Though two years passed since the SEC put an end to the ICO craze, many still cannot differ between utility and security tokens. Digital Asset Live Editor-in-Chief asked Frederik Bussler, the Security Token Alliance Founder to reflect upon this mashup.
Q1: How do you explain the difference between utulity and security tokens now, in 2020?
A1: The word “token” in the blockchain context may evoke mental images of cryptocurrencies and ICOs, regardless of the fact that utility and security tokens are worlds apart.
Put simply, security tokens are securities on the blockchain, or more accurately, digitized rights to ownership of a security, such as equity, debt, or a real asset, on a blockchain. They link the physical with the digital, creating tangible investment opportunities with greater liquidity, lower fees, lower investment minimums, and more transparency.
Q2: What do utility tokens do then?
A2: Utility tokens grant a user access to certain features of a network. They are, in the sense of the word as most people think of it, far closer to a “token” than a security token is. This creates a lot of confusion for outsiders, who may try to draw comparisons between utility and security tokens, forgetting that security tokens are digital encapsulations of securities. Comparing the two would be like comparing apples and oranges.
Q3: How do utility tokens get value?
A3: Utility tokens derive their value based on the underlying platform. If the platform is valuable, then the tokens, if they actually offer utility, will be valuable.
Q4: And what about the security tokens, how are they valued?
A4: Security tokens derive their value based on the underlying security, a tradable financial asset. If it’s an attractively priced asset with the potential for growth, then the token will be valuable.
Q5: Given the above differencies, why do they even have partially similar names? You are now giving an interview to Digital Asset Live, perhaps here lies the solution?
A5: Indeed, many have proposed alternative naming conventions like “digital security,” “digital asset,” or even “virtual asset,” but the latter two have been applied to utility tokens as well, and “security token” has stuck as the default nomenclature.
Q6: You described the differencies between the utility and the security tokens. What do they have in common?
A6: The only real similarity is that both are blockchain-based constructs, but if you’re to believe that blockchain will become as important in our digital infrastructure as the Internet, then this is a meaningless similarity.
Q7: Are they two types of tokens technically different?
A8: Although they both use the blockchain, they’re still completely different on a technical level. Utility tokens most commonly choose the Ethereum ERC-20 protocol, which offers just a few basic functions.
Security tokens are designed to increase compliance efficiency, so they have to account for things like securities regulations, requiring protocols with far greater complexity that can handle parameters from a token holder’s jurisdiction to their accredited investor status.
Let this be a lesson to those new to the space: Security tokens and utility tokens are fundamentally dissimilar.