The word ‘cryptocurrency’ is often used to describe any of the myriad of new digital assets available in the market today. This grouping is not inaccurate, but it is highly generalized and fails to capture the different types of cryptocurrencies, the ways in which they are used, and how they should be treated by consumers, businesses, and governments around the world.
While there are numerous ongoing efforts to classify ‘cryptocurrencies’ based upon asset types and use cases, there is still no general consensus regarding categorizations or naming conventions. The result of this ambiguity is general lack of practical understanding of the different forms of cryptocurrency, both on consumer and governmental levels around the world. As such, the regulatory, legal, and tax requirements and their implications can be very hard to define, which are causes for anxiety and instability in the industry. Classifying cryptocurrencies is a critical step toward bringing wider understanding and stability to this increasingly important asset class.
When is Cryptocurrency not a Currency?
Most people are aware that there is now a multitude of different cryptocurrencies available in the industry, and the perception can be that these are all potentially equally important, or even that they are basically the same thing. However, the range of uses and technical aspects of cryptocurrencies is so broad that it may not be possible to compare any two given cryptocurrencies. This is the case with two of the biggest cryptocurrencies in the industry, Bitcoin and Ether.
Bitcoin is a form of digital cash that is used to make payments across a global network. Ether are ‘platform tokens’ that are used to power the Ethereum blockchain, a decentralized computing platform. In practice, Bitcoin and Ether are very different, and are not good candidates for direct comparison. Bitcoin should only be compared to other cryptocurrencies intended to perform the same function, and the same applies to Ether. Without understanding of the different asset types and proper classification, inappropriate and illogical comparisons are made between cryptocurrencies with completely different functions.
Categories of Cryptocurrency
The application of categorization allows for cryptocurrencies be appropriately compared and contrasted. Still, there is a variety of ways in which cryptocurrencies might be classified, and there is some disagreement regarding how to categorize some projects that may fall into multiple categories.
The following list of categories is by no means comprehensive, nor are the included classifications agreed throughout the industry, but it offers some insight into the variety of cryptocurrency categories and their differences.
The original use case for cryptocurrencies was that of remittances and global payments. Cryptocurrencies could be used to pay for goods and services across borders without incurring significant fees for doing so. Additionally, this type of cryptocurrency would avoid the influence of governments that might seeking to control the flow of money in and out of their economies. This category was first popularized by the illegal drug trade on Darknet sites like Silk Road. However, the usefulness for this type of digital currency soon became obvious, particularly in nations where government-controlled currencies are subject to rapid devaluation and hyperinflation.
Examples: Bitcoin (BTC), Litecoin (LTC), ZCash (ZEC)
Platform tokens (also referred to as ‘protocol tokens’) are used to power entire decentralized networks. These tokens are used to pay for computing power on a network and as economic incentive for operators to keep the networks operating efficiently and securely, and to perform various other functions on the platform. Without platform tokens for economic incentivization, decentralized platforms could be flooded with network requests and entire systems could be brought to a standstill. Many platforms provide a jumping-off point for other projects to create their own utility and/or security tokens directly compatible with the platform upon which they are built.
Examples: Ether (ETH), EOS (EOS), Tezos (XTZ)
Tokens that grant the use of a service or utility within a network are referred to as ‘utility tokens’. This classification is occasionally used to encompass platform tokens as well. Utility tokens are used for products or services from the company that issues the token, and not for direct investment, although the value of these tokens may rise and fall with demand. These tokens have a real-world application, such as file storage and cloud computing.
Examples: Ripple (XRP), Filecoin (FIL), Golem (GNT)
Security tokens are cryptocurrencies that under US securities laws are considered to be securities, like stocks or bonds. Security tokens are subject to restrictions under securities laws, and a multi-state public offering will require registration with the US Securities and Exchange Commission. Unlike traditional securities, security tokens have the benefits of decentralized, digital tokens, which include being easily divisible into fractional units and being available for trading globally around the clock.
Examples: tZero (TZROP), CoinMint (CBM), CityBlock Capital (NYCQ)
Regulators will Choose their Own Path
Industry experts and developers may create different classifications or categories for cryptocurrencies, but regulators still have the power to classify these assets in whatever manner they deem fit. How individual governments and regulators will classify cryptocurrencies remains one of the biggest questions in the industry.
Some regulators regard utility tokens as closer to securities, and therefore subject to securities regulation. SEC Chairman Jay Clayton has famously said he has yet to see an ICO that is not a security. At the same time, the SEC has also affirmed that Bitcoin itself is not a security, a fact that many consider to be a major win for the industry.
While cryptocurrencies were created with the intention of remaining outside of government control, categorization by government regulators has significant implications for the freedom and autonomy of cryptocurrencies. The manner in which each project is categorized will determine which governing body is responsible for monitoring, how financial gains will be taxed, and how the cryptocurrency can be used to transact between consumers and businesses.
Bringing Order to a New Industry
The application of a standardized classification for cryptocurrencies is necessary to further the education of new users, investors, and governmental agencies. It seems likely that the present situation of confusion and disagreement will continue, but the resolution of this issue is an important milestone in the development and maturation of this young industry. The first step, however, must begin with the simple acknowledgement that there is far more to ‘cryptocurrency’ that simply ‘digital cash’.