What’s the Difference Between Utility Tokens and Security Tokens?

For most crypto beginners, tokens are simply a representative of their favorite cryptocurrencies. Yet, if there’s anything they need to know, it’s that the tokens are different in their functions.

To a large extent, they can determine how much profit you’ll make from your crypto investing. Right now, we have two token types in the cryptocurrency market. They are utility and security tokens.

While they may be similar on the surface, they are vastly different, offering different benefits and rewards to its users or investors. Let’s take a quick look at both of them.

Utility Tokens

These are tokens created by the crypto founders to be used for something specific. They range from native platform tokens to gaming tokens. Cryptocurrency startups that create these tokens do so with the intent of getting more user engagement.

Of course, there’s always a reward of some sort from the use of the token. For instance, the Binance Coin –Binance’s own native token- helps lower withdrawals costs by offer as much as 50 percent discount on withdrawal fees.

This may not seem like a lot to small or long term investors. But, it’s a huge incentive for day traders with large trading volumes or capital. The same goes for Filecoin which issues its token as a reward for participants who offer their excess storage space.

Utility tokens have become increasingly popular, thanks to the creation of more projects with those tokens. Many of these tokens are often created on the ethereum platform, thanks to its ease of use and creation.

Ethereum’s blockchain is designed in such a manner that developers and regular users can create their tokens in a few minutes. With the opportunity for the easy creation of dApps (decentralized applications), it is possible for a crypto founder to also create his tokens and launch his own initial coin offering (ICO) through the ethereum platform.

Many of these utility tokens are actually released to the public in the hopes of improving the crypto project’s liquidity and ensuring its solvency. At the end of the day, these tokens have actual uses in pretty much the same way as flyer miles, and reward points do.

Utility Token Benefits

The first thing these tokens do is serve as a reward of sorts for the use of the crypto platform or participation in the project. They are often used to incentivize users and participants.

For instance, a founder looking for more engagement or an even bigger sized community around their crypto project can easily offer these tokens as rewards. The same goes for a real world project that wants to encourage participation.

For example, to help encourage the use of solar as an alternative source of energy, certain companies like Swytch are offering rewards to participants on the platform. Their tokens can then be exchanged for bitcoins or ethers, and further on to traditional currencies. Others are working on tax rebates or other such incentives.

Utility Token Disadvantages

While utility tokens are great, they also have their downsides. First is the relative ease of creation. This has created a regulation quagmire that the industry has to deal with.

Because they can be easily created, they aren’t subject to regulatory scrutiny, thus making them a bit of a gamble for the users. Users who invest in these tokens can lose their monies if the company suddenly goes belly up or even decides to terminate the validity of the tokens.

Even worse is the fact that because these tokens can be easily created, scammers are taking advantage of this and churning out tokens as they please. Most of this is done with the sole intent of scamming people of their hard earned money by getting them to invest and then bolting with their funds.

This is a serious problem and one the industry needs to look into. In the meantime, investors need to be sure of the validity of the project behind the tokens. Don’t just invest in something because they have an excellent roadmap or whitepaper.

Make sure the team is fully committed, known quantities and verifiable. And in the event that they are unknowns, you might want to look at their backers –and verify those too. Most crypto projects have backers in the venture capital sector.

Security Tokens

These are cryptocurrency tokens that were created with the sole purpose of making money for the investors. This is usually clearly stated in the whitepaper’s project, with milestones outlined to help investors track their progress. These usually pass the Howey Test and fall under the Security and Exchange Commission’s regulatory purview.

These can be focused on tokenizing real world and/or digital assets, and are considered a popular option for many industries looking to raise funds. These tokens are representative of an investment contract between the issuing entity and its investors, with the investors promised some returns.

These are great because not only do they serve as investment vehicles, they can also be used as collaterals for loans because they are verifiable and legal. These are meant to completely change the way asset ownership is defined.

Up until now, there are assets that only the super wealthy can own or have access to. With these security tokens, these assets can now be easily accessed by regular folks. Of course, they don’t have buy the whole asset, as that would be too expensive.

But, they can buy parts of it, even with their meagre resources, thus improving their asset portfolio and even helping them achieve their goals of financial independence. With these assets “divided” into smaller parts, investors can enjoy benefits and rewards in the forms of dividends and asset value appreciation.

With security tokens, every physical asset or financial instrument can be tokenized. This tokenization opens up a world of opportunities for average investors.

Security Token Benefits

The first advantage of security tokens is the fact that they are usually legitimate. Unlike utility tokens that can be easily created and launched, security tokens go through a rigorous vetting and approval process.

So, whenever you’re investing in security tokens, you’re essentially investing in something akin to real world investment vehicles like stocks and bonds.

All security tokens undergo scrutiny and a vetting process vetting process by the Security and Exchange Commission (SEC) to ensure that they not only pass the Howey Test, but are also run by legitimate ventures.

This makes them a more reliable investment instrument, thus ensuring that investors get their returns on investment. For instance, dividend payouts are almost always guaranteed after a pre-determined timeframe. This makes it a great option for those looking to generate more passive income.

With these, you can invest in a wide variety of industries and asset classes. This gives the investor access to a large pool of investment options that they wouldn’t have been able to access in the past. Also, if you’re in a bind and need your capital or funds real quick, you can easily sell off the tokens and get your money in short order.

For startup companies, they can easily launch a Security Token Offering (STO). This will help them access a worldwide pool of investors, thus helping them skip the part of having a full blown blockchain business before seeking investors.

Coins of Security Tokens

As with all token types, this one isn’t without its demerits. For starters, they must pass the Howey Test. After that, they will then be subjected to strict regulatory processes –a concept that directly opposes the very nature of cryptos.

The entire process is often daunting with firms needing to adhere to the SEC’s rules and regulations. For instance, the SEC would require a firm to declare its financial records –something that many startups don’t have.

Then, there’s the investor limitation, particularly in the United States. Here, the SEC requires all security token investors to be either worth a $1 million at least, or earn $200k a year.

These two criteria alone have ruled out the majority of investors who would like to participate in the opportunities. The good news is many other countries don’t even have these restrictions. So, investors resident outside the US can participate, while those in the US may have to find a way around those limitations.

The final disadvantage lies in the process of tokenizing those real world assets. This will involve humongous logistical processes that many startups can’t handle. This is probably why only established companies have been able to partake in the security tokens opportunity.