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Security Token vs Utility Token — Key Differences Explained With Examples

security token vs utility token

To learn and understand the key differences between security token vs utility token, you need to understand some basic terms first.

Security Token vs Utility Token - What’s a token again?

A token serves as a tangible representation of a particular entity or something in an ecosystem. A token is not restricted to one particular role it holds a stake, right to vote, and many more roles things that it can fulfill in its native ecosystem.

There is a common confusion with the difference between a token and a cryptocurrency coin. A cryptocurrency coin is an independent platform like BTC, Ethereum, and many more familiar cryptocurrencies which can be used in the form of currency beyond their native environment.

Golem, OmiseGO, and some others are some utility token examples which exist on a particular platform.

Golem, OmiseGo are tokens based on the Ethereum platform.

Interestingly, a vast majority ( as much as 96%) of the tech startups in the Blockchain and crypto space were launched on Ethereum's dApps platform. The other popular Blockchain-based platforms after Ethereum are Waves and Stellar.

Security token Vs Utility Token Source: InWara's Market Intelligence Platform

A token is a representation of a security or utility which company has and offers for sale to investors in the form of Initial Coin Offering (ICO) for utility tokens and in the form of Security Token Offering (STO) for security tokens.

Security Token vs Utility Token: What makes the tokens appreciate in value?

William Mougayar says that for a token value there three tenets which are roles, features, and purpose. Each and every token has a particular feature and purpose. Now, let's look into the roles of a token that it can take up:

· Right: By claiming a specific token, the holder gets a specific measure of rights inside the system. For example, by having DAO coins in your ownership, you could have had to cast ballot rights inside the DAO to choose which tasks get financing and which don't.
· Value Exchange: The tokens make an interior financial framework inside the limits of the task itself. The tokens can support the purchasers and sellers exchange value inside the system. This enables individuals to pick up rewards for the completion of specific tasks. This creation and upkeep of individual, internal economies is the most prominent task of Tokens.
· Toll: It can likewise go about as a toll portal with the goal for you to utilize certain functionalities of a specific framework. For example, in Golem, you need GNT (golem tokens) to access the advantages of the Golem supercomputer.
· Function: The token can likewise empower the holders to improve the client experience inside the limits of the specific environment. For example, In Brave (an internet browser), holders of BAT (tokens utilized in Brave) will get the rights to advance client experience by utilizing their tokens to include promotions or other services on the Brave platform.
· Currency: Can be utilized as a store of significant worth which can be utilized to lead exchanges both inside and outside the given environment.
· Earnings: Aides in the fair conveyance of profits or other related budgetary advantages among investors in a specific task.

All in all, how does this all assistance in token valuation?

So as to turn out to be more valuable, a token must satisfy more than one of these properties. Actually, more properties that a token can have, the higher its valuation.

Security Token vs Utility Token: How Does A Token Offering Work In Either Case

Initial Coin Offering is nothing but crowdfunding using cryptocurrency. The ICOs have been really progressive and have managed to achieve stunning results:
· They have given the least complex way by which DAPP developers can get the required financing for their project.
· Anybody can progress toward becoming an investor to a project they are keen on by acquiring the tokens of that specific DAPP and become a piece of the task themselves.

How A Token Sale Works

Right off the bat, the developer issues a particular number of tokens. By keeping a restricted measure of tokens, they are guaranteeing that the tokens itself has a value and the ICO has an objective to go for.

The tokens can either have a static pre-determined cost or it might increase or decrease relying upon how the crowd sale is going.

The exchange is quite straightforward. In the event when somebody wants to purchase the tokens they send a specific amount of ether to the crowd sale address.

At the point when the agreement recognizes that this exchange is done, they get their particular number of tokens.

Since everything on Ethereum is decentralized, an ICO is viewed as a successful one if it is well-distributed and a huge share of its lump isn't claimed by one entity.

During H1 2019, ICO projects projects outperformed Security token projects in terms of funds raised, according to Blockchain and crypto report: H1 2019

Security Token Vs Utility Token

Source: Blockchain and crypto report: H1 2019


Security Token vs Utility Token: Which Fits The Howey Test?

In 1946, the Supreme Court took care of a case.

The case was SEC versus Howey which would set out the establishment for the, presently infamous Howey Test. The case was tied in with building up a trial of whether a specific arrangement includes an investment contract or not.

To keep a long story short, two Florida-based corporate defendants offered land contracts for tracts of land with citrus forests.

The defendants offered purchasers the choice of leasing any obtained land back to the defendants, who might then watch out for the land, and reap, pool, and market the citrus.

As a majority of the purchasers were not farmers and did not have farming expertise, they were glad to lease the land back to the defendants.

Be that as it may, this was regarded as illegal by the U.S. Securities and Exchange Commission (SEC) and the defendants were immediately sued.
As per the SEC, the defendants infringed upon the law by not recording a securities registration statement. After researching the defendant’s leaseback and finding that it was without doubt security, the Supreme Court settled on a genuine milestone choice.

They built up a test that will be utilized to decide if a specific exchange is an investment. contract or not. In the event that it is, at that point, it will be subject to the securities registration requirement.

The exchange will be called an investment contract if it satisfies these criteria:
· It is an investment of cash
· The investment is in a common enterprise
· There is a desire for profits from the work of promoters or the outsider.
So, are utility tokens securities?

It depends on the enterprise behind the project and the effects of its actions on the tokens value.

The expression "common enterprise" is available for understanding. In any case, numerous government courts have characterized a common enterprise as a level undertaking where the investors pool their cash and assets for a particular project.

Despite the fact that the first Howey Tests utilized the expression "cash", later cases it extended that to incorporate different investments and resources other than cash.

Also, there is another significant interesting point while deciding securities. The benefits that originate from the securities, it is in the investor’s control or is it totally out of it? In the event that it isn't in the investor’s control, at that point the asset has announced security.

All these above mentioned 3 tenets must be met for a coin to characterize as a security. This is a key difference between utility token and security token.

Once when the DAO tokens failed the Howey test, the test and securities had turned to be a big debate in the crypto field.

How did this all start?

The SEC said that the DAO tokens are securities as it satisfied all three criteria of the Howey Test. It had an investment of money, a common enterprise, there was a desire for profits, from the efforts of others.

This investigation took place in the first place because of the infamous DAO hack. In DAO there was an error in the Dao smart contract. The hacker misused that defect to execute a reentrancy attack, over $50 million worth of ether was siphoned away.

Since many individuals put and received back nothing, the SEC mediated to ensure the enthusiasm of the investors and considered the token as a security.

Token Types

SEC and FINMA have broken down tokens into two major categories:
· Utility Tokens
· Security Tokens

Utility Token Definition

Since the majority of the ICOs are investment opportunities in the organization itself, most tokens qualify as securities.

In any case, on the off chance that the token doesn't qualify as per the Howey test, at that point, it is characterized as utility tokens. These tokens basically offer clients with users with a product and/or service.

Consider them like gateway tokens.
Since there is an upper cap on the maximum token accessibility, the tokens may go up due to the supply-demand equation. Supply-demand is entirely straightforward. The thought is that the higher the demand for an advantage, lesser will be its supply and that is going to shoot up its cost.

How do Utility Tokens work?

The utility token holder has the right to use the network and the right to take benefit of the network by voting. Utility tokens are hands down the most famous type of tokens out there, for the most part in view of 2017's ICO boom.

Organizations have utilized these utility tokens to bring a large number of dollars up in funding. In any case, that is only one of the roles that they satisfy. They help in structure an internal economy inside the framework.

They can give the holders to take benefit of a network by casting a vote in it. Think about any blockchain that has a proof of stake model.
When you have secured up a stake in the system, you have the ability to decide on the network’s overall well-being. The most prevalent cause of utility token is the ERC20 Ethereum standard.

The ERC20 standard has been utilized by organizations to construct tokens for their DApps and conduct their ICOs. Filecoin, Siacoin, Civicare are some of the examples of a utility token.

Security Token Definition

In any case, on the off chance that the token qualifies as per the Howey test, at that point it is characterized as security tokens. Their value is usually derived from external and tradable assets. They are subject to federal securities and regulations as the tokens are qualified as security.

In less difficult terms, a token is delegated security when there is a desire for profits from the efforts of others. In the event that the ICO doesn't pursue certain guidelines, at that point, they could be liable to penalties.

Be that as it may, on the off chance that every one of the guidelines is appropriately met, at that point these tokens have tremendously ground-breaking use-cases.

Security Token is an Investment Contract

A security token is an investment contract that represents legitimate responsibility for a physical or digital asset like real estate, ETFs and so on. This possession must be checked inside the blockchain. After the proprietorship is checked, security token holders can:
· Exchange away their tokens for different assets
· Use them as security for a credit
· Store them in various wallets
Having said that, the genuine value in security tokens lies in the way they can totally redefine the importance of "ownership". They can democratize assets and distribute them among individuals everywhere throughout the world.

A token that represents equity in a startup is a security token example.

Regulations that Security Tokens are Subjected to?

Anthony Pompliano works admirably of clarifying the sort of regulations that security tokens will be subject to.

As per him, since Security Tokens are subject to federal security regulations, they are consistent from the main day itself. In this way, in the USA, security tokens need to pursue these guidelines:
· Regulation D
· Regulation A+
· Regulation S

Regulation D

Regulation D will enable a specific offering to avoid from being enlisted by the SEC provided “Form D” has been filled by the makers after the securities have been sold. The person who is putting forth this security may request contributions from investors in consistence with Section 506C.

560C requires confirmation that the investors are without a doubt accredited and the data which has been given during the requesting is "free from false or misdirecting explanations.

Regulation A+

This exclusion will enable the maker to offer SEC-endorsed security to non-accredited investors through a general requesting for up to $50 million in investment.

All together for the necessity to enroll the security, the issuance of Regulation A+ can take much additional time contrasted with different options. For a similar reason, Regulation A+ issuance will be costlier than some other option.

Regulation S

This happens when a security offering is executed in a nation apart from the US and is along these lines not subjected to the registration prerequisite under section 5 of the 1993 Act. The makers are still required to pursue the security regulations of the nation where they should be executed.

Sia Funds, Bcap, and Science Blockchain are some of the examples of security tokens.

Utility Tokens vs Security Tokens

· Utility token builds an internal economy inside the project's blockchain and helps in funding the ICOs. It gives the clients voting rights within the system. A security token is an investment that represents gives legal acquisition of any physical asset or digital asset which is verified within the blockchain.
· In utility token, there is no relationship between the company’s valuation and value of the token. Whereas, in the security token, the token’s value is directly in a relationship and tied with the company’s valuation.
· As utility tokens are unregulated, it is known that scammers make some kind of fake ICOs and tokens so that they can just make quick money and elope. Whereas, a security token is completely regulated and there are very low changes in security being a scam.

Thus, utility token helps in incentivizing the holders to act in a particular way and security token is an agreement that represents legal ownership of an asset.



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