Frameworks for Funding and Token Distribution — Part 3: Unregulated ICOs and IEOs
To begin, let me start with a bit of nomenclature. When I am talking about unregulated ICOs, I mean offerings that neither sell utility tokens (which don’t need most regulations), nor registered securities (which are fully regulated). As a result, the tokens sold through an unregulated ICO are either unregistered securities, or what is widely known as a shitcoin, i.e. a token lacking any quality that might give it a valuation above its speculative value.
As said in the previous part of the series, unless you have the capital that is necessary for a full-blown IPO, securities can only be offered to accredited investors (either VC companies, or individual with a high income). The main reason often cited for such regulations is to protect “mom-and-pop investors“ from shady businesses and risky investments. But then again, nothing is stopping mom and pop from gambling away their life savings at the Blackjack table. Only the casino where the odds are stacked in your the backer’s favor is reserved for those who are already wealthy.
Originally, blockchain technology was meant to lower the entry barriers that prevent the common people from investing in promising businesses and those businesses from raising funds. The idea behind decentralization was to take some of this power away from the rich and mighty. Alas, this movement did not turn out as successfully as many had hoped, for various reasons.
Naturally, the rich and mighty will always fight back whenever their power is threatened and regulating bodies such as the SEC are all too complicit in providing tools for the incumbents to stifle innovation. On the other hand, fraudulent schemes and unsustainable business cases in regards to ICOs have shown that investing into unregulated sectors is risky. In the aftermath, investors who feel cheated and file lawsuits force regulators to take action.
In the wake of the Crypto crash in January 2018, ICO investors became aware that, more often than not, they were buying digital tulips. Subsequently, as we were running out of fresh use cases for our cryptocurrencies, the ICO market collapsed, which further proliferated the bear market. Luckily, whenever a bubble bursts, new business models come up and revitalize the industry. Market crashes can therefore be seen as necessary corrections that appear periodically.
We can compare last year’s bear run to the bursting of the dotcom bubble: while the sudden realization that dotcom businesses were overvalued gave rise to the Web 2.0, the realization that ICOs were overhyped caused the ICO market to mature. In fact, when trying to raise funds through an ICO today, it has become necessary to have a clear value proposition for investors: either by designing a sound utility token, in which case the value proposition is the utility that the token provides, or by designing tokens that represent a tangible asset, which participants can co-own, or take returns on.
Since there are only limited use cases for utility tokens at the moment, the recent rise of STOs have been seen sometimes as a godsend, which could help us to overcome the bear market. So far, this outlook seems promising, as cryptocurrency exchange rates kept soaring throughout the past few weeks. In the last post, though, I analyzed how STOs don’t add to the process of decentralization and should rather be seen as a tokenized version of classical IPOs. This, however, doesn’t mean that you shouldn’t run an STO, if it helps you grow your business.
Creating fully regulated security tokens that can only be offered to accredited investors doesn’t decentralize anything, but it provides us with new investment opportunities. The STO boom is not really what we wanted, but it might just be what we needed. In any case, we can safely say good riddance to unregulated ICOs.
Initial Exchange Offering
A quick word about IEOs, as they are on the rise right now. This seems to be a much more viable approach to fundraising, since the project running them don’t have to worry about exchange listing. The IEO is done in cooperation with an an exchange that will automatically list the token for public trading afterwards. Additionally, exchanges can provide legal support, basic regulatory certainty, as well as help with the marketing. For that reason, this article calls IEOs the lazy man’s ICO.
The biggest advantage of IEOs compared to ICOs is that being backed by an exchange creates a sense of safety for investors, as exchanges will do their best to weed out scams and only partner up with the most promising projects. There are drawbacks, however. Relaying all the core preparation steps on outsiders who are not deeply involved in the project is indeed lazy and may still lead to a failure, especially when conducted on one of the many small exchanges that offer IEOs. Legal advisors and a strong marketing team are therefore still needed.
Another drawback is that the tokens are only offered to users of the exchange the token is listed on, instead of the general public, making the whole process in itself less decentralized. While IEOs on major exchanges such as Binance are almost a guaranteed success, they often sell out immediately, meaning that few big investors share the tokens among each other, rather than the community. In fact, Binance Launchpad tends to sell tokens so quickly that they recently had to come up with a lottery system to make sure everyone gets a fair chance to participate in upcoming IEOs.
Projects with strong utility tokens, a dedicated team, and a good MVP may therefore be better advised to hold their own token sale. However, for projects that want to conduct early funding rounds that enable them to build an MVP, IEOs can be an attractive solution, given of course that they can convince a reputable exchange to list them. Additionally, many exchanges charge rather high upfront-fees for an IEO listing, which can be much higher than the costs of building an MVP in the first place. Although the bigger and more costly exchanges are under hefty competitions by IEO platforms without upfront listing-fees, it remains to be seen, whether those will be able to provide good services for projects in need of early funding.
Tobias W. Kaiser is a Research Associate at a-Qube. He is specialized in Tokenomics, decentralized business models, and Game Theory.