By Larry Wright
There is no question in anyone’s mind that blockchain technology is producing huge upheavals across practically every business sector that currently exists. The use of blockchain technology paves the way for the development of a wide variety of novel business strategies. Many people believe that blockchain is the only system that, since the emergence of the internet, does have the possibility of bringing about beneficial developments such as decentralization and permissionless networking across different organizations across the globe.
Among the numerous important reasons that have resulted in the development of distributed ledger technology, the use of tokens is among the most important contributors. Tokens are created on top of other blockchain technologies that already live, in contrast to coins, which are actual virtual currencies that operate on their very own original network.
For instance, Bitcoin (BTC) or Litecoin (LTC) are called “coins” since they operate on their native distributed ledgers, whereas Chainlink (LINK) is referred to as a “token” as they function upon the Ethereum network as they don’t have their very own blockchain on which they could function. In the huge community of cryptocurrencies, a digitized token is utilized as a depiction of worth, usefulness, or online property.
Such tokens are beneficial in a number of different blockchain operations, but before you spend your cold hard cash on tokens, it is crucial to know exactly what you are purchasing.
Tokens may be divided into two broad categories: utility tokens and security tokens, as many of you are already well aware. Utility tokens are similar to what you’d discover with any type of advertising or promoting an item, whereas security tokens are subject to government monitoring because they represent a shareholding or stake in an organization. This inspection comes with security tokens only, and no such regulations are associated with utility tokens.
Individuals who are interested in entering the financial system may find that purchasing security tokens is the most effective approach to enter into the crypto space. The idea behind them should not be too foreign to you, too, given that they are comparable to stocks in that they symbolize firm shares; in addition, the possibility of owning a piece of the upcoming big decentralized software start-up is very appealing for obvious reasons.
However, if you are just interested in purchasing something little to keep as a memento from an initial coin offering (ICO) for a firm that is important to you, then purchasing a utility token may be the best option. Prior to making the purchase, ensure that you have a thorough understanding of the token’s redeeming rules by paying particular consideration to the information I’ll provide in the upcoming paragraphs.
This guide will go further into the notion of tokens and assist you in obtaining a clearer image of security tokens versus utility tokens in the process. In addition, you will gain an understanding of the distinctions that exist between such tokens, as well as the uses, benefits, and drawbacks associated with each.
What are Security Tokens?
A security token is a digital representation of a piece of ownership in a company, such as stock, debt, or real estate, and it draws value from exogenous exchange platforms like stocks or estate development. The concept of “security” doesn’t really have anything to do with physical protection if that’s what’s going on in your mind; alternatively, it entails the digitalized representation of the monetary worth of any asset in the shape of an option, stock or bond. There are three kinds of security bonds, namely equity tokens, real-estate tokens, and debt tokens, and they all have different functions to perform.
Tokens that depict the valuation of an equity stake in a corporation and are distributed by that firm are referred to as equity tokens. The possession of equity tokens is verified not on paper documents but rather on the distributed ledger known as the blockchain.
Tokens that denote financial obligations, such as loans or debts, are called debt tokens. Lastly, real asset tokens, also known as RA tokens, are digital representations of physical assets, like real estate, artwork, or commodities. Such tokens may be used to verify the authenticity of such investments. The value among these tokens is determined by the value of assets that corresponds to them.
A security token performs the very same tasks as a conventional security asset. Owners of security tokens receive the very same responsibilities and rights as buyers of the conventional asset when purchasing any standard asset from a brokerage.
This indicates that they both have an equal share of the earnings and the same political representation in terms of the voting rights they possess. The one and only distinction are that a security token is a blockchain-enabled asset and is an electronic representation of a conventional security asset. Additionally, security tokens are intended to be used in the form of investments. As a consequence of this, the very same governmental scrutiny that applies to conventional security assets applies to them as well.
When contrasted to ordinary securities, security tokens come with a number of advantages. Settlement of traditional securities often takes a few working days. In comparison, security tokens are significantly more practical and may resolve inside a few minutes, therefore conserving a lot of energy and time.
Moreover, the introduction of security tokens has made it easier for merchants to do business on a worldwide scale, lowering the bar of entry for individuals who are interested in investing and making it more accessible to the general public.
Moreover, liquidity is hampered when it pertains to traditional securities marketplaces as they are really only accessible during regular business hours only, that is, from Monday to Friday, and so, one can not have access to those on weekends or legal holidays, regardless if that’s the only time when they can actually acquire or sell their electronic assets.
However, traders using security tokens have access to trading opportunities around the clock, seven days a week. In addition, the use of security tokens makes assets more compatible and available. Developers may likewise program security tokens and make them even more compatible and adherent to regulatory rules to make them even more secure. It’s possible that the method for making the tokens compatible may potentially be computerized in the near future, too, which is again a huge benefit.
Rather than conducting initial coin offerings, businesses now use something called security token offerings (STOs). In contrast to ICOs, firms conduct STOs in an atmosphere that is tightly controlled and vigorously monitored to ensure that everything is legal and authentic. STOs are required to be registered with the appropriate regulating bodies by businesses, and these industries must also satisfy all of the regulatory criteria.
What Are the Benefits of Using Security Tokens?
Security tokens have the potential to eradicate the vast majority of frauds operating in the cryptocurrency sector. Since the businesses that issue security tokens are required to clear a substantially higher number of governmental obstacles before making them available to the general public, these tokens have a reputation for being intrinsically more reliable investments.
Moreover, quarterly payments are given to security token holders based on their asset’s revenues, much like stock dividends. They will have a source of revenue that is more consistent and dependable as a result of this. Hence, consistency is a big advantage of employing security tokens.
To add on, security tokens allow investors to have exposure to any type of firm, commodity, investment, or institution that generates value. This brings so much diversity to one’s investment portfolio and, therefore, increases one’s chances of generating even greater revenue meanwhile significantly lowering their potential risks. Hence, the availability of a substantially greater range of financial opportunities to everyone with any amount of capital is made possible by the use of security tokens.
You will be likewise capable of selling your token quickly if you need the cash, and yet, the best part is that you can get your cash almost instantly! Means no delays, and you have your investment cash right in your hands. Lastly, security tokens are actually being practiced worldwide, and so founders or any other sort of producer may have access to an international number of financiers by conducting a security token offering (STO). Hence, your exposure gets significantly higher when you opt for security tokens.
Drawbacks of Security Tokens
While security tokens have a long list of advantages attached to it, there are some disadvantages too, which I believe are really important for you to know. The biggest drawback is that there are so many restrictions imposed by the law when it pertains to employing security tokens for investment purposes. The SEC uses something called the “Howey Test,” which determines how an investment is a security by comparing it to a set of criteria, including the following:
- It involves the expenditure of financial resources.
- It is anticipated that a profit will be made from the investment.
- If there’s profit made due to the contribution of a promotion by a third-party.
- The funds are being used toward the operation of a shared business.
In order for a property to be considered a security, it must satisfy all four of the conditions listed above, which is obviously not an easy criterion to fulfill. It is definitely not a small or easy task to enroll in securities because businesses are required to abide by a stringent body of regulations that demand comprehensive financial documents and so much more.
These laws are in place to safeguard individuals from having their money stolen through fraudulent investment vehicles, though, yet, there are really time-consuming and tedious. Any company might end up spending a lot of money and wasting a lot of time adhering to these rules, so it’s a disadvantage to using security tokens. Moreover, only credited individuals are allowed the purchase of security assets. According to the standards that are now in place in the United States, investors who qualify as “accredited” must have a net worth of at least one million dollars or an annual income of at least two hundred thousand dollars.
Lastly, tokenizing properties that already exist in real life presents a number of logistical problems, the most significant of which is guaranteeing that the information that is being transmitted to the network is updated, accurate and complete. Because security tokens reflect real resources worth billions of dollars, it will be required to source data that is both fast and reliable in order to establish its state, which is again a characteristic difficult to achieve.
What Are Utility Tokens?
User tokens or app coins are two different names that are used to refer to utility tokens. Utility tokens are distributed by a company as part of its initial coin offering (ICO) when it conducts public sales. When a business generates a utility token, it’s effectively establishing an electronic voucher that can be cashed for subsequent discounts or exclusive membership to a specific service or product in the near future.
This coupon may be redeemed for one of two things: discounted costs or special memberships. Utility tokens, in contrast to security tokens, may be excluded from the existing regulations or stringent protocols as they are currently in the process of being set up. This means that utility tokens are not commonly utilized as investments.
The price of utility tokens often varies based on the demand and flourishment of the initiative too. Acquiring utility tokens may result in financial gain for the holder of the tokens if the venture is capable of accomplishing the objectives it set with a satisfactory level of success. Civic, and Filecoin, are two known examples of utility tokens.
Utility tokens have particular functions to serve. Foremost, the holder of the token is granted specific rights, such as the right to make use of or possess a business, as well as the right to propose or vote on particular situations or themes. In addition, possessing utility tokens gives you the ability to store data in a decentralized manner meanwhile enhancing the overall customer experience by supplying incentives for certain actions when those actions are completed successfully.
Within the public ledger technology, utility tokens may serve the function of money too. Additionally, it has the potential to serve as an alternate method of making reimbursements in the decades to come. Lastly, one can also distribute their tokens among people in order to increase one’s chances of success.
A developer has the ability to program a utility token to perform almost any function they see fit. Utility tokens, in the broadest sense, are digital assets that provide holders accessibility to a particular blockchain-based service or item. They could be employed to transfer wealth, although it is not often its primary function.
They were created for other reasons. Non-fungible tokens, often known as NFTs, may function in the same way as a unique utility token. An NFT token demonstrates a one-of-a-kind item of electronic artwork; however, NFTs may also be used to represent other types of media, such as entertainment, songs, or a piece of paintings.
However, it should be noted that utility tokens that have been distributed via initial coin offerings (ICOs) have the risk of being misused for dishonest or fraudulent purposes. For instance, during an ICO mania in 2017 and 2018, numerous new blockchain companies offered investors utility tokens along with the guarantee of significant profits. Unfortunately, the initiatives were hoaxes, and not even a penny of discount was given to the audience. Buyers that made the decision to purchase ICO tokens such as these typically had no other options, and therefore, they ended up losing all they had.
Summary
It is widely held that the fact that security tokens are governed by the same government agencies that are responsible for overseeing the nation’s monetary system at all times makes them an awful lot safer. In addition, there is a possibility that the use of distributed ledger software to handle security tokens may turn out to be one of the uses of the technology that has shown the most promise to this point.
Utility tokens, on the other hand, do not represent any ownership position in the firm in which an investment is being made; rather, they offer the holder the opportunity to purchase or trade the underlying tokens on a selective basis.
I really hope that this article was able to aid you in comprehending the essential differences that exist between a utility token and a security token. According to the information that we have just acquired, the earlier denotes lawful ownership of an object, but the latter refers to a contract that is used to incentivize users’ behavior in a certain manner that is environmentally beneficial.
On the other hand, in contrast to utility tokens, security tokens are subject to more severe limits, which has led to the perception that security tokens are intrinsically more secure.