Security Tokens vs. Utility Tokens – A Beginner’s Guide

Beginner’s Guide / 03.05.2020

One Platform, Many Functions

Blockchain, the pinnacle of decentralized, distributed, and transparent technology, is at its base a Platform. What is a Platform, you ask? A technological sense platform is a nurturing ground for growing and building applications that serve various purposes.

Being a platform, blockchain can be used for a variety of purposes. With a general-purpose technology as blockchain, there is no limit to what innovations can be made.

One such variety seen in the blockchain projects that come up today is the distinction in their native tokens. A token is a cryptographically linked piece of value issued by the project members. The use of a token can be anything from a medium of exchange to a piece of share in the project.

A token is a utility, an asset, or a unit of value issued by a company. In most cases, tokens are issued when a company launches an ICO/IEO/STO or any other token sale — that works more or less like an initial public offering (IPO). Over the years, the market has evolved several types of tokenized digital assets, each with their own properties.

The major classifications that we see today are Security tokens and Utility tokens.

Security Tokens

Security tokens derive their value from an external, tradable asset, such as stocks or real estate. If you buy a tokenized stock version, you will acquire the same rights you would get when you buy stock via a traditional stockbroker – profit share and voting rights. The only difference is that a token comes in digital form.

The major distinction to utility tokens is that security tokens are designed to be investments. Thus, they fall under the same regulatory oversight as other investment products. They are considered by many to be the key to cryptocurrencies achieving mainstream adoption due to their focus on tokenizing digital and non-digital assets, making them useful for almost any industry or application.

A security token is essentially an investment contract that represents legal ownership (as recognized by the SEC) of a physical or digital asset (like real estate, artwork, or ETFs) that has been verified on the blockchain. Security Token Offerings, more commonly known as STOs, have been gaining major interest over the past year. They mirror many qualities of the traditional stock market with the added advantage of being issued on a blockchain.

Important Characteristics

A Security Token, i.e., a token with attached rights and responsibilities, can have all of the following characteristics,

  • Access to multiple asset classes
  • Access to liquidity for traditionally illiquid assets
  • Access to a global network of investors
  • Dividend payouts

Major Security Tokens

Utility Tokens

A utility token has a wider functionality than a regular token like Dogecoin. Utility tokens do have value, but they cannot be considered money as straightforward as a coin. Utility tokens can provide value to investors in different ways. They give users access to a future product or service. Utility tokens are currently the most popular form of tokens.

Utility tokens were easily the most popular form of token issuance mechanism adopted during the 2017 ICO boom and later. The major reason was that utility tokens allowed projects to crowdfund their ideas without diluting the projects’ ownership. According to SEC Director of Corporation Finance William Hinman, a true “utility token” in the sense that many crypto investors seem to have in mind is probably best represented by Bitcoin itself: as he said at the Yahoo Finance All Markets Summit.

Important Characteristics

  • An incentive-based tool to drive human behavior in any network
  • Usually do not carry ownership or membership rights.
  • Used as part of the wide ecosystem
  • Can be used as an alternative for mediums of exchange
  • Can help in the evolution of internal network-based markets

Major Utility Tokens

Conclusion

As of now, there isn’t a clear-cut set of guidelines for what means what. In this nascent and evolving market, regulations and guidelines are of the utmost importance, for the novel reason that we do not know how to treat these different assets. Many experts like to point to the Howey Test (a set of sufficient conditions required for a given asset to be considered security), which sets guidelines for classifying an asset as a security. Still, the criticisms remain that it is an old guideline, made specifically for traditional assets such as stocks and real estate and so on.

For now, we can only use the traditional rules to make new classifications, as we have done above. But as new market strategies are developed, we will see better sets of rules to make better decisions.

As a side note, keep in mind that Blockchain technology general-purpose does not limit it to any form of innovation. We can see more varieties of tokenized assets in the future, some in a hybrid form, some issuing different types of tokens under one roof, and even come packaged in a way never before seen.

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Sudarshan M is a long time crypto-enthusiast. Pulled in by bitcoin early on, it did not take long for Sudarshan to divert all of his academic attention from business studies to blockchain by doing his Masters and eventually pursuing his PhD in the subject.