Crypto Assets - Types
Native Crypto Assets
Native crypto assets (sometimes referred to as “coins”) belong to a specific blockchain. These crypto assets might be perceived as a store of value secured through cryptography and depend on encryption used to store, verify, secure and pass information. Consequently, native crypto assets are sometimes referred to as “cryptocurrency.”
While these crypto assets bear some similarities to traditional currencies (e.g., they can be a means of exchange and can be perceived as having a store of value), crypto assets aren’t issued by central banks and aren’t, except in a handful of smaller countries, designated by governments as legal tender. In addition, the price of native crypto assets, unlike reference currencies like the U.S. dollar, has been very volatile and may be driven primarily by speculation.
Examples of native crypto assets include bitcoin and ether.
Tokens
Tokens are developed on blockchains and depend on the blockchain for their operations. Tokens vary in terms of their purpose. For example, a token can perform a specific utility or purpose through a decentralized application (dApp) and/or the holder might receive governance rights or an ownership interest. Unlike with native crypto assets, multiple blockchains can support tokens.
The ERC-20 token standard is commonly used by developers to create tokens on the ethereum blockchain and uses “smart contracts” to provide holders with additional services and features that extend the functionality of crypto assets. Smart contracts are neither smart nor contracts; they’re simply computer code that automates certain internal operations on a distributed ledger or blockchain.
Here are three categories of tokens:
Non-Fungible Tokens (NFTs)
NFTs are a type of crypto asset that has unique identification codes and metadata such that it can’t be exchanged for an equivalent asset. NFTs can be associated in a variety of ways with digital or real world assets, such as artwork, videos or music, or gaming items. Each NFT is “minted” by an issuer or creator and then bought and sold in primary and secondary marketplaces, generally using crypto assets. NFTs have been offered as securities via fractional ownership, rights to royalties, and through exchange-traded products (ETPs). The benefits and rights (if any) offered to purchasers of NFTs will vary. For example, the purchase of an NFT doesn’t necessarily transfer ownership of any related rights in the associated NFT content.
NFTs have several features, including:
- Uniqueness – Each NFT is unique, making it “non-fungible.” This means NFTs aren’t interchangeable like currency and have different values and characteristics. This is the opposite of fungible tokens, which each have the same value, similar to how one U.S. dollar has the same value as any other U.S. dollar.
- Documentation of Control and Provenance – NFT technology can be used to create digital certificates documenting ownership, control, provenance or origin of an asset—but NFTs can’t guarantee the accuracy of any digital certificate or any representations they make.
- Linked Smart Contracts – NFTs might also be accompanied by a smart contract that places conditions on a token-holder’s rights. For instance, the payment of royalties to the original NFT creator might be part of a smart contract.
Stablecoins
Stablecoins are crypto assets that attempt to maintain a stable value relative to some reference asset or assets, such as the U.S. dollar or other currencies, commodities like gold, or even other crypto assets. Stablecoins are designed to serve as a source of stable stored value within a blockchain ecosystem, potentially reducing the need to convert crypto assets into fiat currency (which can involve administrative burdens and fees). Generally speaking, there are two types of stablecoins: those that purport to be backed by reserve assets and those that use an algorithm in their efforts to maintain price stability.
Despite their name, stablecoins can pose risks for investors, including the potential for depegging (moving away) from the “stable” reference price (e.g., $1), cybersecurity risks, and risks specific to the type of stablecoin held. These risks have resulted in the collapse of some stablecoins.
Tokenized Securities
Some traditional securities, including some stocks and bonds, are being issued or transferred on blockchains through a process called tokenization. These tokenized stocks, bonds and other securities have been digitized to permit the instrument to be issued or transferred using distributed ledger or blockchain technology.
Tokenized securities can involve:
- assets issued and transferred on a blockchain where the issuer or its transfer agent maintains the securityholder registry on-chain; or
- assets issued in a traditional form that are held by an intermediary as the registered owner who tokenizes the assets so they can be transferred using a blockchain and who recognizes the holders of the tokens as the beneficial owner of the securities.
Crypto Asset Offerings
Some crypto asset developers offer coin or token offerings. In the U.S., if a coin or token is a security or is offered or sold as an investment contract (a type of security), federal law requires that the security be registered with the SEC or qualify for an exemption from registration. However, many coin and token offerings aren’t sold in compliance with these requirements, and even the most comprehensive discussions made available to crypto investors tend to lack the features of prospectuses or other offering documents and disclosures required by federal securities laws. For example, audited financial statements, disclosures about the issuer and its officers, and risk factors to consider before investing might not be provided in connection with coin offerings.
If you choose to consider participating in an offering of crypto assets, review all corresponding information, including the website and any prospectus, white paper, or other memorandum or material associated with the offering. Crypto asset offerings might be very technical and difficult to verify. Be alert to the possibility of misleading or fraudulent information, and be wary of offers that sound too good to be true. Be aware that, even if you have reviewed these materials, the offering might be being made in manner that isn’t consistent with the robust regulatory protections and market oversight that investors have under the federal securities laws. Use FINRA BrokerCheck to research any broker-dealers and investment professionals involved in initial crypto asset offerings.
Further, the opportunity to redeem or exchange a coin offering investment for money isn’t guaranteed, and redemption may be contingent on triggering events, such as the development of a new enterprise and the related future public sale of the crypto asset.
Here are some examples of terms that have been used to describe crypto asset offerings:
- Initial Coin Offering (ICO) – In an ICO, crypto assets are offered for sale directly to investors and distributed via a blockchain network. The structure of each ICO is unique, and the benefits offered to purchasers of the crypto asset, if any, will vary.
- Initial Exchange Offering (IEO) – An IEO is similar to an ICO, except that crypto assets are issued through a crypto asset service provider rather than directly to investors.
- Security Token Offering (STO) – An STO is similar to an ICO, except that the offering involves the sale of a token that the promoters disclose is a security. STO tokens might be issued on public or private blockchains, and the benefits offered to purchasers of the crypto asset, if any, will vary. As securities, STOs must be made in compliance with securities laws.
