Security, Currency, Or Utility? Classifying Cryptocurrencies In 2019
Initial Coin Offerings and private token sales have become increasingly popular over the past few years. In fact, the number of ICOs doubled last year, from 966 in 2017 to 2,284 in 2018. Naturally then, ICOs have become the de facto method of fundraising for companies working on applications related to blockchain technology. While enterprises around the world opening up to the cryptocurrency market is a great indicator of growth, the different nomenclature within the ecosystem can be a bit confusing or overwhelming for new entrants.
In the following article, we delve into what security tokens, currencies, and utility tokens are, and establish key distinctions between each category.
The Three Main Financial Assets Of Crypto
Let’s begin with the original type of tokens — currency. These tokens are meant to be used as a medium of payment, as opposed to serving as a fixed asset or collectible.
Bitcoin was created as a decentralized store of value, with the hope that it will — one day — replace fiat money. By that definition, many in the cryptocurrency community regard it to be a currency. Since its release, Bitcoin has exploded in terms of value. The occasional dips, however, make it too unstable to be deemed a currency in the traditional sense. Having said that, it is still widely regarded as one, even by the United States SEC (since it’s definitely not a security or a utility token).
2. Security Tokens
Securities refer to assets that can be traded (shares, bonds, tokens, and so on). In order to determine whether a financial instrument is a security or not, the Howey Test is used by the United States financial regulator. This method, developed as a result of a Supreme Court case last century, can be used for tokens as well, according to the SEC. The Howey Test requires an asset to meet four criteria for it to be considered a security, namely:
- There is an investment of money
- There is an expectation of profits
- The investment of money is in a common enterprise
- Any profit comes from the efforts of the promoter or third party
3. Utility Token
A key characteristic of a currency is that it needs to be used as a mode of payment outside the platform or business that issued it. In the case of a utility token, however, the opposite is true. A utility token removes the expectation of profit or loss, thus differing from a security token.
Utility tokens are sometimes compared to vouchers that are issued by businesses that allow you to purchase goods and services from it. Such tokens can be traded without any securities fee or restrictions and — if demand goes up significantly — can also be sold for a profit.
The Classification Is Still Debated
These classifications allow enterprises and platforms to launch their own tokens and convey their purpose with just a single word, namely utility, security, or currency. However, no token is confined to these roles or restricted by these categories.
When investing in such tokens, it’s important to understand that the cryptocurrency market is still in a rather nascent state, with new forms and instruments still being developed. This means that there are no concrete definitions that classify cryptocurrencies into the categories mentioned above, with Bitcoin perhaps being the most prominent example. If the market suddenly started trading a token originally launched as a utility token, it could pass as a security token in the eyes of some regulators.
However, the fact that many rules and regulations are not concrete is not stopping investors and governments from investing and developing cryptocurrencies as there is a lot of value in these new instruments.