Cryptocurrency is a huge phenomenon. Like any fast-growing sector, there’s a lot of great potentials and a lot of misinformation about cryptocurrency. Now, it’s easier than ever to learn more about cryptocurrencies. One of the essential concepts to understand is the difference between utility coins and securities. Let’s dig in a little deeper and learn about these concepts.
What are securities?
The most prominent cryptocurrencies, like Bitcoin and Ethereum, are valuable for themselves. This is part of their design. Their derivation of value is similar to other currencies on a general market, as described below. However, the key factor is whether you’re investing in a cryptocurrency or blockchain-based coin as an investment in the coin itself. This is because you hope the utility coin will gain in value or because it will provide you access to services from a particular startup or company. Securities, because they’re much closer to being like fiat currencies (currencies issued and controlled by governments or central banks), retain more similarities to investments that you might make in order to make money directly. That means they can gain and lose value, but it also means that they’re subject to a lot more regulation.
What are utility coins?
Startups often use utility coins, which sell them as digital coupons to customers or investors. This provides startups with access to their future services whilst raising money. The key difference between typical crypto coins – securities – and utility coins is that utility coins are not designed to be valuable in themselves; They are only designed as part of an artificial economy set up by a company (like theme-park money can only be spent in the theme park, utility coins can only be spent on the products they were created for). For instance, Filecoin sold tokens to provide users with access to its services, which involved decentralized cloud storage solutions. In turn, the company raised over $250 million. However, because the tokens by design aren’t investments, they’re not subject to regulation in the same way as securities.
The technical definition: the Howey test
There’s a technical definition of the difference between a security and a utility token. In the US, the SEC (the government body that regulates currency trading) has a test, called the Howey Test, that involves asking four questions to see if a coin is a security or not:
- Is it an investment of money or assets?
- Is the investment of money or assets in a common enterprise?
- Does any profit come from the efforts of a promoter or third party?
- Is there an expectation of profits from the investment?
This test matters even if you are investing from outside the US. It matters because what the US does often sets the norm for other systems around the world. Additionally, the SEC is the relevant authority if you want to utilize cryptocurrencies using US resources. More specifically, this includes the use of US-based servers.
Why is the difference important to someone considering buying tokens or securities?
You should know that not all ICOs have the potential to generate profit for you. Importantly, if you plan on investing in crypto coins, you need to read the fine print and confirm whether you’re purchasing utility coins or security tokens. You don’t want to purchase coins in the hopes of letting your investment grow, only to learn that you can only use them to purchase the company’s services. Alternatively, if you’re looking for a secure way to enjoy those services, utility tokens may be the answer. So, utility tokens are less about investing and more about accessing and being part of services you will want to access in the future.