• Nick Roquefort-Villeneuve

Can Speculation Kill Utility Tokens?

[Disclaimer: The following blog post is in no way an investment advice from the writer or Ondiflo. Furthermore, Ondiflo is not currently planning an ICO]

What is a Utility Token?

A Blockchain-based application is called a DApp, or "decentralized application." For a DApp to run on Blockchain, it requires fuel. And fuel takes the form of "utility tokens." Utility tokens are virtual coins that are needed to perform certain actions on a DApp that is run by its creator, who also happens to be the utility token issuer.

Imagine for a second that our company Amalto publishes a DApp that you're interested in using, not only because it solves a critical business issue but also because it brings your organization all the advantages of Blockchain. To use the Amalto DApp, you must buy its native token, which we'll call the "Amaltoken." The way it works truly is no different from continuing to insert coins in an arcade game to extend, for example, a Pac-Man game time. If you don't know what Pac-Man is, please refrain from sharing this information with me. I feel old enough already.

Utility tokens like Amaltokens are similar to fully convertible currencies such as the U.S. Dollar and the Euro. They are used in exchange for a service. The only difference between a fully convertible currency and a utility token is that the latter can only buy a specific action, whereas the former can buy anything that fits within your budget. The specific action the utility token buys is confined within the realms of what the DApp does. In other words, if your local grocery store were to issue a utility token that you'd choose to purchase, simply because you enjoy shopping there for their delicious organic produces, well the token would only be redeemable in that grocery store, and nowhere else. It is exactly the same with the utility token that is attached to a DApp.

One mechanism used to purchase utility tokens is called an ICO.

What is an ICO?

An ICO or Initial Coin Offering is quite similar to an IPO or Initial Public Offering, in the sense that both depict a fundraising mechanism.

In the case of an IPO, investors use fully convertible currencies to purchase shares of a company that becomes publicly traded on a stock exchange. During an ICO, new projects sell their native or underlying utility tokens in exchange for cryptocurrencies like Bitcoin or Ether.

Most ICOs raise money pre-product, which means that ICO contributors receive tokens that they'll use to purchase the product's service, once it has launched. Moreover, the volume of tokens available may be limited (also known as a token cap), which infers that overtime they may appreciate, if the demand for the product or service increases, since the supply never changes.

The utility token is not intended to be an instrument for investment. However, it's important to be aware that there are startups out there that describe their token as a utility but market it as an investment, so they can fly under the radars of regulators who'd consider the asset a security. The utility token is indeed an organizational distinction, not a legal one. Consequently, the SEC has not given official guidance on utility tokens, so they're not subject to securities regulations.

How Demand Affects Utility Tokens?

Utility tokens are not intended for investment purpose. And yet, their value can fluctuate based on the demand for the applications to which they are attached.

There are three elements that can affect the demand for utility tokens. Back to our Amalto DApp example. First, if an individual wants to run the Amalto DApp, s/he must buy Amaltokens to do so. Second, if an individual anticipates that the Amalto DApp will become widely used, s/he will buy Amaltokens because a higher demand will generate a higher priced Amaltoken. And third, the Amaltoken may offer voting rights to identify what new features the Amalto DApp should include in its next iteration, and only Amaltoken holders are eligible to vote. Such voting right may be valuable to someone, who would then acquire Amaltokens.

The second point is what's currently driving utility tokens: pure speculative behavior. A great majority of projects promoting DApps and their associated utility tokens are start-ups. The reality is that the demand pertaining to their tokens doesn't have much to do with their intended purpose. The market is indeed filled by speculators, who are betting on the project's future outcome. As a result, companies that are truly interested in using the DApp will find themselves penalized, because they will have to pay tokens at a premium that may not justify using the application any longer. Ultimately, the DApp's creator will also be penalized, because the speculative environment around his utility token will deter potential clients from adopting his solution.

Utility Tokens and Speculation: Conclusion

Speculation can alter the intrinsic purpose of utility tokens. What is the solution to the problem? One instinctive answer is to call for regulations and the creation of a strict framework for utility tokens. A distinction already exists between a utility token and a token that is offered as an investment, however the message DApp publishers use to describe the tokens they're issuing can be highly misleading. So, should there be a centralized authority that ensures the validity of the process? And, culturally, how would that fit on top of a world that made decentralization its motto?

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