Parsing digital asset classes
Understanding nuances imperative for investors. By Darana Chudasri
The allure of digital asset investment has returned to the attention of investors with legislation that would regulate digital asset trading and transactions in Thailand.
But there seems to be confusion over the definition and essence of each digital asset class, as many have grouped cryptocurrencies and digital tokens into the same category.
"Most people think bitcoin, digital tokens, and initial coin offerings [ICOs] are the same. I must say no, they are different," said Archari Suppiroj, director of the fintech department at the Securities and Exchange Commission (SEC).
Cryptocurrencies are electronic data units created in an electronic system or network for the purpose of being used as a medium of exchange.
Digital tokens are created for a different purpose, specifying the right of a person classified into two main categories. The first is the right to participate in an investment in any project or business, which is called an investment token.
The second is the right to acquire specific goods, services, or any other rights under an agreement between the issuer and the holder. This is called a utility token.
ICOs see a company, usually a tech startup, issue digital tokens, typically in exchange for a cryptocurrency such as bitcoin or ethereum.
Tokens can be used to buy future services from the issuer or can be sold, ostensibly to reap a handsome return.
Difference in essence
Ms Archari compares bitcoin and ethereum as an example. Bitcoin is a cryptocurrency that was created as a means of payment among a group of persons who do not trust financial mechanisms imposed by central banks and governments.
Bitcoin was also created with a feature for cryptocurrency miners to verify financial transactions using blockchain technology.
No one can add anything to bitcoin's blockchain ledger as it is created to be a virtual currency from inception. But the ethereum platform, created using blockchain, allows people to develop a service application such as a blockchain smart contract, where ethereum holders can use it to pay for service on the platform.
Ethereum is essentially a utility token as opposed to a cryptocurrency, she said. However, as the ethereum platform is widely used among a group of tech-savvy individuals, it has been characterised as a cryptocurrency.
"Utility tokens may become cryptocurrencies if they are widely accepted. Although some token creators may not intend for their creations to be widely accepted, they could transform into a medium of exchange where someone could use them to buy a cup of noodles at a nearby shop," said Ms Archari.
The success of utility tokens depends on popularity and wide usage within an ecosystem, or motivation among platform users, she said.
Ethereum is a pioneer among utility tokens, raising funds by issuing ethereum tokens to create a platform. Many people bought this utility token in the hopes of reaping a huge investment profit, said Ms Archari.
The differences between cryptocurrencies and digital tokens are not limited to their origins and purposes. In Thailand, where the digital asset royal decree was published on May 14 to regulate trades and transactions of digital assets, there are several finer points for investors to consider.
First and foremost, licenses to trade cryptocurrencies and digital tokens are separate.
Under the royal decree, there are four types of secondary business intermediaries, classified into digital exchanges, brokerage firms, dealers and token portal service providers, which are also known as ICO portals.
The exchanges, brokers and dealers are required to apply for licences from the Finance Ministry, while ICO portals must be approved by regulators.
ICO portals help screen ICOs, conduct due diligence, prove smart contract source codes and verify the know-your-customer (KYC) process.
Ms Archari said the main reason for issuing separate licences is because cryptocurrencies and digital tokens have different concerns to address.
For cryptocurrencies, which are mediums of exchange, money laundering is a major concern as financial regulators may never have access to verify the identity of an e-wallet holder because the KYC process may not be applicable for some e-wallets.
For digital tokens, the main issue is information asymmetry, as investors may have little information when comparing token and ICO issuers when deciding where to invest. Fraud and scams are the priority concerns for financial regulators, she said.
Although utility tokens are not regulated in many countries, such tokens are controlled in Thailand as fundraising projects often have the whiff of "selling dreams" to investors -- claiming a guarantee of success and that the value of these tokens would climb exponentially, said Ms Archari.
Under the royal decree, digital exchanges have the same obligation as financial institutions -- they are obliged to report certain transactions.
While all digital tokens are tradeable, only stipulated cryptocurrencies will be accepted for ICO transactions.
In July, the SEC announced a list of seven cryptocurrencies accepted as mediums of exchange when conducting ICO transactions. These are bitcoin (BTC), bitcoin cash (BCH), ethereum (ETH), ethereum classic (ETC), litecoin (LTC), ripple (XRP) and stellar (XLM).
"People can trade any digital token at any [regulated digital] exchange, dealer or broker they are familiar with. However, if they want to invest in ICOs, they can only use cryptocurrencies specified in the SEC's list, cash, or convert their digital tokens into cryptocurrencies," said Ms Archari.
The main criteria for cryptocurrencies the SEC has announced comprises of sufficient market liquidity, a well-designed decentralised system, and being able to use a trading pair with other cryptocurrencies.
The last requirement is similar to the US dollar, where many people exchange their local currencies to the greenback while travelling abroad as the dollar is the most accepted currency in terms of investment, trade or speculation.
No ICO portals have been approved by the SEC, but there have been ads promoting unregulated ICO investments. In response, the SEC has issued several warnings for investors.
By year-end, at least one ICO portal is expected to be approved.