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Utility Tokens vs. Security Tokens: What You Need to Know

May 23, 2019

Cryptocurrencies go by many names. While some crypto assets have a negative stigma associated with them, thanks to the widespread crash of fake and scam ICOs, some crypto assets function as securities and are therefore safer and more valuable in the long term.  

Before we dig into the differences between utility and security tokens, let's establish what a token actually is. A crypto token is a representation of some value within an organization, including a stake, a voting right, or some other benefit. Investors (or buyers, depending on the classification of the token) exchange cash for these tokens.  

Most often, tokens are issued in the form of an ICO (Initial Coin Offering), which is effectively the same concept as an IPO (Initial Public Offering) of stock.  

Unlike cash, tokens only operate on a specific exchange within the organization and maintain their value only in that ecosystem (much like stocks in a company). They serve a particular purpose within the startup that funds them. Even big tokens (like Bitcoin) still only function on the blockchain.  

Utility Tokens vs. Security Tokens

The primary difference between security tokens and utility tokens is their functional value and widespread use. Utility tokens represent a promise of something specific in the future, while security tokens represent an investment.  

A Utility token's use is limited to a "cash like" value, a product or service, or a promise of future value. The availability of utility tokens is subject to a cap, which then makes their value vary depending on supply and demand. Utility tokens are not created for investment purposes.  

Consider a startup that launches a GoFundMe account asking for money now in exchange for products in the future. Utility tokens help build economies within their platforms by bringing in cash when it's needed. Most ICOs (from success stories like Bitcoin to the myriad scams that crashed in 2017) are utility tokens. Effectively, buying utility tokens is a gamble. Maybe the company will succeed, and you will benefit, but nothing is protecting your investment and no governing body to oversee these transactions.  

A Security token, on the other hand, is a digital asset gains real value based on another asset that is traded in the marketplace. Security Tokens pass Howey Test (the test that determines whether something qualifies as a "security.") To pass the test, a security token must answer "yes" to these questions.  

  1. Are the token holders allowed to provide funding to the company and claim a share of the profits?
  1. When raising funds with the token, are profits generated by individuals other than the creators or founders of the token?  

Security tokens give the investor a share of the value of a company, just like a trade-able share of stock. They compute to digitalized ownership of a  company. Because they are securities, security tokens are subject to SEC oversight and regulations. Failure to comply with these regulations is a serious offense and could result in penalties or worse for the company. This makes them a much better investment vehicle.  

At its core, a security token is akin to a legally binding contract. It is proof of ownership of a part or a whole of an asset, usually that asset being a company. To be able to use the security token, you must verify that you own it, and this happens on the blockchain where the token is stored.    

Utility tokens are essentially a way for companies to raise funds and grow an internal ecosystem. Security coins, however, are investment options, legally binding, and are tradable with a variety of other assets. Unlike utility tokens, the value of security tokens and the value of the company go in tandem and influence each other.  

Security tokens have to meet stringent SEC regulations and comply with certain requirements. As such, in terms of the safety of your investment, security tokens are by far much safer than utility tokens could ever be.  

Want to learn more about security tokens? Contact CERES today.