Coin vs. Token vs. Security — regulated?
Today we want to look at the different types of coins and tokens — the vehicles used in initial coin offerings (ICOs / token launches) to raise capital. Of course we had to dive deeply into this when preparing our own token launch with unibright.io.
It is very important to be clear about the type of coin/token that is going to be emitted during an ICO or token generating event, as there are governmental institutions like the U.S. Securities and Exchange Commission (SEC) that watch the market and take actions. As long as U.S. investors can participate in an ICO, U.S. securities law apply from whichever country the ICO is being staged.
For example the DAO token issued by a foundation residing in Switzerland was found to have run afoul the U.S. securities law after it has been on the market for quite a time. In July 2017, the US Securities and Exchange Commission determined that tokens from The DAO were, in fact, securities.
1. Coin (Cryptocurrency)
Humans have used coins as a medium of exchange since the beginning of civilization. Traditionally, currency has been issued by a government / federal bank. A digital currency like Bitcoin is he most prominent example of a coin that uses blockchain technology to allow payments independently of a governmental, central bank.
2. Utility Token
These tokens are units of services that can be purchased. Balaji S. Srinivasan compares these kinds of tokens in his blog (https://medium.com/@balajis) with API keys that are being used to access a service. Those tokens are mostly pre-mined and sold in token launches. As an example, there is BAT, the Basic Attention token — a token that empowers the Brave browser and its ecosystem. A utility token is a digital asset that allows the user to interact with or gain utility from a platform.
3. Equity tokens / tokenized securities
Equity tokens represent ownership of an asset or shares of a business. There is the Howey test (https://www.investopedia.com/exam-guide/series-63/securities/securities.asp) that asks the following questions that have to be met for an investment to be qualified as a tokenized security:
1. An investment of money
2. An investment of funds in a common enterprise
3. An investment with an expectation of profits mostly from the efforts of others
Often, it appears that digital assets surpass the boundaries between tokens and securities. Ether for example might fall into this category. There are people who will use Ether as a currency and there are people who will use it as a utility token.
We distinguish between Utility ICOs and Security ICOs — with Security ICOs being an investment contract, which is a security that is regulated by the SEC.
How can one check whether a specific investment is a security?
The key difference between security/equity tokens and utility tokens is, that security/equity tokens entitle the holder to ownership right, while utility tokens function as coupons and do not provide ownership rights.
Both types of tokens are traded on exchanges and have prices that may fluctuate.
Bottom line: With the blockchain world evolving ever faster, boundaries between currencies, securities and utilities become indistinct. It is vital for all players in this field to have a clear regulatory structure that allows distinguishing between digital assets that function as a currency (coin), utility tokens (which provide utility) and equity tokens (that enable investment opportunities).
An alternative view on the token world can be set up when asking two questions:
- Why is the token valuable?
- What creates that value?
Using this questions as dimensions in a graph, all tokens can be plotted onto it. Tokens in the upper-right quadrant or near it, have big chances to qualify as a security.
Disclaimer: This article should not be taken as, and is not intended to provide, investment advice. Please conduct your own research before investing in any cryptocurrency. You should not rely on this post as legal advice. It is written for general informational purposes only, as a guide to certain of the conceptual considerations associated with the narrow issues it addresses. You should seek advice from your own counsel, who is familiar with the particular facts and circumstances of what you intend.
