Utility Tokens vs. Security Tokens: What Are the Differences?

Utility tokens, security tokens, access tokens – there are so many different assets in the crypto space, it’s easy to get overwhelmed. While some assets might seem similar on the surface, the truth is that they all have their purpose. 

Understanding the differences between these tokens – particularly utility and security tokens – is important. Whether you’re an investor, project founder, or even a token creator, you need to know how each asset works and how it is regulated. 

Here’s everything you need to know about two of the most common types of tokenized assets, how they work, and how they’re governed. 

What is a Utility Token?

Utility tokens make it easier for participants to engage within decentralized applications (dApps) or blockchain networks, often by acting as internal currency or providing fee discounts, governance privileges, or premium features. 

Utility tokens are all about providing access to functionality. Think of them as digital “passes” to an application’s services. In a blockchain ecosystem, users with a specific number of utility tokens might be able to access discounts or use new features early. 

You don’t get “ownership” in a project or asset – and utility tokens aren’t backed by formal revenue-sharing structures. But utility tokens can be useful. 

Many blockchain-based services and decentralized networks employ utility tokens to facilitate on-platform transactions. For instance, a data storage project built on blockchain might require users to pay network fees in a native utility token whenever they upload or retrieve data. 

Alternatively, a gaming platform can offer a utility token as an in-game currency, letting players buy virtual goods or vote on upgrades to the system.

Examples of Utility Tokens

• BNB (Binance Coin): This token was originally introduced to provide reduced trading fees on the Binance exchange. Now, it also powers transactions on the Binance Smart Chain.

• ETH (pre-merge) functioned like “gas,” or the payment for performing actions on the Ethereum network. Today, Ethereum has shifted toward a more stake-based approach post-Merge, but the ETH token is still a good utility example.

• FIL (Filecoin) pays storage and retrieval fees on the Filecoin network. Miners who supply storage capacity earn FIL, creating a marketplace for decentralized data storage.

What are Security Tokens in Crypto?

Where security tokens focus on functionality and engagement in an ecosystem, security tokens concentrate on investment. They usually grant fractional ownership in a real-world asset or represent a stake in the underlying entity. 

A security token is a digital representation of an investment contract. That means it needs to meet specific legal criteria. For instance, in the US, regulators use the Howey Test to classify whether a token is a security. If there’s an expectation of profit solely from the efforts of others, the token is more likely to be deemed a security. 

Because they represent ownership or an investment contract, security tokens frequently come with stricter compliance requirements. They may pay dividends, share profits, or grant voting rights, much like traditional shares in a company.

While a utility token’s value often hinges on the demand for a particular product or service, security tokens pull value from underlying assets. Those assets could include company equity, real estate, or profit streams. If the underlying asset increases in value, so does the security token. On the flip side, if an asset’s value dips or the project falters, security token holders feel the brunt of that decline. 

Examples of Security Tokens

• GKCP: Used on the InvestaX platform, the CKCP token represents a fractional share in a GameFi investment portfolio (usually high-growth). 

• tZERO: tZERO, a platform for tokenizing, trading, and maintaining digital assets, offers STO tokens, giving investors exposure to blockchain-based assets that align with securities laws.

• Real Estate Backed STOs: These tokenize property ownership, enabling fractional investing. For example, a large commercial property could be split into thousands of tokens, each representing a proportional share in that building’s value.

Utility Token vs Security Token: Key Differences

Both types of tokens live on a blockchain, and can usually be traded on exchanges – but there are big differences in their purpose, liquidity, and regulatory status. 

Purpose: Access vs. Investment

Utility tokens give holders access to a special feature or part of an ecosystem. They might unlock reduced fees, advanced features, or the ability to vote on proposals. For instance, the Chainlink LINK coin rewards node operators for providing external data to smart contracts. 

Security tokens are linked to a specific investment or asset. They acquire value over time and act similarly to an investment in a stock or share. 

Regulation: Light Oversight vs. Strict Compliance

Utility tokens can often avoid heavy regulations if they’re deemed not to pass the Howey Test. That doesn’t mean that regulators completely ignore these tokens. But they’re usually less scrutinized than security tokens, which represent real-world assets. 

Securities in all forms need to adhere to rules around disclosures, registrations, and investor protections. Fail to comply with industry standards, and you risk fines. 

Legal Framework: The Howey Test in Action

The Howey Test, established by the U.S. Supreme Court, identifies whether a transaction is an “investment contract.” If it is, securities laws apply. This test looks at factors like whether buyers invest money in a common enterprise with an expectation of profit based on someone else’s efforts.

If your token doesn’t promise a share in profits or rely on a centralized team for success, it has a better chance of being classified as a non-security (or utility token). If the token’s value hinges on a company’s success or a common enterprise, you’re likely dealing with a security.

Liquidity: Ease of Trading vs. Restrictions

Because they’re less regulated, utility tokens usually trade on cryptocurrency exchanges with fewer hurdles, it’s relatively easy to buy and trade these assets. Security tokens, on the other hand, trade more on specialized security token platforms that comply with financial regulations. This sometimes limits the pool of potential investors and can reduce immediate liquidity, although the market is expanding as global interest grows.

How Regulations Define Utility vs. Security Tokens

We’ve already mentioned the Howey test, which identifies whether an asset is a “security” based on four factors, including whether an investment of money was involved, whether it’s linked to a common enterprise, and whether there’s an expectation of profit taken from the efforts of others. 

If all four conditions are met, the asset is considered a security - this is where security tokens in crypto offerings come under strict scrutiny. The SEC has made examples of several projects, from ICO-era startups to large-scale ventures.

In the EU, the new MiCA regulation also requires the classification of security and utility tokens. Usually, utility tokens aren’t exposed to the same security laws and regulations as security tokens. Securities, though, need to comply with EU regulations linked to registration, disclosure, and investor protections. 

To bring the issue into perspective, look at the SEC vs Ripple battle. The SEC argued that XRP should be classified as a security because it allegedly meets the Howey criteria. Ripple countered that XRP performs a utility function within its cross-border payment solution.

How to Identify a Token’s Type

The easiest way to identify whether a token is a utility or security is to check if it passes the Howey test. If there’s an investment of money connected to a common enterprise, and you expect to receive profits from the efforts of another group – the token is probably a security. 

If not, you might be in utility token territory (though nuance abounds, and legal advice is often essential). Whether you do invest in utility or security tokens, watch out for red flags. 

Be wary of any token promising “guaranteed returns” or “profit-sharing.” Another red flag is if a single corporate entity has ultimate control over the token’s success - such as all the coding, marketing, partnerships, and decision-making. While centralization alone doesn’t prove that something is a security, it often layers on factors that regulators can examine.

At the same time, remember that “utility” is more than a buzzword. A token can’t simply label itself as “utility” to sidestep legal frameworks. If it behaves like a security, it’s likely to be regulated as one, or come under scrutiny eventually.

Exploring Tokens in the Crypto World

When you’re exploring the opportunities offered by digital assets, understanding the difference between utility and security tokens is essential. While utility tokens often prioritize direct access to applications and services, security tokens rest on heavier regulatory foundations, offering an avenue for regulated investments. 

Both token classifications shape how projects fundraise, how users engage, and how regulators assess market activity. For investors, this classification sets the standard for compliance requirements, liquidity, and potential returns. For project teams, it influences how they explain their token’s core features, comply with regulations, and mitigate risk. 

As new frameworks like MiCA come into play, regulatory clarity will only increase. The good news is that the broader blockchain community should benefit from improved clarity. The more easily we can identify tokens, the more we can innovate and make intelligent decisions.

Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service. Trading digital assets and digital asset derivatives comes with a significant risk of loss due to its high price volatility, and is not suitable for all investors. Please refer to our Terms.