What is an Initial Exchange Offering?
IEOs are the latest fundraising tactic in the crypto world
First there was the Initial Coin Offering, or ICO. Then came the Security Token Offering, STO. Now, we have Initial Exchange Offerings, or IEOs — the latest addition to the alphabet soup of acronyms that litter the cryptocurrency ecosystem.
Initial exchange offerings are a variation of the more popular form of fundraising known as initial coin offerings. As the name suggests, these sales are conducted on cryptocurrency exchanges. For example, Binance, on most days the world’s biggest exchange by trading volume, operates Launchpad, while OKEx, another prominent Chinese exchange, has Jumpstart.
As with ICOs, IEOs attract investors hoping to make quick cash on new tokens. Fetch.AI, an IEO for an artificial intelligence project that claims to build an “economic internet,” conducted its token sale on Launchpad. The team raised $6 million in just six seconds.
The basic process for conducting an IEO is similar to the one for ICOs: A company or a startup comes up with an idea for an innovative project and sources global capital through an offering.
In an IEO, however, the exchange plays a central role. Specifically, it acts as a counterparty, ostensibly reducing the risk of unscrupulous developers or entrepreneurs taking flight with investor money.
The exchange is also responsible for disseminating the project token to investors. After fashioning the project’s specifics and minting its tokens, the entrepreneur hands over control of the offering to an exchange, which then takes over.
Why was the IEO invented?
ICOs have grown wildly in popularity over the last couple of years, but their rise has led to a certain amount of freewheeling. Bad actors thrived in an ecosystem where regulatory oversight was absent. ICOs quickly gained a reputation for being a hotbed for scams.
Security token offerings (STOs), in which projects offer their tokens as securities, provided a way out of this mess — but they leave utility tokens out of the equation.
IEOs combine the benefits of a coin offering with the checks and balances of operating an exchange. Tokens participating in an IEO are vetted by exchanges. In addition to this, exchanges also ensure token investors undergo the KYC/AML process prior to accepting their money. These practices clean up the market for coin offerings and reduce risk for investors and developers.
What are the benefits of IEOs?
For investors, the single biggest benefit of an IEO is the introduction of a reliable third party to vet token sales. Such oversight was absent previously, and investors primarily relied on their own research and industry opinion to evaluate projects.
By acting as a counterparty during IEOs, exchanges are putting their own reputation at stake. They have every incentive to ensure that only “clean” projects are allowed through the door.
Prior to having their token offering on an exchange, project developers must submit an application that consists of details about the legal status of their token. Binance’s Launchpad application asks developers to provide legal opinion as to why their token should not be considered a security token.
An IEO also offers several advantages to project developers.
Perhaps the biggest advantage is bringing a ready pool of investors. The bigger the exchange, the bigger the pool that’s available. Prominent exchanges also screen participants on their platform for KYC/AML compliance. In an ICO and STO, the expense and responsibility of maintaining a whitelist of accredited investors lies with project developers. Marketing costs for coin offerings are also reduced as exchanges are responsible for spreading the word about an offering to investors on the platform.
Established exchanges also offer the promise of a liquid market for project developers. Illiquid or thin liquidity markets result in tokens that are prone to wild price fluctuations. While such tokens may offer the prospect of quick profits, having too many in the markets can be deleterious for everyone.
Finally, cryptocurrency exchanges benefit from IEOs by driving volume for its own native tokens. For example, staking (or holding a token for an extended period of time) a BNB token is necessary to purchase IEO coins at Binance. BNB already leads the exchange token market in market cap and liquidity. As more IEOs are held, it’s likely that BNB’s volume — and perhaps also its price — will also increase.
What are the drawbacks of IEOs?
The introduction of cryptocurrency exchanges as active participants during an offering is not always a guarantee of its legitimacy or credibility. Consider the case of RAID, whose IEO on Bittrex was cancelled at the last minute. Each party blames the other for breaking the terms of the deal, but one thing is certain: IEOs are not foolproof.
IEOs may also drive up fees for offerings. At the height of crypto mania in 2018, exchanges jacked up their listing fees to sometimes exorbitant levels. According to some accounts, IEO issuers are giving over a percentage of their tokens to the exchange as a fee for hosting the sale. Others state that crypto exchanges charge a “large percentage” of Bitcoin and Ether to hold an IEO. Either way, there are added costs for developers.
This close relationship between exchange and token developer may eventually lead to increased regulatory scrutiny. Imagine if NASDAQ demanded a percentage of Facebook’s shares in exchange for its IPO. If there’s one thing crypto doesn’t need, it’s more scrutiny.
Finally, it’s important to note that investors are still at risk from hacks and security breaches at crypto exchanges. For the most part, cryptocurrency exchanges are not regulated across jurisdictions. As a result, they have widely differing standards and security implementations.