Utility tokens explained

What is a utility token?

A utility token is a crypto that gives users access to specific parts within a blockchain ecosystem, such as a product, service or functionality. This makes it different from cryptocurrencies like Bitcoin, which are primarily designed as a digital means of payment or store of value. A utility token has a functional role within a specific ecosystem and can be compared to a digital key that gives you access to the ecosystem and is required to perform specific actions within a platform.

A utility token can be the native token of a network, which is for example used to pay transaction fees, but it can also be issued on an existing blockchain by developers. Examples of this are ERC-20 tokens on Ethereum, BEP-20 tokens on BNB Chain and TRC-20 tokens on Tron.

Example: Ether (ETH) is the native token of the Ethereum network and has a clear utility function. ETH is used to pay transaction fees (gas fees) and to execute smart contracts and decentralized applications on the network. In addition, there are also utility tokens on Ethereum that are issued according to the ERC-20 standard. Examples of these are the Basic Attention Token (BAT), which is used within the Brave browser to facilitate advertisements and rewards, and Aave (AAVE), an ERC-20 utility token that is used within the Aave protocol for decentralized lending and borrowing services.

Key Takeaways

• A utility token provides access to specific functions, services or applications within a blockchain ecosystem
• Utility tokens have a functional role and are not intended as an investment or store of value
• Utility tokens can be native tokens of a network or be issued on existing blockchains such as Ethereum
• The use and value of a utility token are strongly linked to the activity and popularity of the platform

How does a utility token work?

A utility token is usually issued on an existing blockchain, such as Ethereum or Solana. The token makes use of the infrastructure and security of that blockchain, while smart contracts define how and for what purposes the token can be used within a specific dApp or service. In this way, the utility token provides access to certain functions, services or parts of the platform.

When you own a utility token, you can use it to pay transaction fees, activate functions or gain access to specific parts of the platform.

Issuance of utility tokens

Developers can issue a utility token through the tokenization process. This works as follows:

• A project team chooses a blockchain on which they want to issue their token, such as Ethereum, Solana, BNB Chain or Tron.
• On the blockchain, a smart contract is developed in which the properties of the token are defined, including the total supply of tokens, the distribution of the tokens and the specific function of the token within for example a dApp.
• The smart contract follows a fixed token standard, such as ERC-20 on Ethereum or BEP-20 on BNB Chain. These standards ensure that the token is compatible with wallets, dApps and exchanges within the ecosystem.
• The smart contract is executed on the blockchain and the tokens are 'minted', meaning they are created.

After the tokens are created, the project becomes operational and the tokens are in principle tradable on decentralized exchanges (DEX's) within the ecosystem. Subsequently, the distribution takes place. This often happens via airdrops, ICO's or through other distribution methods, where users for example acquire the tokens via token swaps on DEX's.

How can you recognize a utility token?

You can determine whether a token is a utility token by researching the project. You can do this by looking at the function of the token within the project, for example via the official website or by reading the whitepaper. A whitepaper explains what the token is used for. If the token provides access to a service or specific functionalities within a network, you can assume that it is a utility token. The token is then often not described as an investment or financial product, but as a usage token within an ecosystem.

Do not confuse a utility token with a governance token. A governance token only gives voting rights. A utility token can also have a governance function, but in addition it has one or more other use cases within the platform.

What can you do with a utility token?

With a utility token, you can perform various actions within a platform, depending on what the token is designed for, such as:

• paying transaction fees within a blockchain network or application
• using specific services or functionalities within a platform
• purchasing digital products or gaining access to premium features
• participating in votes on technical proposals or protocol changes
• contributing to the use, maintenance or security of the network
• trading the token on decentralized exchanges (DEX's) or centralized trading platforms
• earning passive income through mechanisms such as staking, liquidity mining and lending

Although utility tokens are often freely tradable on exchanges, their primary value lies in their use within the associated platform and not in speculation.

Examples of utility tokens

Within the crypto market, there are various utility tokens, each with their own functionalities, such as:

• Ether (ETH) - is used within the Ethereum blockchain to pay transaction fees and execute smart contracts
• BNB (BNB) - is the native token of BNB Chain and is used for transaction fees and applications within the BNB ecosystem
• Solana (SOL) - is used within the Solana network to pay transaction fees and execute smart contracts such as decentralized applications
• Chainlink (LINK) - a utility token used to pay for oracle services within the Chainlink network
• Uniswap (UNI) - is an ERC-20 utility token and is used within the Uniswap protocol for the operation and management of the decentralized exchange
• Aave (AAVE) - is an ERC-20 utility token and is used within the Aave protocol for decentralized lending and borrowing services
• Basic Attention Token (BAT) - is used within the Brave browser to reward users and content creators
• Filecoin (FIL) - functions as a means of payment for decentralized storage services within the Filecoin network

These are just a few examples of utility tokens and their functions within a blockchain or project. Each of them fulfills an important role within its own ecosystem.

What is the difference between utility tokens and security tokens?

Another type of token that utility tokens are often compared to is a security token. However, these tokens are very different and difficult to compare in terms of functionality. The difference between utility tokens and security tokens mainly lies in their function and legal meaning. A utility token gives users access to a product, service or functionality within a blockchain platform. The token has a clear usage purpose and is necessary for the ecosystem to function. A utility token does not grant any right to profit, ownership or control over the company behind the project. This is different for security tokens.

A security token represents a form of investment. Ownership can entitle the holder to profit distributions, dividends, interest or a share in the value of the underlying project or company. This makes a security token more similar to traditional financial instruments such as shares or bonds. This is a major difference compared to utility tokens. As a result, security tokens are subject to strict financial laws and regulations in many countries.

The purpose of these two types of tokens is therefore different. Security tokens are aimed at raising capital from investors, while utility tokens focus on usage within the platform itself. Although utility tokens can sometimes increase in value, this is not their primary purpose.

Final thoughts

A utility token plays an essential role within blockchain projects by providing users with access to services, functionalities and applications within a specific ecosystem. In contrast to cryptocurrencies that are mainly used as a means of payment or store of value, the focus of utility tokens lies on usage and functionality. They form the building blocks of many decentralized applications and networks and make it possible to carry out transactions, use services and actively participate in a platform. Due to the clear distinction from security tokens and the absence of profit rights, it is important to assess utility tokens based on their practical application and usefulness within the project. Those who understand how utility tokens work and what they are used for can better assess the role they play within the broader crypto market.