Tokens: Securities vs Utility

One of the hottest topics in the crypto world involves the legality of using, selling, and holding digital assets. This is especially true in countries like the United States, which has a governing body called the Securities and Exchange Commission (SEC), whose purpose is to protect the public from scams, ponzi schemes, and other attempts at conning people out of their money.    

What are securities?   

Some of the financial products that the SEC can pass laws and issue fines over fall under the category of “securities”. In brief, securities are financial products which have the intention of earning a profit, whether it is through value growth or paying out dividends.   Some cryptocurrencies are classified as securities, which means they will issue dividends based on their platform’s profits. It can also be that the rules governing the token are constructed in a way which suggests that the value of the token will increase considerably over time. Some securities represent shares or act in a manner that holding them generates even more coins. Examples of security tokens are coins such as KuCoin Shares, Aurora DAO, and Coni.    

How Are Securities Defined?   

The law regarding the way securities are handled today goes back to a court case from 1946. In the case of the US Securities and Exchange Commission vs W. J. Howey Co., something called the Howey Test was developed. In order for a financial product or service or contract to be classified as a security, it must meet the following criteria:    

1. It must be an investment of money
2. With an expectation of profit
3. In a common enterprise
4. With the profit to be generated by a third party

While not every cryptocurrency qualifies to meet this criteria, the SEC issued this statement in 2017, grouping them all together, regardless. https://www.sec.gov/news/public-statement/corpfin-enforcement-statement-report-investigation-dao   

In short, any ICO that was not registered with the SEC was declared illegal in the United States, and American citizens were not allowed to participate in them. This is a considerable blow to the industry, as the United States holds a number of ICOs, blockchain and crypto enthusiasts.     

In a potentially groundbreaking decision, on June 14, 2018 the SEC decided that Bitcoin and Ethereum are not securities. This means that a special license is not required for companies to buy and sell the two largest coins. If they had decided otherwise, only financial firms or agents with licenses to trade securities would be permitted to offer these to their clients. This would have caused a temporary shutdown of most cryptocurrency exchanges in the US, but fortunately, this disaster was averted.    

What are utility tokens?   

Utility tokens are very much the same as tokens you’d buy at an arcade or gift cards, utility tokens can be used to purchase products or services from one specific place. There is no promise of financial gain and token holders have the benefit of using the token to buy the solutions the company provides.

Products like Ethereum, NEM, NEO Gas, and Stellar Lumens are great examples of utility tokens. Ethereum doesn’t pay out dividends or promise an increased return on investment, but people can use ETH to run smart contracts on the Ethereum blockchain. NEM and NEO Gas also have similar use cases, and Stellar Lumens can be used to pay for transactions on their platform.   

There are some coins, however, that sort of fall into the middle. They are utility tokens, but there are some things in place (such as planned token burns and airdrops) to make token ownership a more active process. Examples of this are XYO, who burn some of their tokens to increase their value and do airdrops for their token holders, and EOS who are also doing airdrops for their investors.   

If you want more information about a coin you are interested in, then join the live support chat for your coin. Most legitimate projects have a live chat room on Telegram or Discord, and someone there can answer your questions. An excellent question to ask the community is, “What are the benefits of holding this token?”, and see what others have to say. If there is a promise of a profit or dividends, it is a good bet that the token is classified as a security, even if it does not exactly meet all four criteria.    

As usual, do your research before participating in any ICO or purchasing any cryptocurrency. Look out for scams, and only invest in projects you understand, and address a gap in the market. And never invest more than you can afford to lose.