Security Tokens vs. Utility Tokens : A Concise Guide

There is no doubt that blockchain is causing significant disruptions across almost all industry verticals that are in existence. Blockchain technology makes it possible to create a wide array of new business models. Blockchain is credited with being the sole technology since the invention of the internet brought about valuable innovations such as decentralization and trustless networks. Using tokens is one of the significant factors, out of the many, which have contributed to the success of blockchain technology. This article will delve deeper into the concept of tokens and help you gain a clear picture of security tokens, utility tokens, and top NFT tokens. Also, you will be learning about the difference between these tokens.

Overview

The term “Blockchain” can be confusing itself, and so are its terminologies. Talking about tokens, coins, and cryptocurrency, they all are considered one thing by most people. However, they all have their own functionality, which differs from each other. Tokens are of a few types. Here we will be discussing security tokens, utility tokens, and NFT. Security tokens are a form of investment, and anyone can utilize utility tokens for a particular service or  product. On the other hand, a Non-fungible Token is a unique type of token and a collectible token. It is a form of art where artists can monetize their work. The prices of NFT are significant and can have extraordinary value.



Here, we are going to discuss all these tokens in detail and what is the use of tokens in the blockchain industry.

Understanding Tokens

A token may simply refer to any given cryptocurrency token or a token that exists on another cryptocurrency’s blockchain in computer security and cryptocurrency. A token is an asset, utility, or unit of value that a company issues. Tokens represent programmable assets or access rights which are managed through a smart contract and an underlying distributed ledger.

These are issued when a company launches an Initial Coin Offering (ICO), which is more or less the same as the Initial Public Offering (IPO). The main difference between an IPO and an ICO is that in an IPO, you receive stock in exchange for the investment you will make, whereas in an ICO, you will receive a token in exchange for your investment. Tokens can be redeemed to access the product or service of a company in the future.

What Are Security Tokens?

Security tokens are digital assets that derive their value from an external asset that can be traded. These are subject to Federal laws that govern security. It is mandatory for the security tokens to comply with these regulations. Failure to comply would lead to severe consequences such as penalties and potential derailment of the development of the project.

These depict assets such as participation in real physical underlyings earnings streams, companies, or entitlement to interest payments or dividends. In terms of economic function, these are the same as bonds, derivatives, and equities. If the startup abides by the regulatory requirements, security tokens offer a wide array of applications. These are also known as securitized tokens. Security Token Offering (STO) is built to increase the trust of the investor to invest in various projects.

  • Security tokens authenticate identities electronically by storing personal information.
  • They are issued by Security Token Services (STS), which authenticate the person’s identity.
  • They may be used in place of or in addition to a password to prove the owner’s identity.
  • Security tokens are not always secure—they may be lost, stolen, or hacked.

How does Security Token Work?

Security tokens are created as investments. Dividends in the form of additional coins are given to token holders each time the issuing company of the tokens earns a profit in the market. Users who hold the security token will also gain ownership of the company. Blockchain provides a platform that can be used to create a voting system that allows investors to exercise control over the decision-making process of the company. In short, a cryptocurrency token that passes the Howey Test is deemed a security token. They derive value from an external tradeable asset. As these tokens are deemed a security, they are subjected to federal securities and regulations. The Howey Test was determined by the Supreme Court to determine whether certain transactions qualify as “investment contracts.” If so, those transactions are considered securities under the Securities Act of 1933 and the Securities Exchange Act of 1934 and are subject to certain disclosure and registration requirements. In the USA, Security Tokens are subjected to regulations such as:

Regulation D

This will allow a particular offering to avoid being registered by the SEC-provided “Form D” that has been filled by the creators after the sale of the securities. The individual who offers this security may solicit offerings from investors in compliance with Section 506C. This section needs

verification stating that the investors are accredited and that the information provided during the solicitation is free from misleading or false statements.

Regulation A+

This allows the creator to offer SEC-approved security to non-accredited investors through a general solicitation of up to $50 million in investment. When compared to other options, this regulation may take more time compared to other options for the requirement to register the security. Due to this reason, this regulation will be more expensive than any other option.

Regulation S

This regulation is for any security offering which is executed in any country apart from the US and is not subjected to the registration requirement under section 5 of the 1993 Act. The creators will still need to follow the security regulations of the country where they will be executed.

On the other hand, utility tokens are not intended to give their holders the ability to control the decision-making process of a company. They aid users in interacting with a company’s services. Utility tokens are also not subjected to any regulations.

Having differentiated security tokens and utility tokens based on regulations, intended use, and functionality, let us now learn the three other crucial areas of distinction.

What Are Utility Tokens?

Utility tokens are user tokens or app coins. This is a token that is given out during crowd sales as a project executes an ICO. When a company creates a utility token, it means that it is essentially creating a form of a digital coupon that can be redeemed in the future for discounted fees or special access to a product or service. Unlike security tokens, utility tokens are not used as investments as they can be exempted from the federal laws governing securities if they are properly set up. Examples of utility tokens are Filecoin, Siacoin, Civic, etc.

Roles of Utility Tokens

  • The token owner has certain rights, including the right to utilize or own a product and the right to pitch or vote for particular cases or topics.
  • Having utility tokens allow you decentralized storage. These tokens provide the exchange value for the services they give.
  • It also improves the user experience by giving rewards for particular things.
  • Utility tokens act as currency in the blockchain. Also, it can be an alternative to financial payments in the coming years.
  • It is possible to share utility tokens for earning certain things.
  • Tolling users can enter the blockchain infrastructure or decentralized service.

Above discussed are the six roles of the Utility token, which it can perform efficiently, and below, we are going to earn about the issues and challenges it holds.

Utility Token Issues and Challenges

Utility tokens are a good option for gaining profits and getting finances for new developing projects. However, it can provide some risks too. The Utility tokens became popular with the ICO boom in 2017. This was due to the excessive use of the utility token mechanisms. Also, the next year this reason dragged them down, causing trust issues and constant audits of the new projects.

The main reason which caused this fall was the projects had unrealistic goals, and the tokens were not regulated like the Security tokens. Therefore, it is necessary that the project must have a real utility.

Problems that utility tokens face are as follows:

  • No natural mechanism for increasing the token value.
  • Token lacks value when the project does not succeed.
  • Cryptocurrency adoption is not promoted.
  • A liquidity problem occurs when the project does not achieve the capital required for development.
  • The token holders do not hold any decision-making. The founders and developers manage all.

Security Tokens Vs. Utility Tokens

Security Tokens and Utility Tokens can be differentiated on the basis of the following points:

Purpose

A security token is an investment contract representing the legal ownership of a physical or digital asset that has been verified within the blockchain. Utility tokens help fund ICOs and create an internal economy within the project’s blockchain. The user who holds a utility token will also have certain voting rights within the ecosystem.

Expectations

In a security token, the value of the company is directly tied to the company’s valuation. More valuable the company, the more valuable the token. In a utility token, there is no relation between the current state of the company’s valuation and the value of the token.

Scam Potential

The chances of a scam are infinitesimal in a security token as it is highly regulated. Utility tokens are highly unregulated, and hence, scammers are known to create bogus ICOs and tokens to make quick money.

Regulation Status 

It’s very tough to create regulations for the ICO as Utility tokers are relatively non-regulated. On the other hand, in Security Token, the company and investor need to get through a Howey test.

Conclusion

Hope this article helped you understand the basic differences between a security token, utility token, and NFT tokens. We have now learned that one helps incentivize holders to act in a certain way while the other is a contract representing the legal ownership of an asset. But out of these two, security tokens are considered safer than utility tokens due to the strict regulations imposed upon them. At the same time, the NFT token is represented as a one-of-a-kind collectible digital item.   To read more such blockchain-related articles, visit Blockchain Council.

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