Token Classification - Utility vs Security
Understanding the crucial distinction between utility and security tokens
Is It a Tool or a Security? Smart Token Design for Founders
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 this writing, U.S. lawmakers were actively engaged in the creation of new laws that could impose brand new rules and regulations around not only the classification of tokens but the crypto industry as a whole. 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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