The difference between utility and security tokens is substantial because the tokens serve different purposes in the cryptosphere. The processes are different during issuance and trading. If you’re wondering why there are even security tokens on the market, the answer is not that hard.
The growth of the ICO sector is massive, and it has led to enhanced scrutiny from regulators such as the SEC.
Developing regulations for the growing ICO market falls on the SEC depending on the token’s use.
Utility tokens vs. security tokens – The Howey Test
It’s not very easy to determine if a coin is a security or utility token. A lot of times, a coin can start as a security during its ICO and later it can evolve into a utility. This happened to Ethereum (ETH) for instance. Back in June, the SEC ruled that ETH operated as a security at the beginning, but now it’s a utility token.
The simplest way to determine whether a token is a security or utility token is to use the Howey Test. This is a short questionnaire created back in 1946 by the Supreme Court.
The Howey Test basically asks investors four essential questions which can be applied to tokens to determine whether they are securities or not.
- Are You are Investing Money?
- Do You Expect Profits from Your Investment?
- Are You Investing in A Common Enterprise?
- Will You Profit from the Efforts of a Promoter or Third Party?
Main features of security tokens and utility tokens
Utility tokens are used within a platform, and they are essential to the functionality of that platform. More than that, they don’t give token holders rights to the company’s future developments or profits. They transfer without regulations, and any company can offer them without meeting the SEC regulations. On the other hand, the open nature of the tokens made them the favorite choice for investors, but they also attract massive issues from regulators.
Security tokens are entirely different in terms of how they operate and their requirements. A company cannot simply host a security token offering without fulfilling certain conditions. They have to offer investors a massive amount of data including the company’s address, names of board members, open financial records and more. As you can see, these involved enhanced transparency, but on the other hand, these requirements protect investors from fraudulent activity. So, in the long run, if you want enhanced security and transparency, security tokens are the choice for you.
Companies cannot sell security tokens to anonymous individuals, and they need to provide and prove the identity before investing in the tokens. When securities are moved between owners, Know Your Customer (KYC), and Anti-Money Laundering (AML) laws have to be adhered.
It’s true that most investors see security tokens as a burden for the crypto space, but they are an essential bridge between traditional investment and the crypto market, providing enhanced protection for investors who prefer avoiding future financial and legal issues.