Crowdfunding used to be a simple concept. You invest in a project and receive special perks at its launch. That was the deal. The advancement of cryptocurrency has changed that. We’re now funding virtual money before it’s even created to make massive profits from the latecomers. The competition has evolved and we call it Initial DEX Offering (IDO.)
The benefits of the Initial DEX Offering are undeniable, but there are also risks. This article will walk you through the pros and cons as well as what is an Initial DEX Offering and how it works.
Defining Initial DEX Offering
An Initial DEX Offering (IDO) is a way for projects to sell their newly created crypto tokens to the community through a decentralized exchange (DEX). A typical IDO allows investors to lock funds into a smart contract right before a project launches its native token. At the token generation event — the moment a project launches its token — these new tokens are released to investors in exchange for the locked funds, which are being transferred to the project. IDOs provide projects with a simple and cost-effective way to distribute their tokens and raise funds, while at the same time granting higher levels of security to investors when compared to ICOs.
Investors wanting to participate in an IDO need a crypto wallet like MetaMask. The wallet needs to be topped up with funds in crypto to subscribe to the IDO and pay for transaction fees. Caution should be used when investing in any IDO. Always do your own thorough research. This includes researching a project’s tokenomics, vesting periods, the founding team, and the specific IDO mechanisms, which can vary from project to project and on different platforms. And most importantly, only invest in projects that are launched on trustworthy DEXs.
How Does an IDO Work?
During the ICO boom in 2017, crypto projects that raised funds by selling their tokens simply provided a wallet address to which interested investors could send Ether. In return, investors would receive the project’s token — unless they were ripped off.
To provide investors with full assurance that they will receive their tokens, IDOs have professionalized this process by using decentralized exchanges (DEXs) to facilitate token sales. Instead of selling their token directly to investors, crypto projects provide their tokens to a smart contract run by a DEX. At the same time, investors commit funds through the platform to the same smart contract. The DEX then makes the final distribution and transfer of funds. These processes are fully automated and executed by smart contracts on the blockchain.
Depending on the underlying smart contract and the DEX running it, each IDO has its own rules and stages. Nevertheless, most IDOs follow a similar procedure:
Vetting
Before projects can run an IDO on a DEX, due diligence is performed by the DEX team. This keeps (most) scammy projects off the platform and protects investors.
Price Fixing
After a project is accepted, it determines a supply of tokens that will be offered for a fixed price.
Whitelisting
Usually, there is a whitelist. Investors might have to register their wallet address, join a community forum on Discord, or perform marketing tasks to be added to the list.
Investing
Whitelisted investors can then lock the funds they want to invest into a smart contract on the DEX. In return, they will receive the project’s tokens once released.
Liquidity Pools and Fund Transfer
Parts of the funds that have been raised are deposited in liquidity pools together with the projects’ token on the DEX. This ensures trading liquidity from day one. The rest of the funds are released to the project. At the same time, the project’s tokens are transferred to the investors’ wallets.
Trading Starts
As soon as the funds have been exchanged between parties, the liquidity pools open for trading and the token price is determined by the market. Depending on the project, parts of the funds received by the project and the tokens transferred to the investors can be locked up for a certain period, usually referred to as vesting period.
Advantages of an IDO
Over time, token offerings have mostly become fairer and more secure for investors. IDOs have some distinct advantages that support this:
1. You don’t need to deal directly with a project and trust their smart contracts. A reliable IDO platform will have several successful sales completed. If the smart contracts are the same, you can have some trust in the offering.
2. Immediate liquidity provided post-sale. IDOs will lock up some of the funds raised in liquidity pools to create a liquid market post-sale. This helps reduce slippage and volatility.
3. No sign-ups are required. You only need a wallet and funds to participate in the sale, and personal details aren’t required. This makes it open to all kinds of users. However, the lack of KYC or AML processes can also be seen as a disadvantage (more on this below).
4. IDOs are affordable and accessible for projects. It’s often easier and cheaper for a small, less-known project to launch their token through a DEX than a large, centralized exchange.
5. IDOs often have anti-whale measures, meaning no single investor can buy a large number of tokens.
Disadvantages of an IDO
Some of the strengths of the IDO also bring about some of its weaknesses. These problems stem mainly from the decentralized and anonymous aspects of an IDO.
1. No KYC or AML. Investors and projects are protected when proper checks are completed. These measures help avoid the laundering of illegal funds and the evasion of economic sanctions. For example, certain countries may not legally participate in an IDO if the token counts as a security.
2. Less due diligence of projects. It’s much easier for an unreputable project to distribute their token through an IDO than it is through an IEO with a large, regulated exchange.
The Future of IDOs
IDOs are the newest way for crypto projects to get their tokens out to the public, but still needs improvement. With IDOs, though, a decentralized exchange means there is a lack of control mechanism. When it comes to fundraising, it’s important to have some form of control to remove token price changes or have KYC regulations.
Another improvement that should be focused on is scalability. Right now, only decentralized finance (DeFi) projects have raised money through IDOs; however, that’s not to say other projects within the crypto space can’t use this form of crowdfunding. Of course, for these projects to take off, they’ll need some interest from existing DeFi users to invest in a project’s token.
Why? Simply because using DeFi platforms is a learning curve, which may be a barrier to the average crypto trader. Another improvement would be to boost awareness and education of DeFi as this industry grows.
The concept behind crypto is to open the doors of finance by making it decentralized. IDOs are one step to making this happen, but who’s to say if a new project is the next best thing or a rug pull waiting to happen? Consequently, it’s difficult to say if a particular coin is worth X amount.
The future of IDOs could be bright, but more awareness is needed. Not only that, but DeFi users are only a small fraction of the overall crypto market that is still a relatively niche field, but exponentially growing in size.
