What is an Initial Exchange Offering (IEO)
The increasing demand for cryptocurrencies and wide adoption by financial institutions and payment giants such as PayPal and Square reflects its undeniable ascent. While Bitcoin and crypto have had a somewhat rocky start, today’s BTC value has surpassed the predictions of experts when it first launched, and more cryptos are emerging to follow in its footsteps.
In general, you can purchase cryptocurrency during its initial release in the initial coin offerings (ICOs). But the ICO fever of 2017 proved to be a risky environment for investors. In contrast, an initial exchange offering (IEO) offers a more secure alternative for investors to purchase tokens with funds directly from their exchange wallets during the fundraising phase.
Defining Initial Exchange Offering
An Initial Exchange Offering, as its name suggests, is conducted on the platform of a cryptocurrency exchange. Contrary to Initial Coin Offerings (ICOs), an IEO is administered by a crypto exchange on behalf of the startup that seeks to raise funds with its newly issued tokens.
As the token sale is conducted on the exchange’s platform, token issuers have to pay a listing fee along with a percentage of the tokens sold during the IEO. In return, the tokens of the crypto startups are sold on the exchange’s platforms, and their coins are listed after the IEO is over. As the cryptocurrency exchange takes a percentage of the tokens sold by the startup, the exchange is incentivized to help with the token issuer’s marketing operations.
IEO participants do not send contributions to a smart contract, such as governs an ICO. Instead, they have to create an account on the exchange’s platform where the IEO is conducted. The contributors then fund their exchange wallets with coins and use those funds to buy the fundraising company’s tokens.
How Does an IEO Work?
An IEO is used by start-up companies to obtain crowdfunding for their enterprises. These companies raise funds by working directly with a cryptocurrency trading platform to commence a token sale to interested investors. The key highlight of IEO is the exchange platforms will carry out their due diligence to perform a profusion of assessments before the sales.
The IEO process to assessing these blockchain projects work like this:
- White paper drafting: The start-up company drafts a white paper that explains precisely how the tokens will be funded, along with the backing sources and the payment platform that will be available for transfers and transactions using this new cryptocurrency. This white paper outlines exactly how the funding that supports the cryptocurrency will be obtained and the expected value of the cryptocurrency upon its release.
- Project submission: The company or project registers with the platform chosen for their IEO to signal their interest in selling tokens through that platform.
- Vetting process: The crypto exchange platform then performs due diligence to confirm that the project and the token issuer are creditworthy. That includes assessing the project’s unique selling points, tokenomics assessment, team background check, and the projected trajectory. That is to determine if any loopholes, threats, or other issues exist within the project offers. This is accomplished by examining the company’s white paper, financial records and other information available through public sources.
- Contract agreement: If the IEO is approved by the cryptocurrency exchange platform, the project will be required to pay a certain proportion of their utility tokens, as well as a listing fee, to the platform before the tokens can be made available for sale. This will result in the IEO being listed on the exchange within a few days after its approval.
- Security and legality: Because IEOs do not offer an investment interest in the company, the U.S. Securities and Exchange Commission (SEC) does not generally regulate IEO investments. This can simplify the process of sales and issuance of IEO tokens for companies looking for start-up funds for their new cryptocurrencies. However, the regulations are can differ from one country and region to another.
- Once all investigations have been completed, and the IEO project has passed muster, the platform posts a notice of token sale allowing investors to purchase these utility tokens. The company issuing the IEO will typically also list the tokens on their own site to publicize their availability.
- Investors who are interested in the project need to go through the IEO platform’s Know Your Customer (KYC) and Anti-Money Laundering (AML) before gaining full access to the project development.
For companies interested in raising funds, IEOs are usually preferred to ICOs. Understanding why can help you to make the best choice for your investment activities.
Advantages of an IEO
Essentially, IEOs are advantageous due to:
- Increased investor confidence. Investors do not deal with the IEO project team directly, but with the exchange which makes it more credible and secure in case things go south.
- Security for both token issuers and investors. Token issuers gain as well since IEO platforms manage all things related to regulations, such as mandatory KYC/AML checks for every participant.
- Frictionless process. IEO platforms ensure almost anyone, regardless of their experience in the crypto space, can easily contribute.
- Guaranteed exchange listing. IEO tokens are listed on the IEO exchange soon after the IEO.
- Removal of scams. The IEO project teams are neither anonymous nor fake, so they won’t disappear after collecting your funds.
- Benefits for the projects, like enhanced marketing effort by the exchange, more credibility, exposure, and interest in the project.
- Benefits for the exchanges, including new users signing up with them only for the sake of purchasing and trading IEO tokens.
- Benefits for the exchange token holders. Most exchanges use IEOs to add another use case for their native token (if they have one) which is likely to raise its value.
Disadvantages of an IEO
However, IEOs are also the subjects to the following risks and concerns:
- Unclear regulations and restrictions. Many countries have issued restrictions or banned ICOs completely, which may reflect badly on IEOs, too. Although it is a slightly different beast, the core principles of an IEO remain the same.
- All investors must comply with AML/KYC. The cryptocurrency community is known to be full of privacy-obsessed individuals, so going through AML/KYC procedure may be a big no-no for some.
- Market manipulation and concentration of coins. Most IEO tokens are minted beforehand, so you should always double-check the dynamics of token allocation and distribution before investing. Both the project team and an IEO exchange may keep an unreasonably large portion of tokens to themselves, which may result in meddling with prices later on. Besides, it’s no secret that the vast majority of exchanges participate in “wash trading.”
- A limited number of investors. There has been many complains from investors that not everyone manages to purchase tokens during IEOs.
- Bots. There is a concern about bots that can be programmed to participate in IEOs and beat out human investors.
- FOMO. Remember to do your own research and examine the projects and their ideas yourself. Both IEO project managers and IEO platforms have the incentive to create as much hype as possible to sell all the coins. Be sure to check the project’s whitepaper, idea, and whether it even needs a token in the first place. For more potential IEOs “red flags,” see our guide on ICO risks in 2021.
The Future of IEOs
ICOs created a fundraising boom in 2017 and 2018. However, a significant percentage of the crypto projects were operated by scammers or were of a dubious nature. Because of this, as well as ICO bans, we can say that this is not an efficient fundraising model for cryptocurrency startups.
On the other hand, IEOs provide an increased level of trust among cryptocurrency projects, because the exchanges hosting the crowdsales actively participate in the fundraising process, which improves the efficiency of the crowdsale. Therefore, IEOs have the potential of becoming the standard model for raising funds in the crypto space and maybe even creating the next fundraising boom.
If you’re an investor looking to lower your risk when purchasing cryptocurrency, IEOs can mitigate some of the most important drawbacks of ICOs while helping you to pursue your investment goals. IEOs are also touted by the Journal of Alternative Investments as the next evolution in cryptocurrencies and are likely to remain at the forefront of cryptocurrency investment for many years into the future.