Security Tokens
Security tokens are digital tokens that, by their economic nature, represent investment assets and fall under securities market regulation.
Unlike utility and governance tokens, which are primarily designed for use within blockchain ecosystems, security tokens are associated with expectations of financial return, rights to income, profit participation, or exposure to the economic performance of a business.
The key characteristic of security tokens is that their legal status is determined not by their name, but by their economic substance.
Two Fundamentally Different Classes of Security Tokens
Within the crypto economy, the term security token is used in two closely related but fundamentally different meanings.
Tokenized Securities (Classical Security Tokens)
In the first case, security tokens represent the digital form of traditional financial instruments, including:
- shares,
- bonds,
- investment fund units,
- derivatives.
These tokens constitute a technological implementation of classical securities, transferred onto blockchain infrastructure.
Examples include:
- tokenized company shares,
- tokenized bonds,
- digital real estate fund units.
In this case, the token does not create a new economic entity, but merely digitizes pre-existing financial rights. Their classification as securities is evident from the outset.
Crypto Project Tokens Classified as Securities by Economic Substance
The second and most complex category includes tokens of blockchain projects that may formally be labeled as utility or governance tokens but function economically as investment assets.
Such tokens typically exhibit one or more of the following features:
- sold primarily to raise capital,
- expected to appreciate in value,
- linked to platform revenues,
- provide rights to profit sharing,
- participate in buyback and burn mechanisms,
- used for generating passive income.
In practice, these tokens are: formally — utility or governance tokens, economically — investment assets.
This category accounts for the majority of regulatory disputes, enforcement actions, and legal uncertainty in crypto markets.
Where Is the Boundary: Investment Nature vs. Functional Utility
The key distinction between utility and security tokens lies not in terminology, but in the economic motivation behind holding the token.
Utility tokens:
- grant access to services,
- are consumed within the ecosystem,
- derive their value from functional usefulness.
Security tokens:
- are acquired with profit expectations,
- are linked to business revenues,
- serve primarily as investment instruments.
Thus, if the primary motive for acquiring a token is financial gain, such a token effectively becomes a security.
The Howey Test — A Core Criterion for Identifying Securities
The most widely recognized framework for determining the investment nature of a token is the Howey Test, established by the U.S. Supreme Court in 1946.
An asset is classified as a security if all of the following conditions are met:
- There is an investment of money.
- The investment is made in a common enterprise.
- There is an expectation of profits.
- The profits depend primarily on the efforts of others.
If all four criteria are satisfied, the asset qualifies as an investment contract, and therefore as a security.
Although the Howey Test originates from U.S. law, its logic is widely applied globally when assessing the legal nature of crypto tokens.
Major Cases of Token Reclassification as Securities
Telegram Open Network (TON)
In 2018, Telegram raised approximately $1.7 billion through the sale of Gram tokens. Despite positioning the token as a functional component of a future ecosystem, the U.S. Securities and Exchange Commission (SEC) classified it as an unregistered security.
The court agreed with the regulator, concluding that:
- investors purchased the tokens with expectations of price appreciation,
- the project’s success depended entirely on Telegram’s development efforts.
As a result, the project was terminated, and investor funds were refunded.
Ripple (XRP)
The long-running litigation between the SEC and Ripple concerned the regulatory status of the XRP token. The regulator argued that XRP had been sold as an investment asset.
This case highlighted:
- the complexity of legal classification,
- the ambiguity of the boundary between utility and security tokens,
- the decisive role of economic context in regulatory assessments.
Utility Masking as a Market Practice
Due to the strict regulatory requirements applied to securities markets, many projects attempt to formally classify their tokens as utility tokens, even when their economic models exhibit clear investment characteristics.
This has led to widespread regulatory arbitrage and utility masking, whereby:
- the token is labeled as utility,
- but is marketed and used as an investment asset,
- promotional strategies emphasize price appreciation.
Such practices:
- create substantial legal risks,
- increase exposure to regulatory enforcement,
- undermine trust in the crypto industry.
Distinguishing Security Tokens from Utility and Governance Tokens
| Criterion | Utility | Governance | Security |
|---|---|---|---|
| Primary purpose | Service access | Protocol governance | Profit generation |
| Economic role | Consumption | Decision-making | Investment |
| Regulatory status | Usually unregulated | Usually unregulated | Subject to financial regulation |
| Profit expectation | No | No | Yes |
Summary
Security tokens represent investment-oriented digital assets subject to securities regulation.
In the crypto economy, they appear in two principal forms:
- tokenized traditional financial instruments,
- crypto project tokens classified as securities by their economic substance.
The defining criterion is expectation of profit and reliance on third-party managerial efforts, rather than the token’s formal designation.
Understanding the boundary between utility, governance, and security tokens is essential for accurate risk assessment, legal compliance, and economic analysis of blockchain projects.