Utility tokens weren't possible before the Ethereum (ETH) blockchain began operations in 2015. Ethereum was the first project to introduce smart contract functionality, which refers to coded commands that use "if/then" statements to perform automatic tasks on a blockchain. All utility tokens live on smart contract blockchains, and many of these cryptocurrencies use Ethereum token standards like ERC-20.

While utility tokens were around before the 2017 bull run, they gained mainstream prominence during the "ICO craze" of 2017-2018. During this time, hundreds of new Web3 projects began offering initial coin offerings (ICOs) to investors as a way to raise funds.

Many of these ICO companies claimed they were selling their "utility tokens" to early investors. However, in reality, most of these tech start- ups had no intention of providing token holders with utility. Indeed, developers typically used the "utility token" label to evade sanctions from the U.S. Securities and Exchange Commission (SEC).

As authorities caught wind of the many scams in the ICO space, they began drawing more precise distinctions between a utility token versus security token. A cryptocurrency must provide a viable use case beyond mere speculation to qualify as a utility token. Valid utility tokens also can't be connected with partial ownership in a company or third-party endeavor.

In contrast, a security token represents partial ownership in a third-party enterprise. For instance, a token that tracks the price of Amazon's stock would be a security token. There are also innovative trading platforms offering security tokens representing partial real estate ownership.

Since security tokens are defined as "securities," they must register with the SEC. Utility tokens, however, don't need SEC approval to list on crypto exchanges.