In the universe of alternative financial instruments and that of cryptocurrencies, a token is a resource, utility or unit of value issued by an organisation. It is a set of digital information within a blockchain that confers a right to a particular entity.
The terms 'token' and 'cryptocurrency' are often mistakenly used as synonyms. The reason for this is closely linked to the presence of certain elements in common. In fact, both are instruments that are accepted within a specific context and refer to blockchain technology.
Although they are used interchangeably, there is a basic difference between a token and a cryptocurrency. Indeed, while a cryptocurrency operates independently and uses its own platform (think of Bitcoin, for example), a token is a digital asset built on an existing blockchain (Ethereum, for example).
There are different types of tokens, depending on their use. Here we elaborate on two of them: security tokens and utility tokens.
Security Tokens
A security token is a type of asset linked to financial securities that takes value from the company that issues and backs it.
A security token is a regulated security, just like shares, but blockchain technology provides much greater flexibility; it can thus offer many unique advantages and features not available with traditional securities.
A security token can represent fractional ownership in virtually any type of asset, such as shares in a company, commercial real estate, works of art or even vintage cars. The issuer splits the asset into a certain number of tokens and then sells them to investors through a regulated offering.
The process of issuing security tokens is actually quite similar to selling shares in a company through a stock offering with the advantage that the use of blockchain technology transparency and immutability, thus providing greater flexibility in the types of securities offered.
Utility Tokens
Unlike security tokens, utility tokens are usually issued for a specific purpose. Such a purpose may be, for instance, the possibility to use tokens on a platform to redeem a special service or receive preferential treatment with respect to certain services.
Utility tokens represent the majority of tokens that are issued in the context of ICOs (Initial Coin Offerings) and are mainly used by companies to stimulate interest in their products. They are also used in the application and creation of value in blockchain ecosystem services.
By purchasing a utility token, an investor does not acquire any actual stake in the monetary ownership of a company. Utility tokens, therefore, do not arise as investment opportunities in the proper sense of the term, but instead serve to provide a specific utility on a platform or application, which entitles the holder to use certain products or services.
Security tokens or utility tokens. How to choose
The main difference between these two assets is that a security token is considered a financial asset in its own right, as if it were the share of a listed company, whereas a utility token is simply seen as a means of access to a service, but is not to be understood as a financial investment.
There is a test that can assess whether a token can be considered security or not: the Howey test. This test makes it possible to determine whether a transaction carried out has the characteristics of an investment or a security if it satisfies all three of these conditions
· it is an investment of money
· it is made in a joint venture; and
· it carries with it an expectation of profits that depend on the work of other people.
From a practical point of view, security tokens give the right to contribute to a company's governance decisions, while utility tokens only refer to a specific product or service that can be acquired.
A final point on which these two instruments diverge is that the value of utility tokens is determined by supply and demand and is independent of the company's share price. In contrast, in security tokens the price is closely linked to the performance of the company and the project in which one invests. Security tokens therefore carry a higher risk for investors, but could also provide profitable returns if the project in which one invests increases in value.