Understanding When Tokens Are Not Securities: A Legal Guide to Utility Tokens
In the evolving landscape of blockchain and cryptocurrency regulation, distinguishing between security tokens and utility tokens is paramount. For startup founders, token issuers, and legal professionals navigating the regulatory environment, knowing when a token does not qualify as a security under U.S. law is critical to ensuring compliance and avoiding enforcement actions by the Securities and Exchange Commission (SEC).
This article provides a structured, plain-English explanation of when tokens are generally considered utility tokens rather than securities, based on established legal interpretations and regulatory guidance.
What Is a Security?
A security, in legal terms, typically refers to an investment vehicle—such as a stock, bond, or other financial instrument—where an individual provides capital with the expectation of earning profits derived primarily from the efforts of others. This definition stems from the landmark U.S. Supreme Court case SEC v. Howey, which established the so-called Howey Test.
If a token offering satisfies the criteria of the Howey Test, it is classified as a security, triggering a suite of federal regulatory obligations including disclosures, filings, and compliance requirements under the Securities Act of 1933.
When Is a Token Not a Security? Understanding Utility Tokens
A utility token is primarily designed to grant holders access to a product or service, rather than to serve as an investment vehicle. Utility tokens are generally not subject to SEC regulation, provided they clearly fall outside the definition of a security.
1. The Token Grants Access, Not Profits
Utility tokens are designed to function within a specific ecosystem. They might offer:
Access to cloud storage or computational resources
The ability to book travel or use a digital platform
Discounts or premium features within an application.
The key distinction is that these tokens are tools, not financial instruments. The primary intent behind acquiring them is to use the service, not to generate income.
2. Users Are Buyers, Not Investors
Another important factor is the intent of the purchaser. If the token is sold primarily to individuals who plan to use it on the platform—as opposed to those intending to resell or speculate—it is more likely to be treated as a utility.
Selling tokens to a user base who actively engages with the platform's services, rather than to passive investors seeking appreciation in value, supports the utility token classification.
3. No Promises of Passive Income or Returns
Tokens that are marketed with promises—or even implications—of profit, dividends, or other financial returns raise immediate red flags for the SEC.
Avoid statements such as:
"Stake your tokens to earn returns"
"Buy now, watch your value grow"
"Token holders receive quarterly dividends"
The absence of profit-sharing, rewards, or revenue guarantees helps distance the token from the characteristics of a security.
4. The Platform Is Already Operational
A functioning product or ecosystem at the time of token sale is a critical factor. If a platform is live and users can immediately deploy the token to access services, this supports the utility designation.
In contrast, selling tokens for a product that is still under development—and offering speculative benefits once it launches—suggests investment intent, which aligns more closely with securities law.
5. Buyers Maintain Control
When the value or function of the token does not depend on the managerial or entrepreneurial efforts of a central entity, and users have discretion over how to use their tokens, it suggests the absence of an investment contract.
This decentralization of control—particularly in fully developed, open-source, or community-run projects—further distances the token from being labeled a security.
Red Flags: When a Token Is Likely a Security
Tokens are likely to be deemed securities if they meet the following conditions:
They are sold primarily to raise capital for business operations
Buyers are led to expect profits based on the efforts of the development team
Marketing materials focus on price appreciation or investment potential
The platform or ecosystem is not yet live
The token has no immediate or practical use
Legal and Regulatory Implications
Misclassifying a security token as a utility token can result in significant regulatory consequences, including fines, enforcement actions, and reputational harm. Issuers should conduct a careful legal analysis, often in consultation with securities counsel, before launching a token offering.
Organizations such as the SEC and the Financial Crimes Enforcement Network (FinCEN) continue to provide evolving guidance. Staying current with this guidance—and ensuring marketing and technical development align with a utility use case—is crucial for legal compliance.
Conclusion
A token is more likely to be considered a utility token, and not a security, when:
It provides functional access to an existing platform
Purchasers are users, not investors
There are no promises or implications of financial return
The token’s value is not dependent on a central team
For businesses seeking to issue tokens or structure compliant digital assets, proactive legal counsel is essential. Proper structuring and transparent, compliant marketing can make the difference between a legitimate utility offering and an unlawful securities issuance.
To discuss how your token offering may be structured to comply with U.S. law, contact our firm at 786.461.1617 for a consultation.
