Getting Up-To-Speed on Cryptocurrency: What are Tokens, App Coins, and ICOs?

Cryptocurrencies are gathering speed—there are now over 4,300 cryptocoins and over $500 million was raised through crowdsales and initial coin offerings (ICOs) in the first half of 2017. If you’re feeling a little left behind regarding how this decentralized financial system works, here we break down some of the key terms for you.

Quick refresh on cryptocurrencies

Cryptocurrency, or digital/virtual currency, operates independently of central banks. Transactions take place on blockchain, digital ledgers which store these transactions chronologically and publicly in distributed networks by “miners.” Miners are incentivized account holders that process the transactions using the internet and suitable hardware. Picture data centers and individual computers all over the world storing information as opposed to a fixed number of server farms.

Cryptocurrency removes the need for middlemen like banks and brokers. Account holders can transfer funds globally and directly to one another using wallets, which work like digital banks. As the number and value of cryptocurrencies continues to increase rapidly (Bitcoin’s value increased over 200% in the first half of 2017), the potential this movement has to completely disrupt the financial services industry is incredible.

In their infancies, cryptocurrencies are volatile, and while some like Bitcoin and Ethereum appear here to stay, further innovation is on the way.

Tokens & coins

The terms “tokens” and “coins” are often used interchangeably. Tokens and coins are units of currency (Ethereum’s ether is an example), and are stamped digitally as entries on a blockchain. You can trade them for assets, send them to other people, or you can trade them for other currencies. Your ownership of tokens is marked by keys (digital codes) you receive when you participate. While tokens aren’t money in the way you’re used to thinking about money (virtual currency doesn’t have legal tender status in most jurisdictions yet, and was only recently accepted in Japan), they do mark transactions.

There are a variety of tokens, but Protocol Tokens are the main use case.

Protocol Tokens are what you traditionally think of in the cryptocurrency space. Bitcoin and Ethereum both fall under this classification. They are not linked to traditional assets or centralized entities. They’re governed by a protocol, or standard language (like SMTP which allows you to send and receive email) across a distributed network, and enforced through blockchain. Melonport’s Melon Token (MLN) is a protocol token that participants must use to access Melon’s digital asset management capabilities.

Traditional Asset Tokens are associated with non-cryptocurrency assets like fiat currency, precious metals or goods. These assets are governed by one or more centralized parties. Think of these tokens as literally buying an item or a service. While these tokens do have use cases, we won’t go into detail here as they currently represent less than 1% of current cryptocurrency use cases.

App coins are native to specific applications, known as DApps (decentralized or distributed applications that meet specific criteria). For example, on Steem (a DApp), a blockchain-based social media platform similar to Reddit, users can earn Steem Power and Steem dollars for participating in the platform.

What can you do with your coins and tokens?

Here are a few main use cases for cryptocurrency:

Exchange of value: Buying Bitcoin gives you the ability to make nearly instant transactions with anyone else who has a Bitcoin wallet. Early buyers of Bitcoin also benefited financially as the currency’s value increased. DApps built on the Ethereum platform have the benefit of access to smart contracts, contracts written in code and replicated and supervised on the blockchain by a network of computers. For example, Augur’s users participate in event predictions, where winners’ receive currency based on smart contract agreements.

Shared ownership: You purchase coins to own a share of a network. Ownership can give you voting rights over future feature development. Dash’s self-governing protocol gives users opportunities to pitch ideas and vote on changes, such as a marketing budget or mobile wallet development. Tezos is an example of a more direct model with token holders having voting rights.

Access to resources: Say you run a multimedia company or use artificial intelligence and occasionally need access to more computing power than you currently have. Projects like Golem give users access to resources, in this case a distributed computing network where people can share their unused computing power in exchange for Golem coins (GNT).

Get it first: Initial Coin Offerings

How do these cryptocurrencies get funding? Initial Coin Offerings (ICOs) are a sort of hybrid of IPOs and crowdfunding, and are a popular way to fund projects. They’re an alternative to raising venture capital that some prefer to call crowdsales. A lot of risk is involved—ICOs generally occur before any product or service is launched.

The popularity of ICOs has prompted the U.S. Securities and Exchange Commission to issue an investor bulletin providing some guidance on the legality and where these coins fall in U.S. regulatory framework:

Depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities.  If they are securities, the offer and sale of these virtual coins or tokens in an ICO are subject to the federal securities laws.

ICOs are events wherein the cryptocurrency project sells some of its tokens or app coins in exchange for money. Ethereum raised over $18 million, as one of the first large ICOs, and their market cap is now in the billions. Mastercoin and Waves are other examples. The money, which is usually raised in Bitcoin or ether, goes partially towards developing and maintaining the project. It also provides early liquidity for the tokens once participants begin trading them. Shortly after the ICO is complete, tokens get listed in cryptocurrency exchanges, such as Poloniex or Coinbase once the token is more established, where you can trade against other cryptocurrencies or traditional, government-backed currencies.

Joseph Lubin, CEO of ConsenSys and co-founder of Ethereum told Fortune’s Robert Hackett that the ICO gold rush “will be responsible for a great thawing of capital.” Token buyers can sell and trade at any time, unlike traditional venture capital investments. This prediction was forward thinking; in 2017 the majority of investments in blockchain and token technology is coming from ICOs vs. traditional venture capital funding.

When you participate in an ICO, you don’t become an owner of a company as you would investing in a startup during an IPO. You own the coin or token that gives you access to a resource, voting rights and/or a store of value, but in all three cases you generally have a financial stake in the project’s success. This encourages a network effect, where ICO participants help raise awareness about and increase participation in the project.

Cryptocurrencies are still in their infancy, though they have the potential to profoundly change the financial services industry and distribute wealth globally. Defining and regulating an industry so innovative will take time, and it’s imperative participants understand the risks involved. Understanding how cryptocurrency works is the first step.

About the Author

Josh Davis is a Strategist with ITFO Communications and Managing Editor on the blockchain and cryptocurrency research team. He has over a decade of experience in financial services and technology communications, helping clients implement tangible, multi-year global programs by leveraging future trends. His research on emerging technologies has been quoted in top publications, including The New York Times, Tech Crunch and Forbes.

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