“The fundamentals of the token model are valuable and powerful. They allow communities to govern themselves, their economics, and rally a community in powerful ways that will allow open systems to flourish in a way that was previously impossible.” – Fred Ehrsam

Cryptocurrencies such as Bitcoin were originally created for the purpose of daily use as an alternative to money. The digitized currency was adopted by techies and geeks at first.

Bitcoin started gaining popularity from 2013 onwards when financial investors started buying it as a commodity worth investing in.

Bitcoin still has a long way to go before it can replace traditional money. However, the dynamic functionality of the blockchain has opened up new possibilities in the financial and utility markets.

New tokens are being developed for two distinct purposes; either as security tokens or utility tokens.

Are they security tokens or utility tokens?

Security Tokens

These types of tokens are similar to stock or company shares held by investors. By using the blockchain technology and smart contracts, a company can remove the need for holding an IPO. New companies can now issue shares and voting rights through a blockchain platform.

Investors can buy the tokens during the ICO or from other investors later.

Security tokens can also be used by lenders to create debt owned by the company. These digitized loans would be highly liquid as they can be traded over the platform.

A lot of crypto experts believe that security tokens will become the predominant type of ICO in the future. It has many similarities to the IPOs that are common in the financial markets.

However, the US SEC has indicated that ICOs would be subject to the same federal securities regulations as corporations if they intend to acquire funding in this manner.

Very few ICO projects possess the resources and legal capability to issue tokens that comply with all applicable regulations of the SEC.

Are they security tokens or utility tokens?

Utility Tokens

Utility tokens are popular because they give users future access to a product or service at discounted rates. A company raises capital by the sale of utility tokens through an ICO.

The capital is then used to develop the blockchain and infrastructure of the company.

Think of utility tokens as a form of credit which is redeemable in exchange for future services from the company. Once the project is off the ground and running, the company can sell the redeemed credit to new users who want to continue buying their service.

Basic Attention Token or “BAT” is a good example of a utility token. The token was launched by the developers of Brave browser ecosystem.

The founders wanted to create a network of internet users, publishers and advertisers that would be mutually beneficial for all the parties.

Advertisers can purchase ads using BAT tokens which can be earned by publishers and browser users as compensation for watching and hosting the ads.

Are they security tokens or utility tokens?

Security Tokens or Utility Tokens?

The main difference between the two types of tokens is in terms of intended use and functionality.

Security tokens are designed to be investments. As the company behind the project earns profits in the market, the token-holders can receive additional coins as dividend through the process of Proof of Staking.

The holders of the security token also get ownership rights in the company. The blockchain platform can be used to create a system of voting where investors can exert control on the company’s decision making process.

Utility tokens are not meant to give holders control over the decision making process of the company. A tech business can create a method for users to earn and spend utility tokens by interacting with its services.

Both utility and security tokens can increase in value if the price of the token appreciates in the market. It is one method available for investors in the token to earn profits.

While there are some differences between security and utility tokens, there are also many similarities which can make it difficult to differentiate between the two.

The SEC employs the Howey test to determine if the token for a cryptocurrency can be considered utility or security.

Are they security tokens or utility tokens?

The Howey Test

The test is comprised of asking two simple questions.

Does the token give its holders an opportunity to fund the startup’s capital and have a share in its profits?

Does the fundraising effort of the ICO involve investment in the project where profits are generated completely from the work of individuals other than the creators or founders of the project?

If the answer to either of the two questions is yes, then the token is very likely to be seen as a security token by the SEC.

It is important for both investors and company founders to know if the ICO would be categorized as security tokens or utility tokens by the SEC. This is because security tokens are subject to the same federal regulations that are imposed on public listed companies.

Are they security tokens or utility tokens?

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