What is a Utility Token?
Utility tokens grant holders rights to perform specific actions or claim specific benefits within a given ecosystem. For example, Filecoin’s token (FIL) is a utility token that enables holders to use the Filecoin decentralized storage platform for storing files that may contain information or data that supplements certain transactions as those transactions are immutably recorded to a distributed ledger. One possible use case for a scenario like this is when a transaction is recorded to a distributed ledger in order to memorialize the purchase of a physical item. A digital photo of that physical item might be stored “off-chain” in a service like Filecoin since the on-chain transaction payload itself may not have the capacity for a file attachment. The on- and off-chain records are essentially related to one another in the same way that indexes are used to encode relationships between independently stored records in a relational database management system (e.g., MySQL or Oracle). In this context, possession of FIL affords the token holder access to specific functionality — in this case, off-chain file storage — otherwise described as “utility.”
Ergo, the phrase “utility token.” The reason for classifying a token as a utility token is to sufficiently distinguish it from other token types such as governance tokens or general-purpose cryptocurrency coins. Bitcoin (BTC) or Ether (the native cryptocurrency of Ethereum) are an example of such general-purpose coins whose value is universally exchangeable for just about anything (other cryptocurrencies, fiat currency, goods, services, etc.). In contrast, Filecoin’s intention for FIL is to make it exchangeable for Filecoin’s utility and nothing else.
File and data storage is just one example of a utility that can be acquired according to an on-demand or coin-operated business model. Other examples of utility tokens include but are not limited to:
Note that utility tokens are typically pre-mined, meaning the issuing organization creates the total token supply in advance of issuance. In these cases, once the pre-mining process is completed for a given utility token, there is no additional minting of that token type.
Game arcade tokens are an apt real-world metaphor for DLT utility tokens. Typically, upon entry to a physical arcade, a game player will trade some fiat currency (e.g., US dollars) for special physical tokens that can be used for one purpose only: to play the games in the arcade. Whereas some games may require one arcade token, others might require two or three. But outside of the arcade, the tokens are useless. The games are the utility and the arcade tokens are the utility tokens that are necessary to use the utility. In many cases, arcade tokens cannot be re-exchanged for fiat currency. However, if you have more arcade tokens than you’ll ever use, it is possible that an interested buyer might be willing to negotiate to purchase them from you, albeit at a lesser amount per token than you paid. In the DLT world, some utility tokens are open to similar informal but open market forces, even though it may not have been the original intention of those tokens.
Regulatory Scrutiny Over Utility Tokens
The pre-minting of a given supply of utility tokens can be used for good (incentivizing adoption of the utility) or ill (rug-pulling investors) and thus draws considerable scrutiny from global lawmakers and regulators who are looking to protect their citizenries from scams. In the US, where the Howey Test is often used to determine if a token is a security or not, the people on one side of the “When is cryptocurrency a security?” debate align to the argument that true utility tokens may not constitute an investment contract and therefore may fail the test. At the time this glossary entry was published, the proverbial jury was still out on how to treat utility tokens from a regulatory point of view. Short of any actual laws, not to mention clarity from the US Securities and Exchange Commission (SEC) on utility tokens or even a reasonable amount of case law precedents, it’s uncertain how utility tokens will be classified over the long run.