What are the Differences Between a Utility Token and a Security Token?
In basic terms, a Utility Token is a token that has some sort of use or utility either within a particular platform or across various platforms. ‘Utility’ encompasses many possibilities, including purchasing power, platform access, and much more. All tokens therefore have a Utility Token component. The issue is whether they qualify as being Security Tokens as well. The question therefore should be: ‘is there such a thing as a non-security token?’
Henceforth, for the purposes of expedience, we’ll use the term ‘Utility Token’ to refer to non-security tokens, as that is what people generally mean.
Factors That Determine if a Token is A Security
The factors determining whether a token is a security lies in its functionality. The legal guidelines issued by the securities commission or equivalent governmental body within a given country in many cases are very clear about the functions of a security. The US and Canada are probably the most salient cases. In both, this serves to determine what characterizes a security and that serves as a guideline to understand whether a token is indeed a security.
For instance, according to the SEC, a token would be classified as a security when it represents a degree of ownership in a business. In traditional markets, stock shares, which could potentially allow the shareholder to earn dividends from work done by a third party, would be defined as a security. Some Token holders argue that in the case of tokens, earning interest does not necessarily make the token a security. It is rather a function of inflation if the token is inflationary.
Similarly, certain initial coin offerings (ICOs) that are offering investors interest or dividends on their investments could be equated with bonds and would therefore also be considered equities. There is a small technical difference between them though, as interest rates on tokens, theoretically speaking, would be paid out in tokens as inflation increases and would result in a net gain of 0% for the individual. In the case of traditional markets, bonds (and other types of loans) pay out actual interests. The latter is the approach that many ICOs go with, since they are generally only looking to raise funds.
However, whether the SEC would choose to recognize these nuances is doubtful. It also seems more likely that the SEC will choose to categorize tokens based on their assessment of an investor’s intent in purchasing a specific token, rather than figuring out what the intention of the ICO was.
Other Assets are Also Securities
It is also important to note that according to the SEC’s Howey Test, there are a number of other assets that could qualify as a security. These are generally divided into three sub-categories, namely Equity securities, Derivative securities and Debt securities. Without going into too much detail, a Shares security would be a type of Equity security, Futures contracts would be a type of Derivative security, and a promissory note would be a type of Debt security. These concepts will be expanded upon shortly.