Utility tokens are securities. Their primary function is capital formation, not user enablement. The SEC's actions against Ripple and Coinbase establish this legal reality.
venture-capital-trends-in-web3
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Why 'Utility' Tokens Are a Failed Fundraising Narrative
The SEC's legal framework has rendered the 'utility token' a high-risk fundraising vehicle. This analysis breaks down the legal precedents, market realities, and why VCs must treat these investments as unregistered securities.
introduction
THE FUNDAMENTAL FLAW
Introduction
The 'utility' token narrative is a failed fundraising mechanism that conflates protocol usage with investor returns.
Usage and value are decoupled. A token's utility for protocol access does not guarantee price appreciation. Filecoin storage demand and FIL token price demonstrate this persistent disconnect.
The fee switch is the model. Successful protocols like Uniswap and Ethereum generate value through fees, not speculative token mechanics. Token value accrual requires direct economic linkage.
Evidence: Over 90% of tokens from the 2017-18 ICO boom trade below their issuance price, proving the fundraising model's failure.
key-trends
WHY UTILITY TOKENS FAIL
Executive Summary: The Three Pillars of Failure
The 'utility token' narrative is a fundraising hack that structurally fails to deliver sustainable value or user alignment.
01
The Misaligned Incentive Problem
Tokens are sold as 'access keys' but priced as speculative assets. This creates a fundamental conflict between user adoption and investor returns.\n- Users want the lowest possible cost for the service.\n- Investors demand token price appreciation, which requires scarcity and high fees.\n- This tension is why projects like Helium and early Filecoin struggled with real usage versus speculative farming.
>90%
Of 'Utility'
0 Utility
Post-Launch
02
The Regulatory Sword of Damocles
Most utility tokens are unregistered securities in disguise, creating existential risk for projects and their teams. The SEC's actions against Ripple, Telegram (TON), and LBRY prove the narrative's fragility.\n- Legal Overhead consumes 20-40% of raised capital.\n- Centralized control (e.g., admin keys, treasury) directly contradicts decentralization claims.\n- This forces projects into a perpetual 'waiting mode' for regulatory clarity that never comes.
$2B+
Fines & Settlements
100%
At Risk
03
The Technical Debt Trap
Forcing every transaction through a native token adds unnecessary friction, complexity, and attack surface versus using stablecoins or ETH.\n- User Experience: Requires multiple swaps, approvals, and wallet pop-ups for simple actions.\n- Security: Every new token contract is another $50M+ smart contract risk (see Poly Network, Wormhole).\n- Liquidity Fragmentation: Dilutes capital efficiency across DEXs like Uniswap and SushiSwap, instead of concentrating it in the core protocol.
5-10x
More Steps
+300%
Attack Surface
thesis-statement
THE FUNDAMENTAL FLAW
The Core Thesis: Utility is a Feature, Not a Legal Defense
The 'utility token' narrative is a legal fiction that fails to decouple token value from fundraising expectations.
Utility does not create value. A token's technical function—like paying for gas fees on Ethereum or governing a DAO like Uniswap—is a feature, not an investment thesis. Value accrual requires a direct, enforceable claim on cash flow or assets, which most utility tokens lack.
The SEC's Howey Test focuses on expectation. Regulators analyze whether buyers expect profits from the efforts of others. Promotional roadmaps and VC-led token sales for projects like Filecoin or early DeFi protocols established this expectation, making 'utility' a secondary characteristic in enforcement actions.
Protocol revenue ≠tokenholder profit. Projects like Ethereum burn ETH, and Lido stakes ETH, creating a tenuous value link. However, a governance token granting fee distribution rights, as seen in early SushiSwap models, is the exception that proves the rule: value requires enforceable economic rights.
historical-context
THE FUNDAMENTAL MISMATCH
How We Got Here: The ICO Hangover
The 'utility token' narrative failed because it attempted to force a speculative asset into a product role, creating a structural conflict between user and investor incentives.
Utility tokens are a misnomer. They were a fundraising vehicle masquerading as a product feature. The fundamental mismatch between a token's speculative price and its designed utility creates perverse incentives where user adoption hurts token value.
Investors and users are adversaries. A token's utility often involves spending or burning it, which benefits users but reduces scarcity for holders. This incentive misalignment doomed projects like Bancor and 0x, where using the protocol was economically irrational for token holders.
The SEC's Howey Test won. Most ICO tokens were unregistered securities because their value was derived from the managerial efforts of a central team, not from decentralized network utility. The regulatory reckoning proved the narrative was a legal fiction.
Evidence: Over 90% of ICOs from 2017-2018 are dead. The surviving exceptions, like Ethereum and Chainlink, succeeded by creating genuine network demand for their token's core function (gas and oracle services), not artificial 'utility'.
THE HOWEY TEST IS THE ONLY TEST
Landmark Enforcement Actions: The Legal Precedent is Set
A comparative analysis of key SEC enforcement actions against token projects, demonstrating the collapse of the 'utility token' defense.
| Legal Precedent / Key Factor | SEC v. Ripple (XRP) - 2020 | SEC v. Telegram (TON/GRAM) - 2020 | SEC v. LBRY (LBC) - 2021 |
|---|---|---|---|
Core Allegation | Unregistered securities offering | Unregistered securities offering | Unregistered securities offering |
Defense Argument | Token is a currency/medium of exchange | Token is a consumptive asset for a future network | Token is a utility token for a decentralized platform |
Court Ruling on Token Itself | Institutional sales = security. Programmatic sales = not a security. | All sales constituted an investment contract (security). | Token itself is a security under Howey. |
'Investment of Money' Prong (Howey) | |||
'Common Enterprise' Prong (Howey) | |||
'Expectation of Profit' Prong (Howey) | |||
'Efforts of Others' Prong (Howey) | |||
Primary Remedial Action | $1.3B settlement; injunctions on future sales. | Return $1.2B to investors; $18.5M penalty; project terminated. | $22M penalty (reduced from $20M); cease-and-desist on unregistered offers/sales. |
Impact on 'Utility' Narrative | Fragmented the defense; created a narrow, risky path for exchanges. | Destroyed the 'future utility' defense for pre-functional token sales. | Established that even a functional platform with active use does not negate security status at issuance. |
deep-dive
THE FAILED NARRATIVE
The Investor's Dilemma: Trapped Capital and Regulatory Overhang
The 'utility token' model has collapsed under the weight of its own economic contradictions and legal uncertainty.
Utility tokens create trapped capital. Investors purchase tokens for financial upside, not protocol usage, creating a permanent misalignment between token demand and network utility. This is the fundamental flaw of the work token model.
Regulatory overhang destroys optionality. The SEC's actions against Ripple and LBRY prove most tokens are unregistered securities. This legal risk paralyzes institutional capital and prevents legitimate secondary market development.
Token velocity is the killer metric. Projects like Helium and Filecoin demonstrate that even with real usage, token value accrual fails when users immediately sell earned tokens, a direct result of the utility-for-payment design.
Evidence: The collapse of the ICO market from $11.4B in 2018 to near-zero today is the ultimate data point. The model does not survive contact with real-world economics or regulation.
case-study
WHY 'UTILITY' TOKENS ARE A FAILED FUNDRAISING NARRATIVE
Case Studies in Narrative Failure
The 'utility token' model promised a new paradigm for bootstrapping networks, but its core economic and regulatory flaws have led to systemic failure.
01
The Regulatory Mismatch: Howey Test vs. 'Digital Coupon'
The SEC's application of the Howey Test rendered most utility tokens as unregistered securities. The promised 'utility' was often a post-hoc justification for a fundraising instrument, creating legal overhang that crippled development and liquidity.
- Legal Precedent: SEC vs. Ripple and Kik Interactive cases established that token sales to fund development are investment contracts.
- Market Impact: Projects like Telegram's TON and EOS faced massive fines or shutdowns, chilling the entire ICO market.
- Result: A $10B+ ICO market from 2017-2018 evaporated, with >90% of projects failing or becoming zombies.
>90%
Failure Rate
$10B+
ICO Market Evaporated
02
The Economic Failure: Misaligned Incentives & Token Velocity
Utility tokens suffer from the 'work token' dilemma: users must acquire and hold the token to access a service, but immediately sell it after use, creating perpetual sell pressure.
- Velocity Problem: High turnover (~500%+ annualized velocity for many DApp tokens) destroys price stability, disincentivizing long-term holding.
- Fee Extraction Failure: Projects like 0x (ZRX) and Bancor (BNT) initially struggled to capture value as their tokens were mere fee payment options, not equity.
- Result: Token price becomes decoupled from network usage, rendering the 'utility' value proposition meaningless for investors.
~500%+
Token Velocity
0x
Case Study
03
The Product-Market Fit Illusion: Forcing a Token Where None Was Needed
Tokens were often bolted onto services that functioned perfectly with stablecoins or ETH, creating unnecessary friction and a worse user experience.
- Friction Over Utility: Requiring a user to swap into a volatile, illiquid token to use a file storage service (e.g., Filecoin for storage) or a compute platform added complexity.
- Competitive Disadvantage: Protocols like Uniswap (which launched without a token) and Aave (which added a governance token later) proved that network effects can be built without a native payment token.
- Result: The narrative shifted to governance tokens (e.g., UNI, COMP) which explicitly represent equity-like claims, exposing the 'utility' model as a fundraising facade.
UNI, COMP
Governance Shift
Filecoin
Friction Case
counter-argument
THE FUNDAMENTAL MISMATCH
Steelman: What About True Utility Tokens?
The 'utility token' narrative fails because it conflates fundraising with product-market fit, creating assets with negative carry.
Utility tokens are mispriced securities. They are sold as a product access key but priced as a venture capital bet. The speculative premium divorces token price from actual usage metrics, creating a fundamental valuation mismatch.
Protocols need fees, not token velocity. Successful infrastructure like Uniswap and Lido generate real yield from fees, not token churn. A 'pure utility' token that must be spent and sold creates permanent sell pressure that crushes its value.
The fee switch is the only model. Protocols that redirect a portion of protocol fees (e.g., a fee switch) to token holders create a sustainable equity-like asset. Without this, tokens are a fundraising tool, not a value-accrual mechanism.
Evidence: Look at MakerDAO's MKR. Its value stems from governance over a revenue-generating protocol, not from being 'burned' for a service. Contrast this with early 'gas token' projects whose utility was arbitraged away by users.
investment-thesis
THE PIVOT
The New VC Playbook: Equity First, Tokens Later
Venture capital is abandoning the 'utility token' fundraising model for traditional equity, forcing protocols to build real products first.
The utility token narrative is broken. Tokens sold as 'network access' or 'governance rights' are unregistered securities in the eyes of the SEC. This legal reality has collapsed the initial coin offering (ICO) and SAFT fundraising model, forcing a return to conventional equity.
Venture capital demands product-market fit first. Investors like a16z and Paradigm now require functional protocols with proven adoption before considering a token. This reverses the 2017 model where the token sale funded the build, creating misaligned incentives and vaporware.
Tokens become a post-launch optimization. Successful protocols like Uniswap and Aave launched functional products first. Their tokens were distributed as a retroactive airdrop or governance tool after achieving liquidity and users, creating sustainable value instead of speculative fundraising.
Evidence: The collapse of the ICO market is absolute. In 2024, over 90% of early-stage crypto venture deals are for equity, not token warrants. Protocols that lead with a token, like many early L1s, now trade below their initial sale price despite having a live network.
takeaways
UTILITY TOKEN PITFALLS
TL;DR: Key Takeaways for Builders and Investors
The 'utility token' narrative is a regulatory and economic trap. Here's what to build and invest in instead.
01
The Problem: Fee Tokens Are Not Equity
Protocols like Uniswap (UNI) and SushiSwap (SUSHI) grant governance over fee switches, not direct cash flow rights. This creates misaligned incentives where tokenholders vote for value extraction (fees) that accrues to the treasury, not to them.\n- Governance ≠Value Capture: Voting power is decoupled from financial upside.\n- Treasury Dilemma: Fees enrich a DAO treasury, creating political and execution risk for distribution.
0%
Direct Yield
High
Governance Risk
02
The Solution: Legitimate Staking & Fee-Sharing
Projects like Lido (stETH) and Frax Finance (FXS) demonstrate sustainable models. Value accrual must be linked to a non-speculative, essential service (e.g., validation, stablecoin backing).\n- Service-Backed Yield: Tokens earn fees from a real, used service (e.g., staking derivatives).\n- Burn Mechanisms: Protocols like Ethereum (post-EIP-1559) and Frax use burns to create deflationary pressure tied to usage.
$30B+
stETH TVL
3-5%
Real Yield
03
The Regulatory Reality: The Howey Test Wins
The SEC's actions against Ripple (XRP) and Coinbase establish that marketing a token as a capital-raising tool for ecosystem development is a security. 'Utility' is not a legal shield.\n- Investment Contract: Expectation of profit from others' efforts is the key criterion.\n- Builders Must Pivot: Focus on fully functional protocols first, token distribution last (if at all).
$2B+
SEC Fines (2023)
High
Enforcement Risk
04
The New Model: Points & Loyalty Systems
Leading protocols like Blur, EigenLayer, and friend.tech are bypassing the token question entirely with points programs. This defers regulatory risk, builds community, and creates optionality for future value distribution.\n- Low-Friction Growth: Points drive usage without immediate legal baggage.\n- Data Gathering: Programs create a rich dataset for designing a fair future token launch.
~80%
Market Share (Blur)
$10B+
EigenLayer TVL
05
Investor Takeaway: Demand Real Economics
Scrutinize tokenomics for direct, non-inflationary value flows. Avoid governance tokens without clear fee-sharing or burn mechanics. Favor projects where the token is a required input for a service, not a speculative coupon.\n- Red Flag: Vague 'ecosystem utility' with no sink or flow.\n- Green Flag: Protocol revenue is verifiably distributed to stakers or burned.
>100%
APY = Red Flag
Transparent
On-Chain Revenue
06
Builder Mandate: Protocol First, Token Maybe
Follow the Curve (CRV) model: launch a product people use, then introduce a token to incentivize and align long-term stakeholders (liquidity providers). The token is a coordination tool, not a fundraising vehicle.\n- Product-Market Fit First: Achieve $100M+ TVL or equivalent usage before considering a token.\n- Alignment Engine: Design tokens to secure the protocol (veCRV) and reward essential actors.
$2B+
Curve TVL (Peak)
veTokenomics
Standard Model
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