The Important Differences Between IDOs and IPOs
IDOs, or Initial Digital Offerings, are the crypto equivalents of IPOs. Put simply, they’re both the point when a service or company opens up to public investment, but there are two key differences between them:
- You are not buying equity.
2. You are buying very early in the development cycle.
You’re Not Buying Equity
Initial Digital Offerings are not equity in the traditional sense. For one, a fully decentralized app has no ownership. It’s true that many decentralized apps (dapps) use tokens for “governance,” meaning the token can be used to vote on changes to the Smart Contract protocol, but this doesn’t give you any claim to anything beyond the token. If things go wrong you have no claim in a bankruptcy.
This paragraph might normally tell you the flip side, but from an investor’s perspective there’s no real benefit to not having equity. In fact it makes complete sense that many dapps have started to use token ownership for voting rights as it adds tremendous value to infer some form of ownership from the tokens (if the service is popular and truly decentralized).
Of course you can still buy tokens as a reasonable, if risky, investment. One unique aspect of IDOs is that you’re investing very early in projects, and most tokens are intentionally scarce assets, meaning only so many will be made. This means if you buy a token early, while its demand (and thus price) is low, and it becomes a popular or promising (or hyped) service, you can make very healthy returns as demand for the service grows (since you own the scarce asset required to use the service).
The investment risk is whether or not these services will be adopted to the level that justifies the tens of billions being invested. How much will demand for these services (and thus tokens) rise? You’re not investing in a company, you’re investing in a piece of code. A protocol for public use and betting on how many people will want to use it, not on quarterly profits.
This means it won’t be earnings reports that drive surges in token prices in an established market, but things like Smart Contract updates that increase usability, reports of increased adoption, and staking/other rewards. This is where concerns about market saturation come in.
Tokens Sales Happen Much Earlier in the Product Lifecycle than Traditional IPOs
Most companies don’t IPO until they’re profitable or have a large, dedicated client base. Almost all IDOs happen before a product is even fully live (on “mainnet”). This is because tokens have so many uses.
Tokens are needed to use the services. They can be used for governance. And they’ll be staked to validate and secure the network itself. All this means, of course, that tokens are required for testing. This unfortunately makes it easier for scams to pop up.
It’s relatively easy to create a new coin, so a well-read scammer could put together a logical and promising white paper, market it well and sell a token with no actual development behind the project. These types of intentional exploits are called “rug pulls” and they’re a real concern in the market.
So…what?
There are lots of other implications of investing this early… a totally viable project that gets publicized so early could soon find itself yesterday’s news if a newer project next month promises something slightly newer and better on a similar timeline.
There’s some competing interests here, since it’s also beneficial as an investor who does their research to get in on good projects early. Crypto investors just need to be aware of the risks associated with such early access, and focus on projects with good technicals and white papers, public and credible VCs/founders, public code audits, and any other indicators of legitimacy you can find for investments that don’t have a working product yet.
Notes & Thoughts on These Risks:
· Investors should adopt a VC’s mindset for token investments. Investing this early comes with significant risks: tech getting outpaced by newer projects, more efficient management, better support and partnerships, bad PR, etc. That’s the price of getting in early.
IDOs can function as Kickstarters in many ways, where someone proposes a feasible idea and sells tokens to raise money for the effort. Being this early is extremely risky and requires confidence in leadership and also being ok with that investment going to $0. You can always choose to buy a token later in the development process and still see returns as adoption grows and the stronger management teams become clear. Remember a token’s value is roughly equal to adoption/demand, so try and buy tokens you would use and do your research on the team.
· DEXes can but don’t need to vet tokens more often. It’s nice to be able to add new tokens as a user, like you can on Uniswap. But launch pads offering IDOs definitely need good vetting and will ideally set expectations around MVP availability, code audits and other disclosures that can at least make risks more clear.
· Market saturation is a key concern. Token value is related to demand, so if more money has poured into a coin than the future userbase would amount to, that’s the biggest sell sign for a token (besides fundamental management/operational issues).
Investing so early in the process means there’s a ton of public competition to invest in. So you can spread your money around, make one big and risky bet, or hold until the leaders become established. At this point, when the leaders are becoming more established, is when it’s really critical to try and make an accurate estimate of the potential reach of a project, which is hard right now and where some of the recent stagnation is likely coming from (fear of saturation).
· Always be aware of how the token is actually used. Does the token just have value for validating and securing the network, or also using the service? Governance? The more uses the more valuable the token is to that service’s users, and thus the more valuable overall.
· Dev teams should also explore the possibility of using value-less test tokens prior to Mainnet, to reduce the risk for early network participants. This may only be feasible for projects with significant private backing but it would be a strong sign that the team can be trusted.
· Blockchains are immutable, but maybe more can be done to normalize a process for keeping beta projects sharded and able to be rolled back to reduce incentives for hacks.
The counter argument to all of this is that dapp services will be invested in the same way stocks are. That anything we decide has value, has value; so tokens can be speculatively purchased the way equities are. It’s happening now so it’s plausible, but hasn’t yet been legitimized by regulatory approvals and large-scale tech adoption. And I’d like to read more about how speculative investing in trustless applications would work.
