Token Classification - Utility vs Security
Understanding the crucial distinction between utility and security tokens
One of the most challenging aspects for Web3 projects is properly classifying their tokens. The distinction between utility tokens and security tokens is crucial from a regulatory perspective.
Disclaimer: At the time of writing, the classification of tokens as a utility or a security remains highly debated—even among regulators such as the U.S. Securities and Exchange Commission (SEC)—and is subject to change. Always check the most current legal and regulatory guidelines in your jurisdiction before making a decision.
The SEC uses a four-part test (the Howey Test) to determine if a token is a security:
- Is there an investment of money?
- Is it in a common enterprise?
- Is there a reasonable expectation of profit?
- Does the profit come from the efforts of others?
If your token meets all four criteria, it's likely to be classified as a security and subject to SEC registration requirements. If your aim is to design a token that is classified as a utility rather than a security, here are five aspects to focus on:
- Focus on function rather than fundraising
- Make your token immediately usable (not speculative)
- Avoid profit sharing and dividends
- Refrain from speculative marketing language
- Implement decentralized control
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