> Blog > Utility Tokens vs. Security Tokens

Published September 20, 2022

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When first getting into crypto, it can seem like every answer leads down a new rabbit hole of questions. To make matters worse, the ever-evolving crypto landscape means search results can easily lead to outdated information. On top of that, you have to wrap your head around the increased complexities of tokens.

That complexity typically arrives in two popular types of crypto tokens: utility and security tokens. Although both types of tokens offer critical functionality in a healthy blockchain ecosystem, they individually act in completely different ways.

What is a Utility Token?

functions of a utility token

While crypto coins are essentially the bedrock currency of a blockchain, tokens are built and run on top of an existing blockchain. Tokens take advantage of smart contracts, which are essentially automated contracts that self-execute upon predetermined conditions, to make their magic happen.

Because a utility token functions based on the smart contract that it’s written on, it can be customized in a variety of ways.

Some utility tokens are called non-fungible tokens (NFTs). These are unique, 1/1 digital assets that can be created or “minted” on a blockchain and then traded for coins or other tokens. In their current iteration, NFTs have applied their non-fungibility to take the form of digital art, though their utility stretches far beyond the digital art sphere.

Thanks to the smart contract encoded into an NFT, it can track and display specific traits, and the associated rarity of those traits. This is where the value of the token comes in; desirable NFTs with rarer traits can sell for more, while NFTs with more common traits may sell for less, if at all. This functionality has created an entirely new sector of the digital economy, empowering artists to showcase and sell their work through a brand new outlet.

Other utility tokens act as more of a key. By owning the token, you gain access to exclusive content, ranging from VIP airdrops of new NFTs, to the ability to stake coins for higher returns on investments.

Utility tokens are also crucial components of more consumer-friendly products, like blockchain games. Popular play-to-earn games, like Axie Infinity or ZEDRun, have their own utility tokens that fuel their in-game ecosystems.

How do Utility Tokens Work?

Utility tokens work their magic once you own them. Once they are secured in your wallet the tokens activate via the smart contracts they are written on. The contract typically specifies exchange rules for using the token, as well as any functions or characteristics the token may have.

These tokens can be simply digital assets, but usually they are connected to a decentralized application (dApp) that uses a utility token for its platform’s functionality. This can take many forms, including in-game items and staking opportunities.

Examples of Utility Tokens

NFTs in the Bored Ape Yacht Club (BAYC) collection are a great example of how versatile utility tokens can be. BAYC NFT holders own a digital asset that has increased exponentially since its debut. In addition, BAYC holders gain access to an exclusive online club. They also received a free airdropped NFT that “mutated” the original NFT, offering new desirable traits for BAYC collectors.

As aforementioned, popular blockchain games like Axie Infinity and ZED Run have their own unique utility tokens. With Axie Infinity’s AXS, players can buy and sell the in-game NFT creatures, known as “Axies,” to use in combat for earning rewards.

ZED Run is a blockchain game that revolves around racing jockey horses against other players online. Its native ZED token is used as the main token for in-game actions, like racing, breeding, and lending NFT horses to other players.

Utility tokens don’t have to live entirely in decentralized finance, however. FTT is another great example of a utility token for centralized platforms. FTT is the utility token for FTX’s crypto exchange. Staking FTT on FTX brings numerous benefits, including discounts on trading fees, free Ethereum (ETH) and ERC-20 token withdrawals, airdrop rewards, voting access, and more.

What is a Security Token?

Whereas utility tokens are diverse and complex in use cases, security tokens have a more familiar feel similar to traditional investing.  A security token is a lot like a publicly traded stock on the S&P 500.

The key difference between utility and security tokens is in regulation. Security tokens represent securitized assets from traditional markets, applied to a blockchain infrastructure. Because they represent traditional forms of investments, however, they require more scrutinized regulation. Security tokens are sold to investors through initial coin offerings (ICOs) or security token offerings. Because the issuing companies are basically promising a positive return on their investments, security tokens are actively regulated by the Securities and Exchange Commission (SEC) to help protect investors.

Security tokens could be the future of financial markets. They can be used for anything, from tokenized stocks and bonds, to commodities, or even physical art. These innovative tokens could fundamentally change how we approach investments in any market.

Equity tokens are a type of security token with extra features. In addition to owning assets that ensure profit shares, holders get to vote on certain proposals that shape the future path of the company

How do Security Tokens Work?

Demonstration of tokenization

To understand how security tokens work, it’s important to understand the idea of tokenization in general. Anything can be created into a token, from insurance documents to birth certificates, works of art, and more. Any relevant information can be uploaded to a blockchain and stored within a token to represent that batch of information.

In the case of security tokens, companies can program all the relevant inputs of their company onto a blockchain and use a token as a digital vehicle for that information. This creates a digital asset that’s investable and transferrable on the blockchain, thus enabling records of ownership and activity to be tracked automatically.

Examples of Security Tokens

Enegra (EGX) is an example of a company that saw the power of security tokens and dove in head first by tokenizing all of its equity.

tZero is another popular example of a security token, which actually provides a means for other companies to create security tokens on their blockchain.

INX Token is another popular security token that belongs to INX, an investment platform that focuses on providing both cryptocurrencies and digital assets to both retail and institutional investors.

What’s the Difference Between a Utility Token and a Security Token?

The main difference between utility and security tokens is regulation. Security tokens are under strict scrutiny by the SEC and must follow specific rules and regulations at the federal level. Although all investments carry with them elements of risk, security tokens do offer more financial protection for wary investors than utility tokens. That’s because utility tokens are not regulated, due to being a “service” rather than an investment in an asset.

Utility and security tokens also differ in the way they work. While security tokens are limited to offerings of tokens that represent shares or value in a company, utility tokens are capable of a plethora of uses. Since utility tokens are not as stringently regulated, they have much more flexibility in how they operate. However, that flexibility can also come with greater risk.

Investing in Utility and Security Tokens

When it comes to investing in tokens, there is no tried-and-true way to determine sound investments without looking at the underlying companies that issue the tokens and what their tokens are used for.

FTT DAO likes the FTT utility token not only because of its benefits, but also because of the mission it supports. With every trade taken on the FTX exchange, a percentage of the trading fees are contributed to investments in humanitarian-focused projects as part of the exchange’s effective altruism initiative.

To get involved, consider joining the FTT DAO. Be sure to follow us on Twitter to stay up-to-date with the latest FTT developments and insights on the cryptocurrency space. 

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