What Is an Initial Exchange Offering (IEO) In Crypto?
Cryptocurrency is defined as a digital currency based on a distributed network. 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 BTC’s value is almost surpassing its all-time high again, 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.
What Is an IEO?
An initial exchange offering (IEO) is a way for start-up companies to raise capital by selling utility tokens which confer preferred status with the company through a cryptocurrency exchange platform. In short, crypto exchanges help to oversee the token sale by making sure the project vetting process is scrutinized. The IEO originated in January 2019 when Binance Launchpad launched the BitTorrent Token (BTT). The initial offering sold out within 15 minutes of release, raising funds of more than $7.1 million.
The IEO has gained popularity mainly because it’s easy to participate in. Instead of processing on-chain transactions across multiple blockchains and wallets, the IEO offers a solution for users to assess the reliability of a project and to participate in funds exchange all under one roof. At the same time, project developers get immediate exposure to the crypto exchange’s user base without needing to fork out millions of dollars to formulate and execute their marketing strategies. Thus the IEO is a win-win for both users and developers.
How Does an Initial Exchange Offering 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.
What Considers a Good White Paper?
A reliable white paper should possess a few criteria, but generally, is to educate the potential investors with regards to the project prospects. To bare minimum for a good white paper should disclose detailed information about the project architecture, the team behind the project, a project roadmap, the facts and technical explanations with credible diagrams and statistics that appeal to technically-focused individuals or interested buyers.
Overall, the white paper should clearly inform the potential investors of the project’s vision, mission, overall growth, and how does the token translates its value to the holder. For example, BitDAO’s white paper provides full transparency of the project.
IEO vs. ICO: Which Is Better?
ICOs were the first method used by cryptocurrency companies to raise money. According to Forbes, the very first ICO was launched by a company called Mastercoin in 2013. Ethereum followed suit in 2014, raising about $18.3 million. Its blockchain project was based on what’s known as a charitable foundation model, in which investors make donations to back the project.
IEOs offer some important advantages over ICOs, as described below.
IEOs are comprehensively vetted for compliance with legal regulations and safety by the cryptocurrency platforms on which they’re sold. These platforms evaluate the IEOs for viability and to eliminate any possibility of fraudulent activity and market manipulation. This process can significantly improve investors’ confidence in the security of their financial outlays. ICOs, by contrast, don’t undergo the same degree of scrutiny and are thus considered to be a riskier investment by most financial authorities.
Public offering approach
ICOs allow anyone to purchase tokens. IEOs, however, require that investors be part of the platform that offers the IEO in order to make these financial investments. This reduces the probability that unverified individuals will purchase tokens. ICOs, by contrast, require investors to “go it alone,” purchasing directly from the company issuing these tokens. This not only reduces visibility for the issuer but can result in fewer protections for the investor.
Cost for token sales
In return for the added security offered by IEOs, investors will typically pay somewhat more for IEO tokens than for ICO tokens of the same apparent value. Additionally, IEOs generally list tokens on the exchange nearly immediately. ICOs can take months to list these sales. Companies which issue IEOs usually pay a higher price for this privilege than those which issue ICOs.
For investors, ICOs typically hold much higher financial risks than IEOs. For both types of initial offerings, however, the possibility exists that these investment opportunities may be in violation of certain regulations or legal requirements. Some of the most common legal risks of ICOs and IEOs include the following:
- Legality of the smart contracts established for cryptocurrency: ICOs and IEOs aren’t governed by a comprehensive and nationwide legal standard. The sole federal regulation which covers these types of transactions is the Electronic Signatures in Global and National Commerce Act of 2000, which requires specific timings for electronic disclosures and forms. This lack of regulation can sometimes lead to legal issues if the provisions of the smart contract aren’t in alignment with local or state contract law. Jurisdictional issues are one of the primary legal problems facing cryptocurrency issuers and investors.
- Financial fraud and unauthorized access to confidential data are also significant legal issues that can affect ICOs and IEOs. Bloomberg published information on a security flaw that affected Ethereum accounts that could have put $250 million at risk. In a similar vein, CoinDesk reported in September 2021 that Ledger was the victim of a data breach that put about one million email addresses at risk and revealed personal information of more than 9,000 customers.
- Money laundering can sometimes be accomplished more efficiently through the use of cryptocurrency. The MIT Technology Review published a report in January 2021 indicating that about $2.8 billion in Bitcoin transactions by criminal organizations took place in 2019. Most of these transactions were completed through over-the-counter brokers, which points to the limited ability of cryptocurrency exchanges to prevent these illegal activities.
- Failing to report cryptocurrency transactions can lead to problems with tax authorities in various countries. While the U.S. Internal Revenue Service doesn’t allow cryptocurrency to be used in payments to federal agencies, U.S. taxpayers are required to provide accurate information on their transactions when they file their tax returns.
Determining the legal implications of ICO and IEO investments can help you to avoid issues that could cut into your profits and lead to unwanted legal entanglements associated with your cryptocurrency investment activities.
Why Do Blockchain Projects Prefer IEOs?
Initial exchange offerings are typically far more beneficial than ICOs for all parties involved:
- Project initiators can benefit from the marketing expertise and vetting provided by the cryptocurrency exchange for an IEO. This can help them to reach potential investors much more easily, and boost the chances for legitimate projects to obtain the necessary funding.
- Most investors prefer to purchase IEO tokens over ICO tokens, thanks to the significant amount of investigation and examination these offerings receive before they’re presented to the public. This reduces undue risk and makes IEO investments more attractive for investors.
- Cryptocurrency exchanges who offer IEOs can often attract new traders and increase buzz for their platforms, which can add up to increased profitability and traffic for their companies.
Limitations of Initial Exchange Offerings (IEOs)
While most cryptocurrency exchanges work diligently to ensure that IEOs are examined thoroughly, some platforms may cut corners to ensure a wider range of products for their potential investors. As mentioned, IEOs aren’t subject to the regulators’ oversight. This means that without adequate investigation on the part of the issuing platform, the tokens issued in an IEO could be less valuable than represented during the launch phase.
Additionally, crypto projects are bound to pay listing fees to the crypto trading platforms. Hence, exchanges may charge a higher rate for tokens both to the issuing company and to investors. By contrast, ICOs can set their own rates, which can allow investors to snag bargains during this phase of cryptocurrency issuance. Tokens purchased for IEOs are usually capped at $20,000, which is also in contrast to the lack of limits enforced by ICOs.
The Bottom Line
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. Reuters notes that SEC crackdowns have limited the ability of many ICOs to offer tokens to private investors. IEOs, however, has been 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.