Security tokens vs utility tokens

Security tokens vs utility tokens

April 19, 2024 Commodity Vault, Tokenization

Security tokens vs utility tokens: How they differ and what they’re used for

The growth of Web3 has seen tokenization come on leaps and bounds in recent times. In fact, the tokenization of assets has expanded into so many spheres and areas of interest, ranging from securities to real world minerals.

In this article, we introduce you to security tokens and utility tokens and ascertain the main differences between them. We explain what they are typically used for and consider why you might invest in them.

First, what is tokenization?

Before understanding the nuances between security and utility tokens, it’s necessary to define what tokenization is. Today, anything can be tokenized, be it a currency, a financial asset, or even a real-world mineral like natural gas.

The token is created and launched on blockchain technology. The creators of the token input key information about what the token represents and what it consists of. Then, the token is listed on an investment platform and can eventually be traded.

The creation of digital tokens in the modern day is similar to the paper certificates previously issued to purchases of stock. However, the digital asset exists solely on the blockchain and it can be traded among investors and added to digital wallets for safe keeping.

What are security tokens?

Security tokens, as their name suggests, are securities. This necessitates more rigorous protections for the people who create and sell them, as well as for those who buy them.

In the United States, the securities law came about as a direct result of the 1929 financial crash and the subsequent Great Depression. The “Roaring 20s” saw investors led astray by financial speculation, and the Securities Act of 1933 and the Securities Exchange Act of 1934 were passed by Congress to ensure something similar couldn’t feasibly happen again.

The broad term “Security” is used to define various investments, including stock, bonds, debentures, notes, oil and gas interests, and investment contracts. Securities are not currencies, which is an important distinction to make.

Fast-forward to the 21st century and the age of crypto, and security tokens are a form of digital asset that can be traded online. It is essentially a representation of a slice of ownership of or rights to an asset of a company. The token is created and maintained on a blockchain, and it is the equivalent of a real-world investment like stock, bonds, or other security assets.

Use cases and examples of security tokens

Security tokens are a way for investors to potentially profit from the potential returns typically attached to the investment. They can also be used to tokenize the ownership of real estate, for equity fundraising, and for the tokenization of investment funds.

Vevue is an example of a security token for a Wyoming based corporation. Another is Science Blockchain, which was the world’s first incubator to be funded by its own tokenized securities.

What are utility tokens?

Utility tokens are a form of cryptocurrency used to access a specific product or service within a blockchain ecosystem. The main difference from the outset is that while security tokens are widely seen as a type of investment, the value of utility tokens lies in their functionality within a specific platform.

For instance, they can represent a stake in a new project, provide access to premium features within a blockchain ecosystem, or even provide voting rights relating to a company’s governance.

Crucially, most utility tokens are not sold with the expectation of profit, as they have a non-investment nature. Rather, users can acquire utility tokens to engage with products and services offered within a blockchain ecosystem.

The nature of utility tokens dictates that they have much less stringent regulatory requirements than security tokens and they don’t provide a digital representation of ownership in a real world asset.

Use cases and examples of utility tokens

A common use of utility tokens is within a gaming platform, to buy in-game features or to access locked or restricted content. We also see the use of utility tokens on social media platforms, enabling people to tip creators and contribute to community polls.

Prominent examples of utility tokens include Ether (ETH), which is used to pay for gas fees within the Ethereum ecosystem, and FIlecoin (FIL), which is used to store data on the Filecon network.

What are the main differences between security tokens and utility tokens?

Security and utility tokens are used for different purposes in Web3. But the main differences between the two are as follows:

Purpose: Security tokens are purchased for profit, while utility tokens are purchased to access services, products, or features within a blockchain ecosystem.
Value source: Security tokens derive their value from the real-world assets that they represent, while utility tokens derive their value from their purpose within an ecosystem.
Regulation: Security tokens are subject to relatively stringent regulatory procedures, while utility tokens are not, though they must clearly communicate their non-investment nature from the outset.

Conclusion

Both security tokens and utility tokens play an important role in the Web3 landscape, but their roles are notably different. Security tokens represent real world investment options like stocks, bonds, and debentures and are typically purchased for profit.

On the other hand, utility tokens are used for access to services, products, or features within the ecosystem of a blockchain.

Understanding the difference between the two is important, as they can both serve as part of a diversified crypto portfolio.