There are all kinds of tokens in the world of crypto. In particular, the difference between a utility token and a security token is a loaded topic in connection with the SEC. We will therefore look at different types of tokens in this article, with a focus on the aforementioned two.

What is a token and a coin?

A token is a digital representation of a particular value. This can range from a portion of all cryptocurrency tokens on a blockchain to the right to vote or use services on a platform. A particular type of token does not have its own blockchain and is often created using a token standard via a smart contract created.

For example, many large coins like ERC-20 tokens started, such as Tron and EOS. Nowadays, many meme coins launched as a token via a token standard on the Solana or Ethereum blockchain, for example. On many blockchains, you can launch different tokens that can lead to just about any type of crypto token.

A coin is a cryptocurrency with its own blockchain. Bitcoin is a good example. All other cryptocurrencies of this nature are called altcoins.

What is a utility token?

A utility token literally means a token made for use. So you can use a utility token to do a specific thing on a blockchain network. The issuer of the utility token determines what you can use it for on their platform. By the way, a utility token can still be a coin with its own blockchain.

Common ways you can use a utility token:

1. Discount on transaction fees. A good example is the utility token BNB, which gives you a 25% discount on your transaction fees if you pay them with this utility token. This type of discount is present on several platforms.
2. Rewards. A number of platforms reward users in the form of utility tokens for a variety of things, such as promoting the platform or performing tasks.
3. Governance. Some utility tokens can be used to vote on a proposal to improve the platform. In this way, decision-making becomes more democratic and better equipped for users.
4. Access to services. For example, some utility tokens allow you to get priority when buying a coin that is launched on an exchange. In such an IEO (Initial Exchange Offering), it is often important to be the first to buy so that you don't fall behind the net, giving the utility token extra value.
5. Implementing smart contracts. Some utility tokens are necessary to pay for the output of smart contracts on a platform, such as ETH on Ethereum's blockchain. This can give such a token a lot of extra value, as it will be in high demand when used by decentralized applications, for example.
6. Paying transaction fees when trading on the token's blockchain.

Extension features utility token

Utility tokens can gain more and more functionality over time and be used for more and more things. All these things combine to give the token extra value, which is why some utility tokens quote higher and higher prices.

Tokens on virtually all blockchains are used to pay transaction fees with them. Therefore, you could argue that almost all of them are utility tokens. Oddly, then, you could call meme coins securities, because they are not usually used to pay transaction fees with them.

Well-known utility tokens and the SEC

Well-known utility tokens are ETH, BNB, SOL and LINK. These are used for all kinds of applications, especially for the execution of smart contracts, and so they count as utility tokens. These tokens are offered in lots of places outside their blockchain, so they are seen less and less as a utility token and more as an investment. In this state of affairs, the SEC is trying to get a foot in the door by starting to view it as a security token.

A real disadvantage of utility tokens is the lack of clarity in terms of regulation. They are actually barely covered by regulation, and that is likely to change over time. This could have a big impact on their value.

The SEC on utility and security tokens

Utility tokens are not supposed to be an investment product like stocks and security tokens. Yet the SEC (Securities and Exchange Commission of the United States) is increasingly finding that a utility token is a security, so it should be treated very differently under the law.

The Security Act of 1933

First, let's take out the Securities Act of 1933 so we know what we're talking about.

After "The Great Depression" (the years after the stock crash of 1929), laws came in to restrict the selling of securities (securities) on a large scale (between states or countries). If you wanted to do such a thing, you first had to register the company with the SEC (from 1934, Securities Exchange Act) before issuing it.

The Howey test

In 1946 there was a major SEC lawsuit against the W. J. Howey Corporation, in which Howey was accused of issuing securities without first notifying the SEC. This resulted in a kind of blueprint for determining whether something is a security or not: the Howey test. Howey lost this case, by the way.

This test assesses whether:

An investor puts money into a business through a contract, where he can expect that he is going to benefit from the efforts of others by receiving proof of participation through shares or through nominal interest on the physical assets used in that business. Thus, the investor intends to generate a passive income.

So when you buy shares in a company it is quite clear that it is a security. We will leave out the second part that deals with physical assets in the context of cryptocurrency, because it is not an issue in this discussion.

So the Howey test looks at whether you become part owner through a token and others actually start working for you, with you getting a share of the revenues or profits.

With ordinary companies, it is very simple to do the Howey test. Suppose there are 1000 shares of a company and you have 10 of them, then you get 1% of the revenue allocated to all shareholders. Then we are talking about a security.

The Howey test for cryptocurrencies

With cryptocurrency, it doesn't work that way. There are no shareholders at all and no portion of the profits are distributed to them. You have to get into all sorts of twists and turns to put this anyway. This is why, in my view, the SEC loses case after case: They often have no case at all !

It looks suspiciously like the SEC just hates cryptocurrency and wants to abuse its power to harass all kinds of blockchains. One blockchain after another is accused of issuing unregistered securities, even Ethereum!

The Initial Coin Offering and security tokens.

The SEC accuses blockchains of issuing security tokens at their ICO because participants in the ICO shares of the company would get according to the Howey test. This is an already more difficult thought trick to assess. Usually the team and investors get a portion of the tokens.

The team needs these tokens to sell them in the future so they can pay for the day-to-day operations of a blockchain. Employees also need to be paid. These are not shares, of course, but capital.

Investors in an ICO buy tokens to make a profit from them, that is abundantly clear. I know of few investors who buy something to make it poorer. They are sometimes called angel investors, but angels are only found in heaven. You could, with some imagination, call these stocks, but you have to do your best. Now, when you start a blockchain you need initial capital, and for that you have to be able to sell something.

Crowdfunding or securities?

When you sell these tokens you are actually doing crowdfunding. Whoever buys these tokens does not get a dividend and does not benefit from someone else's work, although you can fight the latter somewhat. After all, the developers of the blockchain normally try to make it a successful project and thus the token becomes more valuable.

The SEC has had some success with this argument, but it is rare. No blockchain has shareholder meetings and profit sharing. If it does, it is a security token. If buying a token for the purpose of making a profit makes that token a security you can call many more things a security. You can then even call art a security if you buy it to make a profit from someone else's brushstrokes.

Therefore, with Trump's re-election, I hope that this "witch hunt" is over and that the SEC goes back to doing what it was created to do, which is to review traditional financial products. Most blockchains do not issue shares. No matter what you think of them.

What is a security token?

As we saw with the Howey test, you can describe a security token as a security token into which you put money and where you can expect profits through the work of others.

Security Token Offering

A security token can be sold in a Security Token Offering, where investors are given collateral. This is a sale where you have to abide by special rules, enforced by financial regulators, protecting investors from fraud. This is in contrast to the ICO, where you sell a (utility) token without any protection for investors, who then have to trust that it is not a scam and that this token is going to be worth more.

After an ICO, new tokens can still be added, whereas a security token gives you a share in a real company. If a token provides passive income, it is considered a security, or share with profit distribution or dividends, for the law. Those who have been reading for a while may well have lost the thread in this story. Quite frankly, I am somewhat so. No wonder it's raining lawsuits from the SEC. This is so unclear that even Proof of Stake can turn a token into a security.

How does security work?

A security can represent both a possession and a debt. With a token, you can do the same. If you borrow money, you can get a security token that represents your debt and your obligations, similar to a bond. A token that represents a possession shows what that possession means and on which blockchain it can be found, similar to a stock or ownership certificates.

The security token is usually used to represent an asset. This token can be issued for several reasons. One such reason is to make an asset more liquid to make.

Suppose you have a villa that you bought for 50 million euros. You actually want to sell it again, but there are so few buyers for it that you don't even know if anyone has enough money to buy it for more than 50 million. You can then make your holding more liquid by dividing it into much smaller shares. For example, you can create 1 million shares on a blockchain and sell them for 60 euros each. That way you can make a nice profit and the shares are good value. This is a security token.

An additional advantage is that anyone in the world can buy a share in your villa. So no one has to physically travel to an auction house, or be present at the online sale. You don't have to pay the auction house a penny, and this villa will be owned by people from all continents after the sale.

Since these title deeds are on a blockchain, they cannot be stolen either. Even if the villa were no longer there the property rights would remain, although I would suggest that in such a case the owners ensure that the villa is well maintained and put to good use, by renting it out, for example.

How do you buy security?

Security tokens can program additional conditions into their token to get on their whitelist. For example, one can stipulate that only investors who fill out their personalia in a Know Your Customer list can participate in investing in their token. Certain countries or regions can also be excluded.

Companies can issue a security token to raise money so they can begin operations. This includes blockchains, which need initial capital to pay their employees. This is called a Security Token Offering (STO), as opposed to an Initial Coin Offering, which does not have to be security.

When does the SEC judge that something is a security?

Generally, the SEC (and similar institutions in other countries) will view a token as a security if new tokens are created and sold over and over again, a kind of permanent ICO, as XRP sometimes does. With most blockchains, it doesn't work that way. New tokens are created by a consensus protocol like Proof-of-Work or Proof-of-Stake. The nodes or miners who make the blocks receive compensation for doing so.

What are advantages and disadvantages of security?

Blockchains that offer security tokens have great advantages over traditional ways of selling shares. For example, you can sell shares much faster and all over the world. It also eliminates the expensive middleman, such as the notary. You also have much less cost in personnel and paperwork. A smart contract is enough. Because the rules and prices are set in advance, they cannot be tampered with either.

Disadvantages of security tokens include regulations, which require a blockchain to incur more costs to market the token. Therefore, many blockchains find that they do not market a security token, but the SEC does not always agree.

What is an equity token?

Equity means equity. Equity tokens are a form of cryptocurrency property, where private property is divided into smaller digital parts by a smart contract.

For example, you could finance a new building with equity tokens. Each token then represents ownership of part of the building, with any increase in the value of the building giving the token more value. Once you also get dividends and voting rights, it becomes a security token.

You can always divide Real World Assets or Asset Backed Tokens into equity tokens through a smart contract to raise debt for financing. The laws for equity and security tokens are very different by region, so issuing them is legally challenging.

So the difference between an equity token and a security token is that with an equity token, you fund an underlying asset, taking partial ownership of that asset, whereas with a security token, you take a stake in the entire company, including profit distribution and codetermination.

What is a real world asset token?

A real world asset token is a token that represents something physical. For example, you can have the physical dollar represented by a digital one in the form of Tether or USDC. Normally, the issuers of these tokens make sure that all their tokens are covered in the real world with liquid assets (such as repo agreements and government bonds), so the value can also remain $1.

Another form of this is a digital gold token, which is backed by physical gold. It can also possibly be backed by assets worth as much as the total number of tokens. Examples include PAX Gold and Tether Gold.

You can create all kinds of tokens this way that are based on the value of real-world physical products. Coverage of this is essential, because once there is only partial coverage, the value of the token can start to diverge from the value of the product it represents, as we saw a while ago with Tether.

What are DeFi tokens?

These are tokens that can be used in decentralized finance. It is a form of programmable money that allows you to enter into financial contracts through smart contracts.

You can use these tokens to do the same things as in traditional finance, but on a blockchain without intermediaries. You can use them to borrow, lend, earn interest, provide liquidity, and so on. Because it is decentralized, the costs for this are very transparent and a lot lower than, say, a bank.

Examples of DeFi tokens are AAVE and Maker.

What is a reward token?

A reward token is a token you can earn as a reward for your contribution to a community. An example is STEEM, which you can earn by writing stories on a social media platform and responding to those of others.

What is a reputation token?

A reputation token is a token that represents your reputation. For example, if you are right very often in predictions, you get a high reputation. Suppose you are right 9 out of 10 times in predicting who will win the Barcelona - Real Madrid match, then you can be seen as an authority on the subject.

It can also be about who wins elections, how often it rains in a region or other events. The more often you are right, the higher your reputation becomes and the more you can usually earn. An example of this type of platform is Augur with their REP token.

What are privacy tokens?

These are tokens that allow you to operate without others being able to find out who owns them when you make a transaction. Having privacy as a high priority allows users to transact anonymously.

The privacy coin is somewhat under fire because authorities want to know where the money comes from and whether it is not being used for illegal activities. It is quite possible that they are going to ban these coins.

Examples of privacy coins include Monero and Zcash.

What is a fan token?

This is a token issued by a popular club, such as Barcelona or Manchester City, that fans can use to buy or do all kinds of things related to that club, such as get a discount on a season ticket or shirts, meet their idols or get priority when buying tickets for a cup game.

Examples include the FC Barcelona Fan Token and the Manchester City Fan Token.

What is a native token?

A native token is a token issued by an exchange that is actually intended to be used exclusively on that exchange, although it may later be given more functions.

Examples include Binance Coin, Gate Token, LEO Token, and so on.

What is a governance token?

A governance token is a token that gives you the right to help decide the future of a project. Usually its value grows with the success of the project.

Governance tokens were created to bring more decentralization to a blockchain, giving developers a connection to the desires of users and investors. These types of projects often call themselves a DAO .

Having a governance token gives a blockchain more cohesion and loyal users and investors. A downside is that people with many tokens can begin to determine the direction, and problematic voting behavior by token holders can get in the way of the blockchain's success.

The first DAO token released went down in such a way that Ethereum emerged from it, leaving Ethereum Classic behind by a hard fork! This project was simply called The DAO.

What is a token as a means of payment?

Some blockchains have a cryptocurrency that you can also pay things with. For example, some tokens allow you to pay in stores as well. Some of them even have as their main purpose at inception to be suitable as a means of payment.

For example, DASH, Monero and Bitcoin Cash are typical examples of so-called digital cash, or digital currency. As crypto more mainstream more and more companies will begin to see the value of crypto payments. It can generate additional revenue, so they will change tack and start accepting the major payment tokens as payment. Bitcoin also belongs to this group.

What are non fungible tokens?

Non fungible tokens, better known as NFTs, are non-exchangeable tokens. They can be unique tokens or they can be issued in a limited quantity. They differ in that other tokens are all exactly the same, just as every Bitcoin is the same as all the others.

At a unique NFT you have to think of the digital representation of art, for example, but also other unique things, such as the first tweet or the only recording of a very important event.

A particular series can also be made, such as the Bored Ape Yacht Club, each member of which is unique, but sometimes they choose to make 10 of each member of such a series or so. Then it is a limited NFT. In some play to earn games and metaverses you may also encounter the NFT, sometimes in very large quantities, such as a pickaxe you need in the game or clothing.

Conclusion

There are many types of tokens, each with their positive and negative aspects, too many to mention. Since regulation around cryptocurrency is still in its infancy, regulation can either get in the way of this world or promote it. Let's be positive and assume the latter.

Over time, the crypto world will mature a lot and regulation will begin to resemble that of the stock world. In any case, people will then know where they stand, which can make the investment climate for cryptocurrency clearer and most tokens safer.