Tokens are different in their function, and this is the factor that determines the nature of the tokens that we use. So, how do security and utility tokens differ?
A utility token is a token issued in order to fund the development of the cryptocurrency and that can be later used to purchase a good or service offered by the issuer of the cryptocurrency. They also can serve as a discount or an advantage to access the features of the service/platform.
These are not designed for an investment purpose, but rather for service usage; however, they still can be profitable if the demand increases. Additionally, a utility token does not offer ownership rights and holders have no control over the decision-making process. A few examples of utility tokens are BAT, AVT, XCM, etc.
A security token is a crypto token that gains its value from an external tradable asset and becomes subject to governmental or federal securities regulations.
Security tokens are considered an investment contract and investors are hoping to gain profit from the token through the price movements. Furthermore, security token holders also get ownership rights, therefore in some cases, investors could receive dividends or participate in votes that affect internal decision-making processes.
How can I tell the difference?
Given the complexity of many tokens, it is not always easy to determine whether a token is a Specified Investment, specifically those types of Specified Investments that are securities, like shares or debt instruments. There are a few factors that are indicative of security.
These factors may include, but are not limited to:
The contractual rights and obligations the token-holder has by virtue of holding or owning that crypto asset
Any contractual entitlement to profit-share (like dividends), revenues, or other payment or benefit of any kind
Any contractual entitlement to ownership in, or control of, the token issuer or another relevant person (like voting rights)
The language used in the relevant documentation, like token ‘whitepapers’, suggests the tokens are intended to function as an investment, although it should be noted that the substance of the token will determine whether an instrument is a Specified Investment, and not necessarily the labels used. For example, if a whitepaper declares a token to be a utility token, but contractual rights that 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 of the indicators that the token is a security, although an indirect flow of payment (for instance 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).