Without question, blockchain technology and cryptocurrencies are creating huge disruptions in nearly every industry. The terms “token,” “coin,” and “cryptocurrency” are frequently interchanged. Both tokens and coins are popular forms of cryptocurrency, but coins and tokens are not the same things. To quickly differentiate between the two: a token is a digital representation of an asset, whereas a coin is merely a digital currency designed to make payments.
While tokens on blockchains can have value, they can’t be used as money in the same way that cryptocurrency coins can. How valuable a token is will depend on the purpose for which it was issued, and there are several kinds of tokens. This is where the distinction between security and utility tokens is important.
What Are Security Tokens?
The value of security tokens is derived from an external, marketable asset. Stocks or real estate, for example. As a result, they are governed by federal securities laws.
So, to fully understand what a security token is, you must first understand what securities are.
Understanding Securities
Any representation of an ownership stake in a publicly listed firm, or the ownership rights represented by an option, is referred to as securities. which is any financial asset that may be exchanged.
A security token is created when securities are issued to digitally reflect a genuine marketable asset. These tokens now reference the original asset. Security tokens can be used to digitally represent assets of many classifications that are exchanged and kept on a blockchain, such as stock, fixed income, real estate, structured products, investment fund shares, and commodities.
If the tokens created by a blockchain project fulfill all three conditions —as defined by the Howey Test— they are considered securities by law:
- It is a financial investment.
- The money is going into a shared venture.
- There is an expectation of profit from the work of the issuing company
How Are Security Tokens Made?
Security tokens are created as investments, so it’s worth understanding how leverage works in trading if you’re interested in acquiring them. Security tokens are issued during security token offerings (STOs). STOs must be registered with the appropriate financial market regulator.
As a result of the added regulatory scrutiny —on top of blockchain technology’s inherent security— security tokens are substantially safer and far less prone to fraud and exploitation.
Token holders receive dividends in the form of coins if the tokens’ issuing company makes a profit in the market. Users that have the security token receive a portion of the company’s equity.
There are two ways to make security tokens:
- Asset tokenization — By tokenizing a traditional financial asset that does not exist on a blockchain, it may be digitally represented. A real estate brokerage, for example, may create a digital token to represent properties or shares.
- Asset origination — Tokens can be generated through asset origination for financial assets that already have an on-chain presence. These assets are known as “natively digital securities.” Depending on the blockchain, they can be generated through mining or staking.
What Are Utility Tokens?
To oversimplify somewhat: if a token fails the Howey Test to qualify as a security, it is classified as a utility token. User tokens or app coins are other names for utility tokens. This should give you some idea as to how they’re used.
Utility tokens simply provide users the ability to exchange them for goods and services. In essence, they are a type of digital voucher that may be used to access the offering company’s network of products or services in the future; in some cases, they provide the right to influence the network by voting.
Utility tokens have value, but they cannot be classified as money in the same way a coin can. And, unlike security tokens, utility tokens are not utilized as investments since, if correctly set up, they can be exempted from federal securities regulations.
How Are Utility Tokens Made?
Typically, a tech startup business creates a digital product or service before launching an initial coin offering (ICO) (Initial Coin Offering), where the startup offers utility tokens during the ICO. Investors can purchase these tokens and use them to make payments on the issuing company’s platform for its products and services.
Differentiating Security and Utility Tokens
Security tokens are investments that reflect the legal ownership of a physical or digital asset that has been confirmed using blockchain technology. Utility tokens are designed to aid in funding initial coin offers (ICOs) and creating an internal economy within a project’s blockchain.
Security tokens are regulated similarly to other investment products, and their value is directly linked to the company’s market capitalization. The token becomes more valuable as the firm becomes more valued.
The value of a utility token is connected to the value of the items and services it may be used to redeem from its issuing firm rather than the value of the issuing company’s valuation.
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