Utility vs Security: What you need to know

December 15, 2017

The world of crypto often operates outside of government regulations therefore independent entities such as FINMA, a Swiss organization, fill a vital role by regulating finance related projects and protecting creditors, investors and policyholders. 

Significant attention is being paid to these regulators and more specifically to tokens and whether they are Utility or Security tokens. Our own, Matej Michalko, recently returned from the BlockShow in Singapore, where this was a hot topic. 

“From what I have seen recently it is clear that some businesses still do not properly understand tokenization.” Reflects Michalko, founder and president of DECENT. “It’s important to understand there are two type of tokens, utility tokens and security tokens.”

Utility Token often have rights to:

  • program, develop or create features for the distributed ledger.
  • access the system.
  • contribute labour or effort to the system.
  • use the services of a system and its outputs at no charge.
  • sell the products of the system.
  • vote in a meaningful way, free information and possibility of exchanging opinions among token holders.

Think of utility tokens as the fuel that drives the entire system.

Security Tokens, a.k.a. financial instruments, often:

  • represent a monetary investment in a startup.
  • give a share of profits and/or losses, or assets and/or liabilities.
  • provide status as equity holder, creditor or lender.
  • count in bankruptcy as equity interest holder or creditor.
  • indicate repayment obligation from the issuer of the Token.
  • Management or board of the issuer have the effective control over the project.

With security tokens there is a reasonable expectation of profits, consisting of dividends, periodic payments and/or the increased value of the investment. Profits are to be derived from the entrepreneurial or managerial efforts of others (i.e. of the founders). Voting rights of the token holders do not provide meaningful control over the startup.

A token is either a utility token or a security token, it can’t be both. Furthermore, Security tokens often require licensing, which can be too costly and administratively demanding for many startups. For this reason most ICOs shoot for utility tokens. Even if new coins qualify for the less regulated utility token, most ICOs are more than happy to use Know Your Customer (KYC) and Anti-Money Laundering (AML).

“We recently launched a Token Generation Event for SophiaTX (ends Dec. 17) under a joint venture with Venaco Group and we were eager to require KYC and AML for our contributors even though SPHTX is a utility token. I think it is a natural evolution and necessary for responsible token sales. I certainly wouldn’t buy a coin without KYC or AML checks in place.”

– Michalko

We hope you found this information on the differences between utility and security tokens useful. If you have something to add to the discussion. Be sure to comment or join the discussion on reddit.