These past two quarters, Initial Exchange Offerings (IEOs) have emerged as a viable token sale and distribution platform for many retail investors and long-term end users of blockchain projects. With exchanges acting as intermediaries between retail investors and cryptocurrency projects, there is an established layer of protection for retail investors. Additionally, cryptocurrency projects can benefit from the existing KYC-AML protocols set in place by the exchanges, while having access to an existing user base, promotional platform, and liquidity mechanisms. But before we explore the impact of the Initial Exchange Offering (IEO) on the cryptocurrency & blockchain space, let’s briefly review the history of crowdfunding in the space.
The ICO is the most common and well-known crowdfunding vehicle for cryptocurrency projects. They are decentralized and fairly unregulated forms of crowdfunding (in that government organizations and centralized institutions do not oversee their issuance).
Interested investors in the offering exchange either fiat currency or preexisting cryptocurrencies (most commonly Ethereum). The most first high-profile ICO that set the standard for countless projects was Ethereum’s ICO in 2014 (having raised $18 million in 42 days). Ethereum’s ERC-20 standard made it easy for blockchain projects to deploy crowdfunding launches- as of May 2019, more than 80% of ICOs have launched on Ethereum for an estimate of 185,387 Ethereum-compatible tokens. 2017 experienced an explosion of ICOs, raising 40 times as much capital than in 2016 for a total of around $6 billion USD.
In a relatively unregulated and unstandardized space, ICOs garnered a notorious reputation because of malicious actors and fraudulent activity. Large internet platforms such as Baidu, Tencent, Facebook, Google, & Twitter all banned ICO advertising. But as of May 2019, Facebook has since unbanned cryptocurrency ads after a policy update. ICOs are banned in China and United States (primarily because of their influence within the global financial markets and the potential for ICOs to disrupt economic activity).
Based on research conducted by BitMEX, the ICO market is down by 97% in Q1 2019. The exhibit shown above indicates the amount of USD (in millions) raised by ICOs from January 2017 to April 2019. A variety of reasons may be attributed to the phasing out of the ICO as the standard crowdfunding vehicle for cryptocurrency projects. Another 2018 study from Boston College indicated that over 50% of projects in its sample failed within four months of their ICO. It’s clear that ICOs are indeed phasing out.
Gaining prominence throughout 2018, the STO substituted the ICO as a means of crowd raising. An STO refers to the selling of security tokens and is usually attached to projects whose platform usually pertain to (but are not limited to) finance, commodities trading, and the equities markets.
Since the United States possesses the most stringent financial regulation standards, the analysis of STOs in this article derive from the context of the Securities & Exchange Commission (SEC). Firstly, an offering made to U.S. residents must either be registered or exempt under the Securities Act of 1933. But the defining criteria lies with the Howey Test, established by the US Supreme Court case of SEC v Howey. In the context of blockchain tokens, according to Manhattan Street Capital, the Howey Test categorizes something as security if it:
Security tokens typically sold to investors in the United States must meet one of the SEC regulations, Reg-D, Reg-S, Reg-A+, Reg-CF and Reg S-1.
According to the exhibit from www.inwara.com, the cryptocurrency market experienced a surge in STO issuances in Q1 2019 (a 130% increase compared to Q4 2019). The top three jurisdictions that issued STOs were: the United States with 11, the United Kingdom with 8, and Switzerland with 4. An interesting thing to note, however, is that 56% of all funds raised through STOs conducted in Q1 2019 came from the United Arab Emirates, according to The Tokenist.
Due to the alignment with existing regulatory and compliance infrastructure, STOs are certainly effective in raising private capital. However, for projects looking to distribute tokens on a more widespread scale to end users and retail investors, the Initial Exchange Offering (IEO) has emerged as an optimal token sale and distribution vehicle.
In an Initial Exchange Offering (IEO), projects mint an allocated amount of tokens and distribute them to exchanges. After distributing an allocation of the total token supply to exchanges, exchanges then open up a token sale for its existing user base to participate in. By doing so, the risk is partially transferred from investors to the exchanges.
IEOs differ from ICOs in that IEOs are not completely wide open for the public to participate in. Typically, after conducting KYC/AML regulations, projects launching ICOs would peg their issued tokens to an existing cryptocurrency, and then send those tokens to the wallets of investors. Instead of sending funds directly to a public address, participants of an IEO may only be issued tokens if they have an account on said exchange conducting the IEO.
In order to also prevent whales from aggregating disproportionate amounts of tokens, exchanges have also generally instilled individual buying caps for more equitable distribution of tokens during an offering. Kucoin (among other exchanges) implemented a lottery system to facilitate the random selection of users who may participate in a token offering. The ultimate aim for these mechanisms is to prevent a small number of users to hoard large amounts of tokens, which could lead to drastic price manipulation.
Here are some of the nuances that differentiate an IEO from other typical crowdfunding platforms in the cryptocurrency space:
As of April 25th, 2019, around $159 million million USD has been raised by IEOs, according to ICO Bench. On average, only 4.4% of the total token supply is made available in the sale. Projects have been prudent in limiting the amount of tokens sold during IEO rounds to prevent the dumping of tokens and subsequent price plummets. Some countries like South Korea, have released guidelines on IEOs, which covers protection of investors, project development, regulatory compliance, & security standards. The guideline also establishes a grading scale (totaling 1,000 points) for projects looking to launch an IEO. Token issuers scoring below 700 points may only raise a hard cap of $1.4 million USD.
The risks of participating in any token sale remain, but IEOs can lessen some of the risks generally associated with participating in token sales. From a macroscopic perspective, the IEO signifies a maturation of crowdfunding vehicles in the cryptocurrency space. While there are certainly cons to participating in token sales, IEOs provide an added layer of protection for consumers through a variety of ways. Collaborative marketing and promotional initiatives can increase community engagement between users and blockchain projects. The streamlined user experience of exchanges can attract more of the non-technical users to participate in token sales. Top exchanges (with grounded legal standing and protection, effective operational management, and robust security protocols) also contribute to a more legitimate form of token distribution. Lastly, exchanges looking to partner with blockchain projects almost always have an internal business development team to conduct due diligence, which can further the legitimacy of a token sale.
While the more restrained and structured IEO method may result in a slower and limited circulation of tokens, it could signify a maturing of the cryptocurrency space.
DISCLAIMER: This analysis is not meant to be legal or financial advice as it reflects our understanding & personal opinion of the industry. When conducting in investment decisions, please consult a licensed professional and always conduct your own due diligence in projects.
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