Utility Token vs Security Token

The main difference between a utility token and a security token is that security tokens give rights of ownership to a company. Think of them sort of like digital, decentralized shares of stock. Security tokens are also classified as securities by financial regulators like the Securities and Exchange Commission (SEC), making them subject to the same rules as stocks, bonds, ETFs, and other securities.

While utility tokens are not currently classified as securities, there has been some speculation that one day, they could be. Even though these tokens are not intended to represent an investment the way security tokens are, that’s not what matters most to regulators. The SEC uses something called the Howey Test to determine whether or not an investment is a security.

The criteria of this test are:

  • A monetary investment

  • People invest because they expect to make money

  • The investment is a “common enterprise,” meaning investors will only make money based on what the issuers of the investment do

  • Profits are dependent on the work of a third party

If the investment in question checks the above boxes, the SEC considers its security. It’s not difficult to argue that they can apply to most tokens and cryptocurrencies.

A utility token can serve just about any purpose a developer wants. In general, utility tokens provide access to a specific service or product with a blockchain ecosystem. In other words, the client might need a certain utility token to be able to perform actions on an altcoin’s network.

While cryptocurrencies are a form of digital money, utility tokens might be better described as pieces of software. They can be used to transfer value, but that’s generally not their primary purpose.

To swap tokens on a decentralized exchange (DEX) or do any number of decentralized finance (Defi) activities, users may need a specific DEX token. Alternatively, such a token could be used to reward users of the platform or to pay out interest to those who deposit funds that the platform then lends out to borrowers.

Non-fungible tokens (NFTs) also serve as unique utility tokens. An NFT token is a one-of-a-kind digital piece of art, although NFTs can also be applied to things like music.

Utility tokens that have been used in Initial Coin Offerings (ICOs) could even be used for malicious or fraudulent reasons. For example, during the ICO craze of 2017-18, some new blockchain projects offered utility tokens to investors with promises of great returns. In reality, the projects were fake, and there wasn’t even any new software application being built. Investors who decided to buy ICO tokens like these often had no recourse and lost everything.

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