It’s still the holidays and you are spending the day with your family. You’ve been talking to your mom for quite a while now and two more bored family members have taken a seat on the couch across from you.
To catch them up, you give a short summary of the first part of this conversation:
The initial idea of Bitcoin was to create a form of money that can be used easily and independently from location or government.
This means that you can send large sums of money anywhere for next to no fees very quickly and without an intermediary. So you don’t need banks, companies, or governments. A computer or a smartphone and an internet connection is enough.
While the first cryptocurrency Bitcoin was set out to function just like money, there are many other tokens and currencies that you can do all kinds of things with. Currently, they are mostly used as an investment, not unlike stock (even though you usually don’t actually own equity) because the prices offer a lot of opportunities for large price changes and therefore large financial gains.
Your cousin Janice is taking in what you’ve just said. She holds a business degree and has obviously heard of Bitcoin before but is confused about the last thing you said.
“So it’s like owning equity but without actually owning it? How does this work? Are there different types of coins?”
“Great question, Janice”, you say. “In its basic function, there are three kinds of crypto tokens. For the sake of simplicity, we are not going to look at staking or mining yet, so if you’ve heard those terms before, ignore them for now. You can buy most coins on so-called exchanges.
To make the whole thing a little more tangible, we are going to look at different “types” of coins using an example that you all know well: Ball games and hot dogs.
Imagine you’re at a baseball game, bored out of your mind, and you are hungry for a hot dog. Of course, there is a stand inside the stadium that we will call ’Coin Dogs’.
In its basic function, an equity token is the same thing as stock. Through contracts, a company can define its shareholdings to be represented by their own crypto tokens. These tokens would be comparable to stock, just that the rights of ownership wouldn’t be written down on a piece of paper. Still, this means that by owning a certain coin, you gain certain investor rights and obligations.
For our Coin Dogs Equity Token, this would mean that the owners of Coin Dogs might decide to sell a part of their company. By purchasing some Coin Dogs Equity Tokens, you would become the proud owner of a piece of the business. You would be able to influence decisions and take part in shareholder meetings. In short, you would own a piece of the company. Winnings would be paid out to shareholders (you) or used to reinvest in the hot dog business.
An equity token could be a regular way of fundraising that is easier to deal with than going through a real stock exchange.
A security token is something that you invest money in to eventually realize a return without taking on an active role in the enterprise that you invest in.
Therefore, any token that you only buy to make money can, and probably will be, considered a security token. Different to an Equity Token, Security tokens don’t necessarily make you a shareholder of the enterprise that you invest in. Rather, the token promises a certain return. This could be through a revenue share model or some other privilege that you gain from buying the coin.
A Coin Dogs Security Token can take many shapes or forms. The owners of the hot dog stand could consider selling the coin at the beginning of the season to stack up on condiments and sausages. In return, they could promise to redistribute 5% of gross hot dog sales at the end of the season for token holders.
A security token offers more flexibility in the structure payouts but gives an investor less control over the company. There are no other rights or obligations attached. A security token could also be used as a fundraising mechanism for companies that don’t want to give up control but still need to raise money.
A Utility Token can be exchanged for the goods or services that the company issuing the token offer. While there are a lot of existing examples in “big” economies for “tokenized” equity and security, Utility Tokens work a little differently. To better understand how we can again look at the Coin Dogs example.
And this is where it gets really interesting. As we said before, Coin Dogs is located inside of a stadium. Because it is located inside of a stadium, you cannot pay your hot dogs in cash or via card. While very annoying, you will have to accept to buy hot dog tokens from the cashpoint that you can then exchange for sweet, sweet hot dogs.
There is only a limited supply of hot dog tokens available and if you want a hot dog, you need a token. This is exactly the way a utility token works.
This mechanism offers a lot of interesting opportunities. Imagine you wanted to make some extra cash at the stadium. You could buy all available tokens, effectively creating a “hot dog monopoly”. If people now want hot dogs, they have to buy tokens from you, because the “official seller” (the stadium in this scenario) is sold out. Unless the hot dog stand gave out more tokens, no one would be able to get any hot dogs without going through you as an intermediary.
In the crypto world, these tokens would obviously be digital and on a blockchain (don’t worry about what that is at the moment).
Back in the “real world”, you could create a utility token for anything, and there are a few projects that have tried. From cloud storage to advertising space, creative coders have come up with a few ways to make utility tokens work.
Janice sounds intrigued, but is not yet convinced. She tries to poke holes in your story:
“So, if Cryptocurrencies are like money, can you buy stuff with them?”
The supposedly first actual purchase done with Bitcoin was done in May 2010. Someone bought two large pizzas for the price of at the time around $30. You might have seen the oft-quoted story of the (in today’s Bitcoin price) $100 Mio. pizzas.
Since then, a lot has happened. There are cafés, restaurants and some shops that accept certain cryptocurrencies all over the world. It’s especially helpful to see ATMs in different countries. Due to the fact that Bitcoin is not bound by national banking restrictions, you can get cash anywhere without having to worry about banking fees.
The adoption of cryptocurrencies is slower than many would like it to be, but it is quite certain that it is moving forward.
Over the past few years, people have also started lending and borrowing through cryptocurrencies. As there are no intermediaries, interest rates can be lower and lending is possible across borders all around the world.
In the next part of this Crypto Dinner Party, we are going to look at the operations. After you have convinced your mom and Janice to get their feet wet in the world of crypto, we are looking at some tools to check out in order to make sure that they always know how their coins are doing.