What is a Security Token?
Security tokens are a type of investment contract that reflect the stake in a digital entity such as virtual real estate, NFT, or ETFs. These contracts are verified on a blockchain and investors have the option to purchase or sell them against fiat currencies or crypto coins.
Security tokens only represent the ownership of a fraction of a given asset. In this manner, the investors can use them as collateral to obtain loans.
Advantages of Security Tokens
- Security tokens make investing more accessible to a wider class of people rather than limiting it to a limited number of accredited investors.
- Security tokens may allow their holders to earn dividends much like stocks.
- Security tokens grant access to a wide variety of investment option offered by a company that can be used for portfolio diversification.
- Security tokens add liquidity such that the investors can sell or purchase them much faster in comparison to the assets they are representing.
- Security tokens allow asset owners to offer their products or services to a global network of investors around the globe by arranging a Security Token Offering or STO.
- Security tokens can be used to create independent projects that are backed by a specified asset reserve.
Risks Associated with Security Tokens
- They are subjected to regulatory scrutiny.
- Scammers can run away with the backed-asset after selling rights in the form of security tokens.
- Token owners run the risk of losing money in case of losses sustained in the asset.
What is a Utility Token?
Utility token as the name suggest is a type of virtual currency that is used to perform a specific task. Utility token by definition has a broad range and a large portion of cryptocurrency market can be classified as utility token.
The most popular form of utility token is an ERC-20 token. This type of token is a standardized token based on the Ethereum blockchain. The most popular use case for utility tokens is their issuance during ICO or Initial Coin Offerings to raise funding for the project.
Advantages of Utility Token
- Utility tokens ensure practical use case for a given cryptocurrency.
- Utility tokens can incentivize people to participate in welfare projects such as environmental cleaning, recycling, and adopting green energy resources.
- Utility tokens help in creating blockchain-as-a-service model in the form of projects like Filecoin that rewards token for storage space and Chainalysis that issue tokens for data resources.
Risks Associated with Utility Tokens
- Utility tokens are subject to scams such as rug pulls that can lead to losses for their investors.
- Utility tokens can face regulatory scrutiny if they are used as a medium of exchange.
Utility Token Vs Security Token: Differences
The function of security token is to represent legal value of a given asset. On the other hand, utility tokens are created to perform a specified task.
Utility tokens do not represent any direct connection to the issuers rather they are used for decentralized protocols. Meanwhile, security tokens stand for a direct connection with the issuer and also subject to profit and loss generated by them.
Security tokens have a limited risk exposure since they are subjected to regulatory scrutiny. In contrast, Utility tokens pose a bigger risk for investors as the issuers can go out of commission or opt out at any time without creating the project that they collected the funding for.
Security laws are applicable on security tokens and they must also comply with the relevant Securities regulator. On the other hand, utility tokens can be decentralized on account of lack of regulatory clarity for ICOs.
Security and Utility tokens are two important types of cryptocurrencies. These tokens offer unique advantages and carry certain risks. By understanding their pros and cons, investors can aid their skills and knowledge of the crypto markets.