Earlier this week, I wrote a Guide for Initial Exchange Offerings (IEO) and in it I talked mostly about what an IEO is, some specifics and why projects chose this crowdfunding method. If you don’t know what an Initial Exchange Offering is, you can read the guide in the link above or after this article. Initial Exchange Offerings are not as popular as Initial Coin Offerings and in this article I will talk about the positive and the negative sides of IEO. The Cons of Initial Exchange Offerings will let us understand why the method is less popular and how can this crowdfunding method be improved.
What are Initial Exchange Offerings and what are the pros?
With Initial Exchange Offerings (IEO) the project “joins forces” with the exchange to make the crowdfunding directly through the exchange. The exchange helps the project with the exchange listing, marketing, the smart contract and more. Investors that wish to participate in the IEO, have to make an account at the exchange and buy the tokens at the sale. This method cuts some costs for the projects and benefits the exchange with fees and an influx of users. Exchanges also bring credibility to the project and an existing user base of potential investors.
Projects that chose IEO, invest a hefty sum of money for the IEO, but can get a great Return of Investment (ROI) in the long run. On the other hand, exchanges can get flat fees or percentage fees, token fees, marketing collaborations, an influx of capital, volume and new users. So a good collaboration can be very fruitful to both projects and exchanges. Projects that do an IEO get listed much easier in the exchange. But because of scam Initial Coin Offerings, big and established exchanges are hesitant on allowing an IEO in their platforms.
Because exchanges can’t control projects to deliver the product from the whitepaper, most big exchanges decide to hedge the risk from making the IEO. The reputation of an exchange is 90% of its marketing and losing the reputation can mean devastating losses far greater than the fees from an IEO. The IEO crowdfunding method has been the most popular in countries where Initial Coin Offerings are prohibited and prosecuted.
Cons of doing an IEO
Unfortunately, the cons of doing an IEO outweigh the Pros, at least until some of the issues are resolved. Even the CEO of Binance, Changpeng Zhao has denied making Initial Exchange Offerings on Binance, one of the largest if not the largest exchange in the world.
- The biggest problem of an IEO is the core problem of too few people owning a majority of the token circulation. This happens mainly because an IEO is limited to one or several exchanges. People that don’t own an account at these exchanges are excluded from the sale, resulting in a small number of people getting their hands on the tokens. Accounts at exchanges need background checks, identity verifications, Know your Customer procedures, all of which takes time. So if you don’t have an account a day or few days before the IEO, you probably don’t have a chance at participating.
- The above reason’s risk is associated to price manipulation. But constricting a coin’s circulation to a single or few exchanges opens up more possibilities for price manipulations, because no one can stop the whales. This also increases the risk of pump and dump schemes. This vulnerability will sway off many investors, because of the risks it poses. That’s why when researching the projects that you want to invest in, you have to take notice of the total token circulation. If the token supply is small and/or is distributed uneven and unfair, it’s highly susceptible to price manipulation and token hoarding.
- Exchanges do their due diligence when they list a new token. Risking their reputation if they fail to do so, exchanges are very precise when they list a token, examining and researching the project’s whitepaper, product, team and more so they don’t list a scam project. The shear abundance of scam projects stays in the way of exchanges pursuing to do an IEO. If an exchange makes an IEO, then the token will be listed easier at the exchange, which opens up a vulnerability and strips the project of their obligations to deliver a good product.
- Centralized exchanges like most of the big exchanges own the private keys of all wallets and making a trade or a transaction only happens on the exchange and not on the blockchain. That way, investors do not truly own their tokens and most of them don’t trust centralized exchanges. This also opens up the possibility of a failure on the exchange’s part.
- When an IEO ends, the token trading starts. But because of the nature of IEO crowdfunding, people that want to invest in the project have to wait for the price to drop. Because of the fact that some investors got a big piece of the pie, these whales can chose to sell for immediate profits, destroying the price of the coin and/or profiting on the expense of small time investors, removing the incentive to trade the token.
The Initial Coin Offering and the Initial Exchange Offering crowdfunding methods aren’t perfect. They have different pros and cons, but they all have liabilities, especially if a project wants to make a decentralized project or application (Dapp). The closest to a perfect crowdfunding mechanism are Decentralized Autonomous Initial Coin Offerings or DAICOs which incorporate the DAO mechanism. The concept of DAICO’s isn’t perfect too, but it has a bigger potential then ICOs and IEOs in the pursuit of perfection. DAICOs are early in their development and I expect improved DAICO versions to become the preferred crowdfunding method that protects both the project and investors. If you want to read more about Initial Exchange Offerings or DAICOs, click the links below.