Utility tokens vs. Security tokens

To this day initial coin offerings have raised a mind staggering amount of money. In 2017 alone more than 6 billion USD were raised in this new kind of funding mechanism. Despite the high amount of value that has been created through ICOs, the legal status and definition of ICO tokens has been unclear at best. This creates a lot of unease with investors who want to have clarity on what they are investing in.

So far two dominant categories for token classification have emerged, one them utility tokens, the other security tokens.

Let us start with a brief description of both token categories. It should be clear that by now different legislations have taken different approaches when it comes to regulating the ICO market.

Utility tokens as the name suggests can be used to access certain products and services on a platform. Being the owner of a utility token I gain access to a platform and thereby access to its products and services.

For example, filecoin is designed with the intent to let token holders have access to its storage network. People can supply their unused storage to the platform and other people who hold filecoin can get access to their storage. This way people get to store files at very competitive prices.

A security, on the other hand, is a wide classification that refers to any kind of tradable asset. If the token is primarily held in expectation of future profits, then it is classified by the SEC as a security. So far there has been significant precedent of the SEC classifying ICO tokens as securities.

In July 2017, the US American SEC (Securities and Exchange Commission) issued a report that retroactively considered the DAO tokens as securities. In 2016 the DAO had been a digital decentralized autonomous organization and investor-directed venture capital fund. People were allowed to contribute to the DAO in expectation of its future profitability. The DAO of 2016 got hacked because of a vulnerability in the smart contract code. As a result one third of the DAO’s funds was sent to a subsidiary account. Presumably, as a measure to protect future investors the DAO was classified as a securities offering by regulators.

The expectation of profit from the efforts of other is central to the classification of a security as is dictated by the so-called Howey test.

Besides the clearly emerging categories of utility token and security token, the Swiss Financial Market Supervisory Authority (FINMA) divides tokens into three classifications: payment tokens, utility tokens, and asset tokens.

The previous discussion guides us to the question of what token classification is applied to Proof of Stake (PoS) tokens. Because they are typically used as a means to secure the network and as voting rights, PoS coins may be classified as utility tokens. However, people also clearly buy these tokens in the hope that their price will go up. Whether the majority of PoS tokens will or will not be qualified as utility tokens only the future will tell. We would argue that due to the inclusion of the token holder in the creation of new blocks, the case to classify PoS tokens as utility tokens is very strong.

At Pool of Stake we will work with two different kinds of tokens.

IOU token is released in exchange for sending a PoS token to a PSK smart contract on the native PoS blockchain. This IOU token can then be deployed to demand back control over the PoS token on the smart contract. The IOU token gives users control over their funds while simultaneously allowing them to delegate management of their token to PSK smart contracts.

PSK token is a utility token sold during the ICO which enables users to get discounts on their withdrawal fee.

Both PSK token and IOU token fulfill a distinct function in the blockchain ecosystem and thus clearly go beyond speculation.