The Fall Of ICOs And The Rise Of IEOs
September 24, 2020
According to a Satis Group study, more than 75% of ICOs were labeled as “identified scams”, where the individuals behind the coins never intended to use the funds for a real project.
Clearly, many trust issues emerged and frightened the ICOs investors. These concerns along with a number of weaknesses led to the creation of the Initial Exchange Offering (IEO).
An IEO is a fundraising event operated on a cryptocurrency exchange platform. The exchange has the role of a counterpart between the investor and the project. The founders of the project coin new tokens and distribute them on the exchange for the financing. They include exchange terms such as the limitation of individual contributions and a fixed price for tokens.
The Dark Side of ICOs
No Guarantees Offered
In the early years of ICOs, the lack of regulation meant more freedom but also constituted a risk factor for the investor. Having an intermediary may cost extra, but it is a guarantee in the event of bankruptcy or fraud.
Since 2018, things have changed: the SEC (Securities and Exchange Commission) narrowed the scope of the ICOs. The advantage of easy access due to lack of regulation therefore disappeared.
An Heterogeneous Audience
The globalization of the collection process is complex to manage in terms of communication. While a worldwide reach represents a great opportunity, it also requires the ability to handle a wide community and a diversified audience.
The Inexperience of Investors
Raising money from beginner investors driven by easy earning prospects has become a boomerang. The impatience of investors, in fact, has often resulted in a disaster.
A small fluctuation in the token price could push investors to sell, causing a fatal price down. A rush to sales occurred even when the (unlikely) expectations of growth did not materialize quickly. The failure of the whole project was the immediate consequence of the catastrophic collapse of the currency.
The Years of Change: from ICO to IEO
If 2018 was the year of illusion, the year when everyone firmly believed that the world was ready to adopt cryptocurrency and blockchain on a large scale. Instead, 2019 was the year of disillusionment. The collapse of the market generated a chain reaction of distrust and disinterest. Ether shrunk to a critical $100, taking the entire ERC-20 token industry with it. What ’s more, the proliferation of scams and failures cast a shadow over ICOs.
A first attempt to solve the issue of regulation was the STO format, aka Security Token Offering. A STO is when instead of selling their currency, projects exchange Security tokens. These are alternative financial instruments representing shares of the company launching the project.
The process is similar to that of an ICO, with the exception that each project must be certified by a regulated body. Therefore, if a project wants to advertise its investment product in the US, it must go through the Security and Exchange Commission (SEC). As long as it meets their guidelines it can enter the market, providing better protection for investors.
However, this forces projects to invest significant sums in legal advice in order to comply with SEC guidelines and to wait for certification. This defeats the purpose of blockchain-based investments, as it again creates a barrier to market entry.
What Is An IEO
After the failure of STOs due mainly to legal and bureaucratic intricacies, a new solution emerged: IEOs. The acronym stands for Initial Exchange Offering and can be defined as a fundraising event that is administered by a cryptocurrency exchange. IEOs had strong momentum in 2019, when Bitfinex raised over $1,5 billion with this new type of fundraising.
A cryptocurrency exchange is a platform where you can buy and sell cryptocurrency. Its main role as an intermediary is to provide the necessary liquidity and technology for this type of transactions.
The main difference is that, unlike Initial Coin Offerings (ICO) where the founders themselves conduct the operation, an Initial Exchange Offering is conducted on a fundraising platform of a well-known crypto-exchange.
The Investors Side
For users, it is easy to participate in an IEO as they only needs an account and some funds deposited to the exchange. The exchange will then conduct both AML, KYC and investor identity checks. After the registration, the investor can deposit crypto currency or fiat currency to the newly opened account. The funds loaded will be used to purchase the coins just minted by the IEOs.
Before starting, the exchange introduces its users and the public to the terms of the upcoming IEO, including the token price, starting date and ending date. Several IEOs use different currencies, so the investor may have to hold more than one currency in the account if he wants to participate in multiple offers.
Delays in listing the new currency or liquidity problems typical of ICOs no longer occur because the offer is already on an exchange. In fact, the exchange, by definition, must provide liquidity promptly.
The exchange hosting the Offering generally examines the projects beforehand, thus ensuring their reliability. Exchanges focus on the success of the project, as they are putting their reputation on the line. As they already have the structures to do all the security procedures, they do not need to go through the institutions and guarantor authorities anymore.
For a project seeking to raise funds, an IEO is advantageous because it offers the promise of an immediate userbase that is exposed to their product. Depending on the size of the exchange audience, it reduces the workload around promotion, allowing the project team to focus only on product development.
Due diligence is the examination of data relating to the subject of a negotiation. The purpose of this procedure is to assess the convenience of an agreement and to identify the risks and related problems. Both to negotiate the terms and conditions of the agreement and to prepare adequate instruments of guarantee, indemnity or compensation. In an agreement with a company, the main subject of due diligence is the financial statement.
The only disadvantage of the IEO is that it requires a substantial initial investment. The project, in fact, has to pay a commission to the exchange hosting the collection.
Let us therefore summarise the pros and cons of IEOs.
- The exchange acts as an intermediary and guarantor, without having to involve the authorities.
- Tokens are listed immediately
- You can invest from the wallet integrated into the exchange
- The exchange offers userbase and visibility
- The exchange provides liquidity
- It requires substantial investment by the project