Utility Token vs Security Token: Key Differences You Must Know

Anisa Batabyal
| 10 September, 2019 | 2 min

Tokens are one of the most useful innovations in the crypto space, transforming the ways how organizations run and equity is conceptualized. While there are many tokens in this crypto space, most blockchain organizations emphasize on the usage of “Security” and “Utility” tokens- major tokens in the decentralized crowdsourcing space. This discussion has again gone into the mainstream of crypto space after the statement from US SEC official that Bitcoin and Ethereum are not securities. 

Let us understand the differences between Security and Utility token briefly:

Security Tokens

Security tokens are digital assets that are issued to the investors, wherein they pay dividends, share profits, which should be compliant with the SEC regulations. These are subjected to federal laws that govern securities. If it's not going as per the regulations, that can lead to severe consequences like penalties.

The US SEC defined Security tokens as the process of investing in an enterprise with the expectation of some amount of profit, derived from the managerial effort of others. The usual “Howey test” proves whether it's a security token or not.

The “Howey Test”, created by the Supreme Court for determines whether certain transactions qualify as “investment contracts.” If so, then under the Securities Act of 1933 and the Securities Exchange Act of 1934, those transactions are considered securities and therefore subject to certain disclosure and registration requirements.

According to ‘Securities Regulation: Essentials’ - a book by Stephen Jung Choi, Adam C. Pritchard, security is found to exist when all four of these elements exist:

  • Investment of money
  • In a common enterprise
  • With an expectation of profits
  • From the efforts of others.

In the ICO world Security Tokens often mean selling shares of the company in the form of tokens.

Examples of some of the SEC-regulated Security Tokens are- tZero, Polymath, etc. whereas SEC has cracked down on some of the ICOs like Tezos and Centra (CTR Token).

Utility Tokens

Utility tokens, also known as app coins or app tokens, provide the users the access to the organization’s products or services. As it is not an investment asset, it has been exempted from having to comply with federal legislation regulating securities.

Utility tokens have two more subcategories —

  • Fungible Utility tokens (that are interchangeable for one another at equal value)
  • Non-Fungible (tokens which are used to determine ownership of digital assets).

Some of the examples of utility tokens are Ether, Sia, Filecoin, etc.

Comparisons

One of the main reasons companies would want their tokens branded as utility tokens is the trading restrictions present on securities. On the other hand, Security tokens are less risky because of their increased costs.

Bloomberg’s Matt Levine compares utility tokens to the Starbucks card:

“A Starbucks gift card is probably not a security, even though you pay money to a corporation for the card and expect to get back something in the future, because you are not investing the money in the expectation of profit: You’re investing it in the expectation of coffee”.

Going through the Howey tests and anti-money laundering inspections allows organizations to accredit whitelist investors, eliminating most of the risk.

From the other perspective, it boils down to barring individuals below a certain economic threshold from participating in high-risk securities investment.

To sum up, Security Tokens give the investor ownership rights (company’s share, for example), while utility ones give certain accessibility inside the company’s platform. No surprise that cryptocurrency that has billions of capitalization becomes the subject of government’s interest. The involvement of regulation proves that crypto is an equal partner in today’s world and is going to reach greater heights. Despite specific attempts to control the crypto sphere, it gives people financial freedom never been witnessed before.

Frequently Asked Questions (FAQ)

      1.  What is the difference between a Security token and Utility token?

We have described both above, you can check the differences above.

  1.     What is a Utility token?

Utility tokens are like app tokens, which most likely gives you access to the services.

  1. What is a security token?

A security token is subjected to the rules and regulations as per the US SEC, where you can expect profit.

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