The Difference Between Security Tokens And Utility Tokens

December 5, 2018

Blockchain technology has many uses and advantages and is expected to create disruption in many industries, such as the automotive industry. The use of tokens has played a major role in increasing the popularity of this exciting new technology and has attracted millions of dollars worth of investment capital.

But what exactly are tokens, and why are investors so keen on getting in on token action?

What is a token?
A token is a utility or value that is issued by a company for a specific reason. It is similar to investing in stock, but where you receive stock in exchange for investment, investing in tokens gets you either a certain value or a particular utility for each token.

When a company issues tokens for the first time, it is called an initial coin offering, or ICO. It is similar to IPOs (initial public offering) that many companies use to generate initial or additional capital. There are two main types of tokens; security tokens and utility tokens, each with its own particular use. Let’s take a look:

Security tokens are essentially the same as stock or shares. They’re assets that can be traded and derives its value via market trading, similar to stock and shares on traditional financial markets. Many new companies who do not want to go the traditional stock route, issue these tokens during ICOs, since they are essentially the same as shares in a company

Since security tokens can be traded, they have to comply to certain laws that regulate securities. If tokens don’t comply with these laws, the company issuing them could face penalties or other legal ramifications that can severely hamper their business.

The regulations, set forth by the US Security & Exchange Commission (SEC), are quite stringent and can be quite costly to implement. This prevents many small companies from issuing security tokens.

A utility token is a digital coin or token that allows the owner to access certain products and services, similar to gift cards or a credit at a store. While utility tokens can be used by companies to raise capital, they’re not seen as investments by consumers who own the tokens, since they are exchanged for goods or services and not actual money.

VINchain’s VINcoin is a good example of a utility token. With VINcoin, customers can access certain services and features that VINchain offers, such as comprehensive vehicle histories.

Difference between security and utility tokens
The main difference between security tokens and utility tokens is that security tokens can be used as investments, and utility tokens allow owners access to certain goods and/or services.

Like regular stock or shares, when a user invests in security tokens, these tokens may accrue or lose value as a result of market trading. Also, when the company who issued the tokens turns a profit, holders are rewarded extra tokens as dividends. How much each coin holder gets is determined by process of Proof of Stake, or how many tokens they own. What’s more, security token holders can get ownership of the company, which includes voting rights based on a system created by the blockchain platform. This gives holders a say in the company’s decisions.

On the other hand, utility tokens, are used for the company’s products or services, and while these tokens can also accrue or lose value in the market, token holders do not gain ownership rights, and are therefore not able to exercise any control over the company’s decisions.

However, the fact that both can be used to earn a profit, can make the difference between the two types of tokens a bit blurry. That’s why the SEC developed the ‘Howey Test’. This test determines whether a token is a security or utility token, and comprises of two questions:

— Can token holders help a company raise capital and do they receive a portion of the company’s profits?
— Does the company raising funds generate profits by anyone other than the creators or founders of the company or project?  

If the answer to any of these two questions is ‘yes’, then the SEC will most probably classify the token as a security token.

It is important to know the classification of a token, since security tokens must comply to the same laws and regulations of normal publicly listed companies, and complying to all these laws and regulations can cost the startup or company a lot of money.

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