a16z: Understand 7 Types of Token Classification and Grasp Where the Value of Crypto Assets Comes From

Original Title: "Defining tokens"

Authors: ++Miles Jennings++ ++,++ ++Scott Duke Kominers++ ++,++ ++Eddy Lazzarin++

Compiled by: Deep Tide TechFlow

As the activity and innovation around token-based network models continue to grow, builders are wondering how to distinguish between different types of tokens—and which type might be the best fit for their business. Meanwhile, consumers and policymakers are striving to better understand the roles and risks of blockchain tokens in applications.

To help facilitate this conversation, we provide definitions, examples, and frameworks to help you understand the seven types of tokens most commonly used by entrepreneurs: network tokens, security tokens, company-backed tokens, utility tokens, collectible tokens, asset-backed tokens, and memecoins. We outline them in more detail below.

Quick Review: Tokens and Their Characteristics

Fundamentally, tokens enable true digital ownership.

More precisely, a blockchain is a decentralized computer network composed of individual computers that maintain a shared ledger—essentially a "++cloud computer++." Tokens are data records on these ledgers that can track quantities, permissions, and other metadata. Crucially, these data records can only be altered according to the rules encoded on the blockchain, which can be used to grant enforceable rights.

Beneath this precision, many details influence design, functionality, value, and risk: because tokens are embedded in software, they can be programmed to represent almost anything—any digital form or property record. This means tokens can be designed as digital stores of value, like Bitcoin, productive and consumable assets, like Ethereum, collectibles, like digital trading cards and in-game items, payment stablecoins, like USDC, and even digitized stocks.

Some tokens provide holders with various rights (such as voting rights or economic rights), while others only allow access to products or network services. Some tokens can be transferred between users, while others cannot. Some tokens are fungible, meaning all units are equivalent (like dollar bills), while others are non-fungible, meaning they represent unique individual assets (one-of-a-kind, like trading cards, or even the Mona Lisa).

These design choices are important because they determine whether a token is a good store of value or medium of exchange; whether it is a productive asset with intrinsic functionality and/or ++economic value++; or whether it is essentially worthless. The characteristics of a specific token also determine how it will be treated under applicable laws.

Therefore, whether you are building a blockchain-based project, investing in tokens, or simply using tokens as a consumer, it is crucial to understand what to look for. It is important not to confuse memecoins with network tokens. The remainder of this article aims to help clarify this confusion.

Types of Tokens

Network Tokens

Network tokens are fundamentally tied to the programmatic functionality of a blockchain or smart contract protocol, and their value derives from this.

Network tokens typically have built-in utility; they can be used for network operations, achieving consensus, coordinating protocol upgrades, or incentivizing network actions. The networks associated with these tokens usually (in most cases should) contain economic mechanisms that drive the value of the tokens. These include programmatic buybacks, dividends, and other changes to the total supply of tokens through token creation ("faucets") or destruction ("sinks") to introduce inflation and ++deflationary++ pressures to serve the network.

Network tokens can have trust dependencies similar to commodities and securities. Recognizing this, the SEC's ++2019 Framework++ and ++FIT21++ stipulate that when the underlying network's decentralization mitigates these trust dependencies, network tokens will be excluded from U.S. securities laws. The core essence of decentralization is that the system can operate ++without human control++ (by individuals, companies, or management teams).

Network tokens are best suited for ++bootstrapping the creation of new networks++, allocating ownership or control of the network to its users, and/or ensuring that the network can self-fund for ongoing and secure operations. Examples of network tokens include DOGE, Bitcoin's BTC, Ethereum's ETH, Solana's SOL, and Uniswap's UNI. In the context of smart contract protocols like Uniswap and Aave, network tokens are sometimes referred to as "protocol tokens" or "application tokens."

Security Tokens

Security tokens represent a digital form of ++securities++, which can be traditional forms (like company stocks or corporate bonds) or have special characteristics, such as providing profit interests in a limited liability company ++or shares of future athlete earnings++, or even ++securitized rights to future litigation settlement payments++.

Securities typically grant holders certain rights, ownership, or interests, and their issuers often have ++unilateral power to influence or construct++ asset risk. As the U.S. Securities and Exchange Commission is expected to modernize securities laws to allow on-chain trading, the number and types of tokenized securities may increase, potentially enhancing the efficiency and liquidity of the securities market. However, even as the category grows, digital securities will remain subject to U.S. securities laws.

Security tokens have been used to raise funds for commercial enterprises. Examples of security tokens include ++Etherfuse Stablebonds++ and ++Aspen Coin++, which represents partial ownership interests in the Aspen Resort.

Company-Backed Tokens

Company-backed tokens are intrinsically linked to applications, products, or services operated by a company (or other centralized organization) and derive value from them.

Like network tokens, company-backed tokens may use blockchain and smart contracts (for example, to facilitate payments). However, because they are primarily related to off-chain operations rather than network ownership, companies can unilaterally control their issuance, utility, and value. Like utility tokens (described below), company-backed tokens typically have their own embedded utility. Unlike utility tokens, company-backed tokens have speculative characteristics.

Given these characteristics—although company-backed tokens do not grant holders explicit rights, ownership, or interests like traditional securities—they have trust dependencies similar to securities: their value essentially depends on a system controlled by individuals, companies, or management teams. Therefore, while company-backed tokens themselves are not securities, their trading may be subject to U.S. securities laws when they attract investment.

Company-backed tokens may become a legitimate category. However, they have historically been used in the U.S. primarily to illegally circumvent securities laws—attracting investment in applications, products, or services controlled by the company, potentially acting as proxies for equity or profit interests in that company. Examples of company-backed tokens include FTT, which acts as a profit interest in the FTX exchange, or a hypothetical cloud service provider issuing tokens that allow holders to access cloud services and earn a portion of on-chain revenue from such services. Meanwhile, BNB is an example of a company-backed token that evolved into a network token with the launch of Binance Smart Chain. Company-backed tokens are sometimes referred to as "startup tokens" or, given their link to off-chain applications, "application tokens."

For more information on the distinction between network tokens and company-backed tokens (including FTT), please read " ++Network Tokens vs. Company-Backed Tokens++ ."

Utility Tokens

Utility tokens provide utility within a system and are not intended for investment purposes. Utility tokens are often used as currency in the digital economy. For example, digital gold in games, loyalty points in membership programs, or points redeemable for digital products and services.

Importantly, utility tokens differ from security tokens, network tokens, and company-backed tokens because they are specifically designed to prevent speculation. For instance, these tokens may have no supply cap (meaning an unlimited number can be minted) and/or limited transferability; if unused, they may expire or depreciate, or they may only have monetary value and utility within the system that issues them. Most importantly, they do not provide, promise, or imply financial returns. Given that they are not suitable as investment products, utility tokens are generally not subject to U.S. securities laws.

Utility tokens are best suited as currency in the digital economy, where issuers gain economic benefits by controlling the monetary policy of that digital economy (acting as a central bank) and maintaining stable token value, rather than profiting from token value appreciation. Examples include ++FLY++, which is the loyalty and payment token for the Blackbird restaurant network. Another example is Pocketful of Quarters, an in-game asset that did not receive action relief from the U.S. Securities and Exchange Commission in 2019. Robux and ++Start Alliance Points++ have not been tokenized, but aside from that, they exemplify the concept of utility tokens well. Utility tokens are sometimes also referred to as "++utility++ tokens," "loyalty tokens," or "++points++."

Collectible Tokens

The value, utility, or significance of collectible tokens derives from the record of ownership of tangible or intangible goods. For example, collectible tokens can be digital representations or embodiments of artworks, music, or literary works; tickets to events; memberships in clubs or communities; or assets in games or the metaverse, such as digital swords or ++metaverse land++ parcels.

These tokens are typically non-fungible and often have utility. For instance, collectible tokens can serve as event permits or tickets; they can be used in video games (like that sword); or they can provide ownership related to intellectual property ++.++ Because collectible tokens are often associated with finished products or goods and do not rely on third-party efforts, they are generally not subject to U.S. securities laws.

Collectible tokens are best suited for conveying ownership of tangible or intangible goods. Many (though not all) " ++NFT++ " products fall into this category. Examples include NFTs that convey ownership of digital art or other media; profile pictures (pfps) like CryptoPunks and Bored Apes, as well as other virtual fashion and ++branded merchandise++; in-game items; and account records or identifiers (like ++ENS domains++).

Some collectible tokens are directly linked to physical products, either providing a digital extension of the experience of a physical product, such as ++Pudgy Penguins toys++ and ++Generative Goods++ trading cards; or providing a digital representation of physical goods for easier tracking and/or exchange, such as NFT event tickets and BAXUS's ++vaulted wine NFTs++.

Asset-Backed Tokens

The value of asset-backed tokens derives from a claim or economic risk on one or more underlying assets. These underlying assets may include real-world assets (like commodities, fiat currencies, or securities) or digital assets (like cryptocurrencies or liquidity pool stakes).

Asset-backed tokens can be fully or partially collateralized and can serve different purposes: acting as a store of value, a hedging tool, or an on-chain financial primitive. Unlike collectible tokens that derive value from ownership of unique items (like digital artworks, in-game items, or event tickets), asset-backed tokens function more like financial instruments, deriving value from their collateral, price peg mechanisms, or redemption rights. However, the regulatory treatment of asset-backed tokens depends on their structure and use. Some tokens, such as fiat-backed stablecoins, are generally not subject to U.S. securities laws. Other tokens, such as certain derivative tokens, may be subject to securities or commodities regulation if they represent investment contracts or similar futures-like instruments.

Asset-backed tokens have many use cases, including:

• Stablecoins, pegged to currencies or assets;

• Derivative tokens, providing synthetic exposure to underlying assets or financial positions;

• Liquidity Provider (LP) tokens, representing claims on pooled assets in decentralized finance (DeFi) protocols;

• Deposit Receipt tokens, representing staked or custodial assets.

Examples include USDC (a fiat-backed stablecoin), Compound's C tokens (an LP token), Lido's stETH (a liquid staking token), and OPYN's Squeeth (a derivative token tracking ETH prices).

Memecoins

Memecoins are tokens that have no intrinsic utility or value, often associated with internet memes or community-driven movements, and have no fundamental connection to a network, company, or application.

The price of memecoins is entirely driven by speculation and related market forces, making them highly susceptible to manipulation. Their main characteristics are a lack of intrinsic purpose (if they have a purpose, they are no longer memecoins), a lack of utility, and the resulting zero-sum nature and volatility. Memecoins ++are generally not subject to U.S. securities laws++, but they are still subject to anti-fraud and market manipulation laws.

For example, PEPE, SHIB, and TRUMP.

Not all tokens fit neatly into these categories—entrepreneurs regularly iterate and experiment with new models. For instance, if social and ++reputation++ tokens are non-investable, they may resemble utility tokens more closely, while if they are controlled by centralized issuers, they may resemble company-backed tokens more. As token characteristics change or new functionalities are added, tokens can also evolve from one category to another, making classification challenging.

But the definitive characteristic that divides these categories is the expected source of value accumulation. A flowchart helps illustrate this:

(Note: The images are AI-translated and may differ somewhat from the original definitions of tokens.)

Acknowledgments: We thank Chris Dixon, Tim Roughgarden, and Bill Hinman for their helpful comments; and Tim Sullivan for editing.

++Miles Jennings++ is the General Counsel at a16z crypto, responsible for advising the firm and its portfolio companies on decentralization, DAOs, governance, NFTs, and state and federal securities laws.

++Scott Duke Kominers++ is the Sarofim-Rock Professor of Business Administration at ++Harvard Business School++, an Associate Professor of Economics at ++Harvard University++, and a research partner at ++a16z crypto++. He also advises multiple companies on web3 strategy and market and incentive design; for further disclosures, see ++his website++. He is also a co-author of ++the book "Everything Token: How NFTs and Web3 Will Change the Way We Buy, Sell, and Create"++.

++Eddy Lazzarin++ is the Chief Technology Officer at a16z crypto. He oversees the engineering, research, and security teams that support the investment process and work with portfolio companies to build the future of the internet.