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What is the difference between security tokens, utility tokens, and NFT?

NFT Image

Image credit: https://decrypt.co/

The term “token” appeared during the development of the Ethereum network. Over the years of the existence of digital assets, this word has become universal. Different tokens are combined into groups that differ in several ways. There are three main types of tokens – security, utility, and NFT. Each of them has its own characteristics, and these features need to be understood before issuing or buying any kind of token. Stobox has more than four years of experience in tokenizing assets for clients, and today will tell you the difference between the three types of tokens.

Utility tokens

These are tokens whose holders can receive a useful advantage (or several advantages) on a certain platform. Such tokens can be compared to chips in a casino, tokens in an online game, or vouchers. They can be earned and used in accordance with the rules of the platform.

It is important to know that a utility token is a token that is only a tool for a particular platform but does not reflect the company’s shares. The value of such digital assets fluctuates based on supply and demand. This type of token can only work in the form of bonuses or a certain reward. For example, such tokens can be used instead of cash to pay for goods or services. There are two options – direct payment or receiving certain discounts.

The utility token is the most popular type of token right now. It is also widely used on cryptocurrency exchanges. With such assets, you can receive discounts on trading commissions and use various functions of trading platforms. Also, utility tokens have another important advantage – they can be freely traded. There are no significant restrictions here.

Security tokens

Security tokens, also known as ownership tokens, are de facto digital securities. For example, they can be stocks or bonds that are listed on the blockchain. Blockchain does not allow changing or deleting information, so it has become a reliable solution for storing tokenized assets.

Security tokens are most often used by private firms that do not trade stocks on exchanges. Previously, such companies could only receive funding from banks, venture capital funds, or private investors with very large capital exceeding $1,000,000. The tokenization technology allowed such companies to find new funding sources, which is exactly the area in which Stobox works, helping its clients launch STOs (security token offerings). 

Security tokens provide higher returns than traditional stocks available for public companies. A study by McKinsey Private Equity Research showed that over the past 10 years, the growth of private markets had exceeded the growth of public ones by 50%.

The key difference between a security token and a utility token is pricing. The price of security tokens is determined by the value of the pegged asset or company. Another important difference is in regulation. Utility tokens are subject to countries’ laws on cryptocurrencies; in many states, there are still no such laws, or they are imperfect. Security tokens are regulated like traditional securities, according to the principle of the Howey test. That is, state regulators of stock markets take controlling measures. For example, the Securities and Exchange Commission (SEC) regulates security tokens in the US.

What is the Howey test?

The Howey test determines whether a transaction is an “investment contract” under US law. If yes, it is recognized as a security and is subject to the relevant laws. Conducting such a test is the prerogative of the SEC. If the Commission decides that the token is a security, then it will be officially regulated. However, there are also important legal nuances. In particular, if the token is considered a security, the issuer will be required to file an application for registration with the SEC and comply with all its requirements.

Due to the peculiarities of regulation in the USA, an interesting situation arises with utility tokens. The Howey test is broadly worded, and many utility tokens fall under its scope. In 2018, the head of the SEC, Jay Clayton, said that all the ICOs he saw could be attributed to the issuance of securities. Because of this, there is an additional risk since the SEC may consider such assets as securities and oblige utility token issuers to register and comply with the relevant requirements. Failure to comply will result in serious consequences.

NFT

Non-fungible tokens, or NFTs, are a relatively new type of tokens. They are collectible digital assets. NFTs are issued either in a single copy or in a small group making a specific collection. A variety of information can be encrypted in the NFT, for example:

  • Texts.
  • Drawings.
  • Images.
  • GIF animations.
  • Video.
  • Music.
  • Domain addresses, etc.

NFT is a unique token that another digital asset cannot replace. For example, if you take two utility tokens from one platform or two security tokens in which securities of the same type and denomination are encrypted, they can easily be replaced with each other. Each NFT token is unique, pegged to a unique object, and there is no other like it. Therefore, they are of exceptional value.

The main function of the NFT is to preserve ownership. Artists, musicians, and authors may sell ownership of the art piece but retain intellectual property rights.

NFTs are also widely used by many companies as digital souvenirs to promote their brand. With their help, companies can influence their image and increase awareness. You can also create corporate NFTs, for example, giving them to employees for certain achievements.

Which tokens are best for raising capital?

Choosing the right option depends on the type of your business. For example, if it is a private company that needs funding but doesn’t want or can’t go public, security tokens are the best option. They are similar to securities, but their issuance is easier. Such tokens can be sold to private investors, which results in receiving the necessary funds.

Utility tokens are another way to raise funds for blockchain projects. Such tokens may also have the potential for valuation, and the issuance of these assets allows you to raise funds actually through the pre-sale of certain works or services. However, the utility token has been losing popularity in recent years, and ICO (Initial Coin Offering) attracts less and less interest every year. However, both types of tokens can be used simultaneously in a blockchain project. If you doubt what type of token you should issue, Stobox will be happy to advise you.

Summary

Security tokens, utility tokens, and NFTs are the three most popular types of tokens, and each has its own characteristics. Each type of token can be used to raise investments; however, there is a difference in legal nuances as well as in fungibility. Utility tokens are gradually losing their popularity, as they may fall under the definition of securities by the SEC. Security tokens are the digital equivalent of conventional securities and are also subject to regulatory scrutiny, but this also provides a higher level of safety for investors. NFT has traditionally been more about the art world and allows you to own the rights to some unique object, hoping that in the future, it will increase in price. Which tokens to issue depends on your type of business and jurisdiction, and here you can not do without detailed advice, which Stobox provides.

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