Cryptocurrency tokens serve different functions, and this is a key factor that determines their nature and usage. Specifically, security tokens and utility tokens have distinct characteristics that set them apart. So, how exactly do these two types of tokens differ from each other?
A utility token is a type of token issued to raise funds for the development of a cryptocurrency, which can later be used to purchase goods or services from the issuer. They may also provide discounts or other advantages for accessing features of the platform or service.
Utility tokens are primarily intended for use rather than investment, but their value can still increase with demand. Holders of utility tokens do not have ownership rights, nor do they have a say in the decision-making process. Some examples of utility tokens include XCM, BAT, and others.
A security token is a type of cryptocurrency token whose value is derived from an external, tradable asset, and is subject to government or federal securities regulations.
Security tokens are considered investment contracts, and investors hope to profit from them through price movements. Additionally, security token holders have ownership rights, which may entitle them to receive dividends or participate in voting processes that affect internal decision-making.
How can I tell the difference?
Given the complexity of many tokens, it's not always easy to determine whether a token is a Specified Investment, particularly if it is a security like shares or debt instruments. There are several factors that may indicate whether a token is a security, including:
- The contractual rights and obligations that token-holders have by owning or holding the crypto asset.
- Any contractual entitlement to profit-sharing (such as dividends), revenues, or other payments or benefits.
- Any contractual entitlement to ownership or control of the token issuer or another relevant person, such as voting rights.
- The language used in the relevant documentation, such as token whitepapers, suggests the tokens are intended to function as an investment. However, it should be noted that the substance of the token will determine whether an instrument is a Specified Investment, not just the labels used. For example, if a whitepaper declares a token to be a utility token, but the contractual rights it confers would make it a Specified Investment, we would consider it to be a security token.
- Whether the token is transferable and tradeable on cryptocurrency exchanges or any other type of exchange or market.
- A direct flow of payment from the issuer or other relevant party to token-holders may be one indicator that the token is a security. However, an indirect flow of payment (such as through profits or payments derived exclusively from the secondary market) would not necessarily indicate the contrary. If the flow of payment were a contractual entitlement, we would consider this to be a strong indication that the token is a security, irrespective of whether the flow of payment is direct or indirect (or whether other ownership rights are present).