Evolution of Tokenization

Evolution of Tokenization

Even those of us whose interests are a far cry from anything crypto & blockchain are aware of the concept of a token. Today we are going to make a brief overview of the tokenization phenomenon, and see a token evolving from a geekish term to an essential part of the modern financial landscape.

Any token represents a value that is tied with a particular ecosystem. As opposed to fiat currency, or traditional assets like gold or platinum, a token is only valuable within the boundaries of a certain project. And there’s another difference between traditional currencies and tokens. Tokens can be issued by literally anyone, but only as long as the issuer can ensure that there’s a value or an asset backing every new batch of newly issued tokens.

Tokenization in Web Services, Gaming, and Online Projects

Years ago no one has heard of Bitcoin. But in those days tokens already flourished within a number of projects and concepts. Many digital services that worked online have imposed internal currencies. Users could either buy or earn these tokens to use them later for upgrading their accounts and paying for new options.

Chances are all of those who read this now have played online games. In this case, you are familiar with the concept of a game token — an internal coin that can be earned through completing missions, finding artifacts, etc. These tokens can be spent on new items or skills for your game character. The majority of games also included an option of buying their tokens for fiat money.

Today it still works the same way. Thousands of games, online projects, and apps have their own tokens. These tokens grant you access to certain benefits in the game or service, but they have no value outside of the ecosystem. Since these tokens represented a utility, they are called utility tokens.

Tokens in Fundraising: the ICO Era

Fundraising has always been a challenge, in particular, for small scale projects. To attract investors, you have to show them a Minimum Viable Product, at the very least. But tech and digital startups hardly have the resources to bring to life even the simplest prototype.

This is where the Initial Coin Offering concept stepped in. The project founders issued tokens representing the future value of a non-existent product. By selling these tokens to anyone willing to buy them they raised the funds they needed for implementing their idea. The buyers paid with cryptocurrency, so the founders could receive investments from all over the world literally overnight without the trouble of working with banks or other intermediaries.

It was assumed that later the token owners would benefit in a variety of ways, e.g., by getting free access to a product, or by paying for the service with the tokens. The other two popular options were selling the tokens on a crypto exchange or receiving dividends from the company’s income.

However, to offer these two benefits was a risky path, since such tokens have fallen short of the definition of a utility token. Tokens with implied profit are recognized as securities when performing a Howey test. According to the Howey test, security is something you invest your money in with an expectation of future profit that comes from the efforts of the security seller, or a third party. That’s why financial regulators like SEC in the USA were soon after some of the companies that have performed ICOs. They were claimed responsible for selling unauthorized securities. Later these companies had to pay huge fines and return all the money to investors.

This got even worse since over half of all the ICO projects failed to deliver the products they promised to. Consequently, they also didn’t fulfill the investors’ expectations. This caused a decline in the community’s confidence and the defamation of the very concept of an ICO.

Security Tokens: the Rise of STO

To avoid the risk of claims from regulators, some companies started to choose a more cumbersome but a reliable and safe path of conducting a Security Token Offering. This fundraising strategy implied performing a legally compliant procedure of selling securities in a form of tokens.

Every token was backed by an asset or a value, but as opposed to ICO tokens, STO tokens had value outside the ecosystem of a specific project. This has revolutionized the idea of a token! Depending on the project’s notion, this value could be a share in the company’s property, or a right to vote for crucial decisions, or a loan with a right to collect it later, etc.

All the types of security token collectively share one feature — they will be still valuable even if the issuer fails to complete the job it grappled with. And, unlike with the utility tokens, this value can be obtained by the means of traditional legal tools.

This incentivizes the investors to purchase security tokens, which is beneficial both for the issuers and the token holders. This is how a token evolved from a mere convention to a solid financial tool.

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