital for the success of the project.
2. Project funding. On the developers’ end, utility tokens represent a tool to raise capital and secure necessary funds for future growth. Distribution and sales mechanisms, such as ICOs, can be used to exchange utility tokens for a much-needed cash reserve. Since ICOs are accessible to anyone, this process fosters financial inclusion.
3. Fostering a closed economy. By making utility tokens in charge of the majority of network operations, the issuers are creating an internal economy. This can lead to improved project independence, as its participants can internally exchange tokens for goods and services without relying on outside financial assets.
4. Facilitating decentralization. Utility tokens often contribute more to decentralization than value-related crypto coins and security tokens. They grant holders certain privileges within their ecosystems, such as voting rights and decision-making benefits. That, in combination with the potential for financial gain outside of traditional finance, makes utility tokens highly sought-after in the crypto space.

Risks and Challenges of Utility Tokens

Potent and versatile utility tokens aren’t without risks. Here are some of the biggest challenges associated with them:

• Regulatory uncertainty. One of the biggest advantages of utility tokens is also one of their biggest drawbacks. A lack of regulation allows any project to use ICOs to distribute tokens, create communities, and raise funds. However, since there’s no regulatory body to govern these processes, there have been many scams from issuers and issuing platforms that resulted in a loss of funds for investors.
• Market volatility. Utility tokens and cryptocurrency market volatility go hand-in-hand. They can go up or down in price for significant amounts and in short periods of time. These fluctuations happen for many different reasons, including overall market sentiment, temporary technological issues, impactful news, and more. While this volatility draws risk-tolerant investors, it can deter long-term holders.
• Security risks. The dynamic cryptocurrency landscape is filled with hackers and other malicious actors who want to take advantage of the drawbacks of self-governance. With no central governing authority, it’s almost impossible to recover utility tokens. Savvy attackers can target poorly secured wallets or even exploit vulnerabilities in badly written smart contracts to steal funds.
• Project failure. Utility tokens are only as useful and valuable as the project they are connected to. If the project fails, associated tokens become worthless, representing a loss for holders.

How to Acquire Utility Tokens

There are several ways to acquire utility tokens, including:

• Initial coin offerings (ICOs). ICOs are the most common method that project owners use to issue utility tokens. They are fairly easy to set up and allow the issuers to distribute tokens in an optimal way while securing the necessary funds for further development. In general, anyone can join an ICO to purchase utility tokens in exchange for established cryptocurrencies (e.g., Bitcoin and Ethereum).
• Centralized exchanges (CEXs). Centralized exchanges, such as Binance, KuCoin, and Crypto.com, often list prominent utility tokens after the ICO. That makes them accessible to a wider audience of people who have accounts with these exchanges. Anyone can create an account with CEX by performing KYC. After that, they can purchase utility tokens with other cryptocurrencies or even fiat.
• Decentralized exchanges (DEXs). DEXs provide alternative ways to obtain utility tokens for individuals who want more control over their assets. They facilitate peer-to-peer transfers without the need for central governing authority, like with CEXs. There’s also no need for KYC verification since all users need is a funded wallet and an internet connection.
• Directly from the project. Many projects continue issuing utility tokens as rewards or incentives (e.g., BAT tokens are given to Brave users). Some projects also allow people to buy their tokens through dApps or websites long after the ICO.

5 Best Practices for Investing in Utility Tokens

Investing in utility tokens can be a profitable endeavor, but it’s important to know what you’re doing. Here are some of the best practices to follow to ensure long-term success when investing:

1. Do your own research (DYOR). To maximize your chances of making a good investment, you should thoroughly research the project and the team behind it. Examine the tokenomics of the utility token, go through the whitepaper, and check out the project’s roadmap. Assessing all that information is crucial to properly estimating the project’s chances of success.
2. Diversify your portfolio. The main rule of investing says, “Don’t put all your eggs in one basket.” No matter how good the project looks, don’t spend all your assets on its tokens. The crypto space is highly volatile, and many projects disappeared overnight. Utility tokens are considered risky investments, which is why it’s generally recommended to only invest a small portion of your portfolio.
3. Secure your tokens. An important aspect of investing in cryptocurrencies is securing your assets. Make sure to follow the best practices when it comes to safety and use proven storage solutions (e.g., hardware wallets).
4. Have an exit strategy. Most investors buy utility tokens to make a profit. In that case, you should plan ahead and know when you’re going to sell your tokens, whether it is to obtain profit or stop a loss.
5. Stay informed. It’s vital to keep an eye on the project and the entire crypto space in general while holding utility tokens. That way, you’ll reduce your chances of being surprised by unforeseen circumstances.

The Future of Utility Tokens

In the future, utility tokens are likely to see wider adoption and regulatory advancements. As blockchain technology becomes more accessible and available to a broader audience, we could see utility tokens being integrated into mainstream businesses and operations.

Their potential to act as rewards and incentives but also as governance tools makes utility tokens handy tools in many ecosystems. Technological advancements might lead to better scalability and interoperability, which could result in more use cases and easier token transfers between blockchains.

On the other hand, there is a good chance that regulatory bodies will closely monitor all of this progress. As the popularity of utility tokens grows, so will their appeal to investors. That could result in relevant institutions seeing them as securities, meaning utility tokens might be subjected to regulation, which could slow down their adoption.

Ultimately, even that could result in improved regulatory clarity, which could be beneficial to the entire landscape in the long run.

Key Takeaways

The cryptocurrency ecosystem has seen many fleeting trends over the years. However, utility tokens have proven their value, and they are here to stay. They are adding practicality to the world of DeFi, further facilitating its adoption among mainstream audiences.

While the path forward is filled with challenges, most of which are from a regulatory standpoint, the future looks bright. As blockchain technology continues to develop, we can expect more use cases for utility tokens and their growth along with the entire cryptosphere!