What is the difference between utility tokens and equity tokens?

Initial Coin Offerings (ICOs) are revolutionising the way that businesses and startups go about early seed fundraising. It seems that they also have the potential to completely revamp the mainstream investment ecosystem as well. By using ICOs, a startup can raise funds by issuing tokens on a blockchain such as Ethereum and then selling them to investors.

Like cryptocurrencies, these tokens are completely tradable as well as fungible and they are unique in the way that their value is derived from something like company equity or access to a service, not as a store of value. There are two main types of ICO token, an equity token and utility token, but what is the difference between the two?

Equity Tokens

An equity token falls into a subcategory of security tokens that represents the ownership of an asset such as company stock or even debt. By using blockchain technology and smart contracts, a start-up can avoid the traditional IPO route and instead issue shares over the blockchain. This also means that a lender could create tokens that represent the debt owed by a particular company which would allow loans to be bought and sold as a part of a high-liquidity environment.

Many investors believe that equity tokens could somehow become the main type of ICO token but the SEC in the U.S has given an indication that equity tokens are subject to federal securities regulations. This means that few startups will be equipped with the necessary means to issue tokens that comply with all of the applicable federal regulations. This means that investors should consider not contributing to an equity token ICO unless they have the legal status of the project on good authority.

Utility Tokens

A utility token can also be referred to as an app coin or a user token and it allows users to gain future access to a service or product. Through utility tokens, an ICO startup is able to raise capital to fund the ongoing development of its blockchain projects. Users are also able to purchase future access to the services, often at a discount of the finished product price.

A good example of a utility token is the Basic Attention Token (BAT). It functions as a medium of exchange between users, advertisers, and publishers which gives browser user compensation for hosting the ads as well as viewing them.

A utility token is not designed as an investment but that doesn’t mean that people will not invest in them in the hope that the value of the token will increase as time passes. Fluctuation in the prices of utility tokens can be compared to the prices of sports tickets which are prone to increase as one of the teams wins a significant number of games and becomes a forerunner for the championship.

Whilst both equity and utility token prices are prone to fluctuation, the main differences between the two are that equity tokens enable the holder to ownership rights, whilst utility tokens function as a coupon and do not provide the holder with an ownership stake in the company.

At E&S we can help you decide which type of token is perfect for your ICO and guide you through all of the legal and regulatory implications. Don’t leave it up to chance, contact us on [email protected] today to find out more.