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Utility token vs Security token: 3 main differences

25 August, 2022 Blockchain

Utility token vs Security token are two terms that make a great contribution to the development of blockchain, which makes many investors of the cryptocurrency market very interested in. This article will help you find out what Security Token is? What is Utility Token? And the difference between these two types of tokens.

1. What are tokens?

Token is a type of electronic money (cryptocurrency), created and operated on an available blockchain platform. This is just the basic definition of Token. To really understand what Token is, you need to understand the concept of cryptocurrency, as well as what is Blockchain concept?

Blockchain is a database system that stores and transmits information in blocks that are linked by encryption. At the same time, Blockchain is scalable over time. In particular, the system participants will directly manage these blocks instead of intermediaries.

Tokens are usually issued during ICOs. ICO stands for Initial Coin Offering, which means “first public offering of cryptocurrency to raise capital”.

Many people misunderstand that ICO is a form of Coin issuance. Therefore, they use the concept of ITO (Initial Token Offering) combined with TGE (Token Generation Event) to bring a more accurate perspective on this issue.

2. What is Cryptocurrency?

To really understand what a token is, we need to understand the concept of cryptocurrency. This is a digital currency that uses cryptography to encrypt information, secure and control transactions on the network.

Essentially, cryptocurrency is a form of digitized database. More specifically, they exist in the form of digital bits and limit the input. No one can change the parameters of a cryptocurrency without fully complying with some pre-existing conditions.

utility-token-vs-security-token-2022

Cryptocurrencies only have value in an electronic environment. We can use cryptocurrencies for certain online payments. Similar to fiat money (paper money), electronic money has the main function of exchange and accumulation of value.

While the government regulates the value of fiat money, the issuer/organization guarantees the value of cryptocurrencies.

3. What is a Utility Token?

Utility Token is a tool to help users access the products and services of the ICO project after completion. This means that you can use these types of Tokens in real or practical applications.

Usually there will be a fixed supply when ICOs issue tokens. Utility Tokens are appreciated when the demand for the project’s products/services increases.

Utility tokens are not issued for investment purposes, so this type of token is not subject to securities laws.

An example of a utility token is Filecoin, which raised $257 million by selling tokens to provide users with access to a decentralized cloud storage platform.

4. What is a Security Token?

Security Token is like a form of investment contract, in which the token holder expects the return to increase in the future such as dividends, or most commonly is arbitrage. Therefore, Security Token must comply with the provisions of securities laws.

An example of a Security Token is tZero – token of the online retailer Overstock. The tZERO tokens are issued under SEC regulations, and Overstock CEO Patrick Byrne has stated that token holders will be entitled to a quarterly dividend derived from the profits of the tZERO platform.

5. How to identify a Utility Token vs Security Token

Utility Token vs Security Token are 2 of 5 main types of cryptocurrency tokens. In order to distinguish between Utility Token vs Security Token, the SEC (U.S. Securities and Exchange Commission) conducted the Howey test (written in 1946) that includes 2 questions:

– Does the Token provide the owner with the opportunity to fund the startup’s capital and receive a share of the profits?

– Does the ICO fundraising effort involve investing in the project where the profit will be generated entirely from the work of individuals other than the creator or founder onto the project?

If the answer to either question is yes, then the token is most likely considered as a Security Token.

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It is important for both investors and company founders to know whether the ICO project will be classified as a Security Token or a Utility Token. This is because the security tokens obey the federal laws that also apply to publicly listed companies.

6. How to distinguish Utility Token vs Security Token

To distinguish between Utility token vs Security token , we can base on the following 3 main characteristics:

Utitlity TokenSecurity Token
LegalityProject owners can “draw” on an idea and then sell tokens to the community to raise capital. This is why Utility tokens are often associated with ICO scam projects.Before issuing a Security token, a project needs to notify a regulatory authority, such as the SEC.
CharacteristicEasier to access.
Anyone can buy/sell it easily at any time.
Security tokens are supervised by regulatory authorities that leads to a more limited approach. It includes the limit in buying and selling in the secondary market.
ProfitabilityThe value of Utility token is based on supply and demand for that project’s products/services.
It does not serve investment purposes
Security token holders will receive future profits such as dividends or certain voting rights.

7. Utility token vs Security token, which form to invest in?

Here are the basic differences between Utility token vs Security token. In conclusion, each of these token types carries with it different risks and benefits. Utility token is more popular while Security token seems to be more secure since it is subject to scrutiny. However, in Vietnam, the ability to access Security tokens has certain difficulties.

Meanwhile, the Utility token is more accessible. You can buy and own them through ICO or market cryptocurrency exchanges. Of course, there is no guarantee for this form either. Investors will face the risk of losing everything if they choose to own utility tokens of fraudulent projects. Therefore, investors need to learn carefully about the information related to the project before making an investment decision.

Read more: What Are Non-Fungible Tokens (NFTs)?

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