Entrepreneurs who use Utility Tokens to reduce CAC (Customer Acquisition Cost) will create the most valuable Security Tokens

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TLDR. The big coming wave is Security Tokens, but the backlash against Utility Tokens is overdone. On Monday, Daily Fintech analysed the recent moves by the SEC to provide regulatory certainty to Utility Tokens. This is a big deal. Until now, entrepreneurs faced a regulatory environment where everything was a security, because in that world there was nothing else. Now entrepreneurs can use a Security Token to raise capital and a Utility Token to reduce their Customer Acquisition Cost (CAC).This is a a big deal for entrepreneurs. It is only exciting for investors who have equity in the ventures created by those entrepreneurs. That is how it should be. A Utility Token is a great business building tool; it is not primarily an asset. If you buy a Utility Token, it may appreciate in value, but you buy it in order to use it and any price appreciation is a side benefit.

This post is an update to the chapter on Investing in Utility Tokens in The Blockchain Economy digital book.

This post describes:

  • The SEC rules governing Utility Tokens.
  • Laws change over time and vary by jurisdiction.
  • Four reasons why other jurisdictions will probably follow the SEC rules.
  • Utility Tokens can be used to improve CAC/LTV, which is a critical metric driving valuation. 
  • Invest in Security Tokens of ventures that offer great Utility Tokens.
  • Two ways that a Utility Token is different from a traditional crowdsale.
  • The future cryptocurrency landscape will have 4 different types of assets.

The SEC rules governing Utility Tokens

The SEC rules were analysed in Ilias Louis Hatzis’s Daily Fintech post on Monday.  For convenience the key rules (defined in a No Action letter for the Utility Token of a company called TJK) are copied below:

  • “Token holders won’t be granted an ownership stake in the company.
  • Any funds raised from the token sale will not be used develop the platform or app.
  • When the tokens are sold,  they must be usable immediately for their intended functionality.
  • Transfers of the TKJ tokens are restricted only to TKJ wallets. External wallets are not allowed.
  • TKJ tokens will be priced at 1 USD per token. Each token will essentially function as a pre-paid coupon for TurnKey’s air charter services. If TurnKey wants to buy back the token (coupon), it must do so at a discount (less than 1 USD).
  • The token must be marketed in a way that emphasizes its functionality, and not its potential to increase in value, over time.”

Laws change over time and vary by jurisdiction

The Legacy Finance world has Debt and Equity. The Blockchain Economy has Utility and Security Tokens. You can tokenise Debt (just like you can tokenise Equity or any other asset) but that does not change the fundamental characteristic of that asset.

Debt is illegal in Islamic Finance (for more please read this). There are workarounds that dress up debt to look like equity, just like there are workarounds that ICOs used to dress up a security to make it look like a utility token. This perspective is useful when you look at the legality of Security vs Utility tokens ie laws change over time and vary by jurisdiction.

Four reasons why other jurisdictions will probably follow the SEC rules

Yes, the SEC only has jurisdiction over one market – America, but here are the four reasons why other jurisdictions will probably follow the SEC rules:

  1. America is still the biggest single market.
  2. SEC is known as a tough regulator that is not afraid to take cross border action.
  3. SEC has defined some clear rules. So entrepreneurs can plan around these rules.
  4. There is no single regulatory market in Asia, which is the growth engine of the 21st century.

There will be minor markets that differentiate by being easier on Utility Tokens, but unless they also offer a large investor pool, that will be “noise on the line”. Europe’s legislation/regulation will be interesting to watch. Unless Europe takes a differentiated position soon, the market will follow the SEC rules.

Utility Tokens can be used to improve CAC/LTV, which is a critical metric driving valuation 

CAC/LTV = Customer Acquisition Cost/Life Time Value.

You can use this to evaluate the value of both Banks and Fintechs, as we described in this post from 2015. In fact just about any company can be evaluated using CAC/LTV.

Both CAC and LTV are complex in their own right, but it is the interaction between the two that is so often confusing or difficult.

Customer Acquisition Cost (CAC) is the metric to evaluate Marketing efficiency.

Churn is the kryptonite of Superman Marketing. The problem with Churn it is not directly under the control of Marketing. This is where Product is key. Another way of saying Churn is “if customers think the product sucks, all that expensive Marketing is wasted”. Churn means customers cancel the service and then Marketing have to win new customers, which is far more expensive than retaining them.

Life Time Value is not static. LTV is all about getting the balance right between cross selling, upselling and low churn – too much selling to customers may increase churn. If LTV goes down, you have to reduce CAC. Product strategy, pricing, marketing, customer service all have to be in alignment.

The story of Banking in the 20th century can be summed up as Low Churn. We are statistically more likely to get divorced than change banks. There was no point in changing Banks, because the difference between banks was marginal. The Fintech disruption changes that. Now customers have more real choice and regulation is seeking to protect consumers from lock-in strategies that make it hard for them to switch.

Crowdsales are a great way for companies to sell a service aka reduce CAC. It is Internet Marketing 101. Crowdsales have been around for a while, but Utility Tokens enable Crowdsales on steroids.

Two ways that a Utility Token is different from a traditional crowdsale.

  • The buyer has the comfort that if they no longer want to use the service they can sell their Utility Tokens. If everybody wants to sell their Utility Tokens because their service is no good, token holders will lose. If the service is great but the token holder’s  life situation changes they can sell their Utility Tokens.


  • The buyer feels more committed to the success of the venture. Some of that commitment is psychological and some of it is quite practical. A Utility Token is like a Loyalty Coin (more than it is like a Security) but it is a Loyalty Coin with some fungibility (you can sell it for cash if the venture/service is a success and demand exceeds supply).

Invest in Security Tokens of ventures that offer great Utility Tokens.

If a venture offers a Utility Token that is successful in the market, that venture is likely to have good CAC/LTV metrics which eventually translates into equity value held in Security Tokens. I say “eventually” because market mismatching can last a long time ie price does not always equal value or vice versa.

The future cryptocurrency landscape will have 4 different types of assets

An Altcoin Pump & Dump is about cornering a very small market. Cornering a big market – like say Gold or Bitcoin – requires a lot of capital. You can corner an Altcoin quite cheaply and then pump & dump your way to fortune. If you are trading Altcoins and not pumping & dumping, then you are the sucker at the table. This is Penny Stocks 2.0 – watch Wolf of Wall Street for an entertaining guide to this sort of market.

So there is good reason why the SEC clamped down hard. Most Altcoins should be regulated into the dust. 

The fact that Bitcoin & Ethereum got a get out of jail free card from the SEC, puts them in much stronger position versus their challengers. The future cryptocurrency landscape will have 4 different types of assets:

  • Decentralised, permissionless cryptocurrencies with market traction and a free pass from regulators – Bitcoin & Ethereum today. 
  • Challengers to above (maybe there is a pony in there).
  • A large number of early stage ventures listing as Security Tokens where the standard rules of early stage ventures apply (market, product, team, funding, timing, valuation etc).
  • Utility Tokens issued by those early stage ventures that have little value other than to users of that service. There are likely to a very large number of these. 

Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is CEO of Daily Fintech and author of The Blockchain Economy.

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

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One comment

  1. Much Ado About Nothing: the SEC’s No-Action Letter
    On April 3, the SEC issued its first no-action letter saying that the tokens proposed to be issued by the applicant, TurnKey Jet (or TKJ, a Florida-based charter airline operator), are not deemed securities. The actual letter is here. The media widely reported this using, in their headlines, the words “crypto”, “ICO”, and one reference to Turnkey Jet as a “cryptocurrency business” (which it is not).

    None of these phrases are referenced in the SEC’s no-action letter itself. In fact, the Forbes article is blatantly misleading, beginning with calling Turnkey Jet a “cryptocurrency business”. The very first paragraph of the Forbes article sounds very encouraging to the ICO community:

    The U.S. Securities and Exchange Commission has issued its first ever letter assuring investors in a startup using crypto-tokens similar to bitcoin to raise capital that it will not take an enforcement action against the company, and in a separate document explained the rationale behind the decision for future companies.

    If anything, the no-action letter implies exactly the opposite!

    Firstly, TKJ is not a “cryptocurrency business”.

    Secondly, TKJ is not proposing to raise capital through the issue of tokens, which are purely utility tokens and have no investment value. The company’s tokens are neither cryptocurrency nor securities.

    Thirdly, the SEC letter does not provide investors an absolute guarantee that no action will be taken against them or the company, since this is not legally binding precedent and the SEC staff reserves the right to change positions reflected in prior no-action letters. Even the current no-action letter is valid only as long as the representations made by the applicant (TKJ ) are correct and fully followed subsequently.

    Unfortunately, the misleading headlines give false relief to those who do not read beyond the headlines. It is important to read the actual submission by TKJ and the SEC response in the form of a no-action letter. In the murky world of ICOs that for the most part turned out to be fraudulent, and of the rest, only a tiny fraction had even a semblance of a credible business plan, TKJ stands out as an example of a legitimate business that took great pains to ensure that its utility tokens have absolutely no resemblance to ICOs or bitcoin. Here are the key factors that led the SEC to issue its no-action letter:

    No investment or capital raise. The proceeds of TKJ’s token sale are not to be used for developing the product or solution; instead, the funds are kept in escrow to be used for payments to service providers upon redemption of the tokens by its customers (travelers on their charter jets), or for repurchase or liquidation (but only at a discount). The only “capital raise” aspect of this is that the interest amount from the interest-bearing accounts is kept by the company and the interest amount is not distributed to the token holders. However, to prevent this becoming a potential loophole by mimicking an ICO-type of sale, the tokens are to be used only for purchasing air charter services and not for development.
    No trading. The tokens can be traded, but only among members of TKJ, and not in a wide secondary market; the motivation to trade is not speculation or investment. TKJ makes unlimited tokens available at a face value of USD 1 per token and repurchases them only at a discount, so speculative trading is meaningless.
    No gain in value. The tokens obviously cannot gain in value from their face value of USD 1 per token, since the company issues them at that price in unlimited quantities as necessary.
    In summary, the SEC granted this no-action letter to TKJ as long as the following conditions are met: no capital raise for funding development, the existence of viable products and services before the tokens are sold, no trading on secondary markets for speculation or investment, no storage in third-party wallets, no repurchase at premium, no expectations are set for increase in the value of the tokens, and that the tokens are not marketed as investments.

    This is as different from an ICO as a camel is from a camel-dropping.

    What is astonishing about this whole issue is that there is already a well-established model that doesn’t even come under the aegis of the SEC: rewards points in various flavors, from Uber Rewards, AMEX Membership Rewards, Starwoods’ Starpoints, Delta SkyMiles, etc.

    All of these membership and loyalty reward programs have been chugging along merrily for decades without any controversy. Utility tokens are no different, except that they are implemented on a blockchain or DLT—and therein lies the rub. The fraudulent ICOs have so tarnished the use of blockchain that any company with a legitimate business such as TKJ feels they have to go through the time and expense to seek a no-action letter for what is no more than a sophisticated implementation of a membership program.

    The real value of enterprise blockchain or DLT, in general, is in its ability to bind a fragmented ecosystem of participants into a trusted network and provide operational efficiencies for their business processes, not to flout regulation at the expense of investor protection.

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