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Initial DEX Offering (IDO)

An initial DEX offering (IDO) is a token offering that occurs on a decentralized exchange.

You may be familiar with the initial coin offering (ICO) boom of 2016 and 2017. But did you know there's a hot new trend that's taken the world of crypto investing by storm in recent years?

The initial DEX offering, similar to the initial coin offering in both name and function, has been the source of incredible gains for many speculators and long-term blockchain investors alike. IDOs differ from traditional ICOs in several respects, however, and it's important to understand exactly what you're getting into before you devote a substantial portion of your portfolio to IDOs.

How Does an IDO Work?

An IDO is, quite simply, an initial coin offering conducted through a decentralized exchange (DEX). These offerings have several advantages over ICOs.

Operates on a Decentralized Exchange

Before delving into the inner workings of IDOs, however, one must first understand how a decentralized exchange fundamentally operates and what sets it apart. Unlike traditional exchanges, which use a centralized repository of buy and sell orders to determine the order in which transactions are executed, a DEX uses smart contracts to form what are known as liquidity pools. These liquidity pools are nothing more than specific collections of two different tokens, and they offer a simplified trading experience.

A liquidity pool's smart contract allows users to freely exchange one token for another, according to the current relative supply of each token in the pool. As users buy more of one token in the pair with the second token in the pool, the supply of the token with more demand decreases. Subsequently, the smart contract updates the new exchange rate to reflect these changes. Notably, the smart contract determining the exchange rate offered by the liquidity pool guarantees that a buyer or seller of a token in the pool will always be able to transact.

Validators and miners on the network where the DEX resides are responsible for processing transaction requests, and these smart contracts operate in such a way as to provide a nonzero amount of liquidity for everybody using the exchange. At any point, users are free to deposit varying amounts of the appropriate tokens to a specific liquidity pool. In doing so, they earn a percentage of the DEX's transaction fees for that pool.

The IDO Process

An IDO takes the innovative user experience of a DEX and stretches it even further, enabling retail crypto investors to participate in initial token offerings through a liquidity pool. The project conducting the offering will often "seed" the liquidity pool with an initial supply of tokens, and then market forces will take over as participants rush to secure the best price.

While some IDOs require initial participants to complete KYC verification, some offerings require no personal information to participate. Often, users interested in the IDO will need to enter their wallet information into a lottery in the hopes of securing the right to buy at the offering price.

In order to maximize the number of participants in these offerings, and to prevent a token's holding from becoming too concentrated, many projects will issue a large number of small allocations. For example, it's not uncommon for a large IDO to limit everyone's initial allocation to approximately $1,000. A larger distribution of holders tends to stabilize the token's price, leading to less volatility.

The Future of IDOs

While no one knows for certain what the future of IDOs will look like, this fundraising method has built a lot of momentum since the first such offering took place in 2019. The IDO landscape is still quite fragmented, and the number of DEXs on multiple blockchains has continued to proliferate in the past several years.

One thing is for certain, however. It's quite likely that new regulations and guidance from government authorities will have a significant impact on the future of IDOs. Furthermore, automated KYC and whitelisting solutions will likely streamline the IDO participation experience in the years ahead. In addition, the growth of crypto research firms will also help frequent IDO investors find quality offerings and avoid scams.

The Benefits and Risks of an IDO

Benefits of an IDO

Guaranteed Liquidity

Arguably the largest benefit of participating in an IDO is that you have guaranteed liquidity for the new tokens you've acquired. When participating in a traditional ICO or an initial offering conducted through a centralized exchange, there are no such guarantees. However, thanks to the liquidity pools and smart contracts on the decentralized exchange where the IDO takes place, you know that you’ll always be able to sell your tokens for some price.

Offer High Returns

Secondly, the fast-paced trading environment of a decentralized exchange can offer astronomical returns on your IDO investment in a very short period of time. During the crypto bull run of 2021, multiple IDOs produced gains of over 10 times the initial offering price within days. The prospect of such returns means that investors don’t need to allocate a large amount of capital to see sizable gains in the value of their overall crypto portfolio.

Risks of an IDO

Being Scammed

The largest risk that many IDO investors face is the prospect of being scammed by an unscrupulous project. In some cases, these scams are as simple as a group of people impersonating a reputable project, and publishing a fake smart contract to trick participants into sending valuable funds in exchange for nothing. In other cases, projects simply disappear after collecting funds from the IDO.

Adequate due diligence, however, can mitigate the risk of being scammed. For example, researching the biographies of the project's team and advisors can give investors added confidence. If a project isn’t willing to provide background information on the team members, then the odds of the offering being a scam of one form or another increases dramatically.

General Market Risk

If you've carefully vetted the project you're about to invest in through an IDO, then the biggest headwind you'll face is general market risk. Bear markets in crypto can be brutal, and even IDOs tend not to do well when general investor sentiment is overly negative. In fact, several anticipated projects have decided to cancel or postpone their IDOs due to poor market conditions in recent months.

While IDOs certainly aren't without their share of risks, there are steps you can take to reduce the chances that you'll take a big hit if things go wrong. First and foremost: Never invest any more of your portfolio than you can afford to lose. While some IDOs do literally “go to zero,” others produce legendary gains that can make up for several losses. IDOs are an exciting section of the cryptocurrency universe, but it's important to always participate responsibly.