Blockchain technology, being dubbed as “the new internet,” is certainly set to cause major disruptions across all industries by opening up the possibility of creating a wide variety of new business models. One of the major reasons it has become so successful is the use of tokens.
What is a Token?
Generally speaking, a token is a representation of something in a particular system. It could be anything – a voting right, stake, or a unit of value, for example. A token is able to fulfill many roles in its system and is not limited to a particular role.
Tokens vs. Cryptocurrency Coins
A cryptocurrency coin such as Bitcoin, for example, can be independent of a platform. Cryptocurrency coins can be used as a type of currency outside of their original system. On the other hand, tokens such as Golem and OmiseGO exist on a particular platform – Ethereum, in this case.
Tokens represent a utility or security belonging to a company and they oftentimes give it to their investors during a public sale known as an Initial Coin Offering (ICO) in the case of utility tokens, and Security Token Offerings (STO) in the case of security tokens.
What are Utility Tokens?
Also known as a user token or app coin, utility tokens are hands down the most popular type of tokens and give users future access to the company’s products or services. In other words, utility tokens are not made to be an investment.
How do Utility Tokens Work?
A startup company can make utility tokens and sell digital coupons for the products or services it is developing. Utility tokens can also:
● Grant token holders a right to use the network
● Assist in building an internal economy within the system
● Permit token holders to take advantage of the network by voting. Think of it this way:
as soon as you have locked up a stake in a network, you have the right to vote on the overall well-being of the network.
The ERC20 Ethereum standard is what most utility tokens are built on. ³ Another example of a utility token is Filecoin. Through the sale of tokens, they raised $257 million. Holders of said tokens will be granted access, through these tokens, to its decentralized cloud storage platform. Other examples of pure utility tokens are Ether and Sia.
There is an upper cap on token availability which can result in the value of tokens going up due to the simple rules of supply-demand: The more demand there is for an asset, the shorter its supply, the higher the price. So even though utility tokens were not created as an investment, people may still invest in them in the hope that the token value increases over time.
These are tokens distributed to investors in an ICO or token sale for the exchange of their money. Crypto tokens that share profits, pay interest, pay dividends or invest in assets or other tokens to generate profits for the token holders are considered security tokens. ⁴ Since they are considered as security, they are subject to federal regulations and securities.
To put it simply, a token is deemed as security when there is an expectation of profit from the efforts of others. It is an investment contract which represents legal ownership of a digital or physical asset and this ownership must be verified within the Blockchain. If certain regulations are not followed by the ICO this could result in penalties being incurred and even the development of the project being stopped.
What are the benefits of Security Tokens?
However, when all rules and regulations are followed, startups can benefit greatly.
One such benefit is that the company is able to offer tokens as a digital representation of shares in its stock. Benefits for security token holders include:
● Being able to store them in different wallets
● Using them as collateral for a loan
● Trading their tokens for other assets
Security tokens bring a new meaning to the term “ownership.” Because of these tokens, assets can be democratized and distributed among people all over the world. For example, instead of owning a gold coin which may be too expensive for a lot of people, 100 people can now each own a piece of that gold coin.
What are the Similarities Between Security and Utility Tokens?
● Both are subject to increase or decrease in value depending on market demand
● They are not cryptocurrencies. Neither one is created for direct commercial use such as buying or selling of external services and products.
● Utility tokens are often incorrectly promoted as an investment, whereas security tokens are misleadingly promoted as the same thing as utility tokens.
Conclusion – Utility Token vs Security Token Differences
|Utility Tokens||Security Tokens|
|Access to utility or protocols||Asset ownership|
|Buyers, no guarantee of profits||Investors with an expectation of profit|
|Token sales are not regulated||Offerings are regulated|
Which is Better? Security Token or Utility Token?
Both have their risks, pros, and cons. That said, care should be taken to differentiate between the two and do your homework otherwise you could end up investing in something that is not compliant with the regulations, in which case your investment funds could be stuck; or investing in something that fails, in which case your tokens are doomed.