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 sphere, most blockchain companies emphasize on the usage of “Security” and “Utility” tokens-major tokens in the decentralized crowdsourcing space. This discussion has again gone into mainstream of crypto space after the statement from US SEC official that Bitcoin and Ethereum are not securities.
Let’s understand what are these and how are they different from each other.
Security Tokens
Security Tokens are crypto tokens, issued to the investors, wherein they pay dividends, share profits, which should be compliant with the SEC regulations.
The US Securities & Exchange Commission(SEC) defines securities as — “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others”.
Nevertheless, a small percentage of the currently available ICO startups boast the resources needed to issue Security Tokens that can comply with SEC’s securities regulations.
Usually, a litmus test, called the ‘Howey Test’, is employed to judge whether or not the crypto is a Security Token. Here is what a Howey Test is:
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, a 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.
As per Token Report, it has been reported that out of 226 ICOs, only 20 are utility tokens. Companies like Civic and Storj are using utility tokens- Civic has created 1 billion utility tokens providing access to the services in a token-based ecosystem.
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).
As Shawn Wilkinson, Chief Strategy Officer of Storj explains “The Storj tokens we released allows people to use space on the network. We raised half a million dollars through the token crowd sale”.
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. 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 crypto sphere, it gives people financial freedom never been witnessed before.
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