What Is An Initial Exchange Offering?

The blockchain-based cryptocurrency promises a revolution in how we transfer value, people world over are looking to invest in this exciting new technology.

However, investing in this space is very different from investing in other markets. As a result, new investment vehicles are emerging. In this context, it is important to understand what is an Initial Exchange Offering (IEO)? I will explain all in this guide.

Contents

How do technology businesses raise funds?
How did “Initial Coin Offerings” (ICOs) emerge?
How do ICOs work?
The pros and cons of ICOs
How small investors can detect fraud ICOs?
What are IEOs?
The advantages of IEOs
A few disadvantages to IEOs
Examples of a few IEO platforms
Planning to take advantages of IEOs for your blockchain-crypto idea?

How do technology businesses raise funds?

Before we get into explaining what an IEO is, let’s recap how technology businesses raise fund. Such businesses can raise fund for expansion in the following two ways:

Initial Public Offering (IPO):

An IPO works as follows:

  • When a technology business intends to become a publicly listed company, they issue an IPO.
  • It had operated a privately held company till then, and then it needed funds to expand.
  • They could not have possibly raised the funds required for expansion by themselves.
  • They sell shares to investors and raise the funds they need.
  • The investors acquire ownership of parts of the company.
  • A company needs to meet several requirements before they can launch an IPO, e.g., they must demonstrate a track record of operating successfully as a private company, meeting an income threshold, etc.
  • Companies launching IPOs must comply with stringent regulatory requirements, and it can take more than a year to meet these requirements.
  • Launching an IPO also involves high costs, in the form or legal and other professional fees.

You can read more about IPOs in “IPO basics: What is an IPO?”.

“Venture Capital” (VC) raise:

Technology start-ups can raise funds for their expansion through a VC raise. This works as follows:

  • VC funds manage the money of investors that seek private equity.
  • Such funds look out for businesses with high growth potential, and as we know from the business world, such businesses are also subject to higher risks.
  • VC fund managers are experienced business people themselves, with a significant track record of building high-performance businesses.
  • They invest in start-ups that show great growth potential and acquire stakes in them.
  • VCs also hand-hold the start-ups during their formative years and coach them. VCs have significant access to markets, expertise, and business media, therefore, the start-ups benefit from these.
  • Being experienced businessmen themselves, VCs screen the start-ups keenly before investing in them. VCs are also concentrated in key business and financial centers, and they prefer to invest in start-ups in those regions only.

If you want to learn more about VCs, then you can read “Venture capital funds”.

How did “Initial Coin Offerings” (ICOs) emerge?

You first need an understanding of how blockchain-crypto start-ups find it hard to raise money via IPOs or VCs, and how ICOs (“Initial Coin Offerings”) emerged, to make sense of the phenomenon of IEOs. Blockchain-crypto start-ups find it hard to raise funds via IPOs and VCs, due to the following reasons:

Download Our Project Specification Template

  • These start-ups are new, and they don’t have enough track record of operating as private companies. This makes it hard for them to go through the IPO route.
  • Blockchain-crypto start-ups are often dealing with very new technology since blockchain itself is a new technology. It’s hard for them to show a clear path to growth since the technology is continuously evolving. Consequently, they are often unable to meet the stringent requirements of VCs.
  • VCs are concentrated in certain regions, which makes blockchain-crypto start-ups operating elsewhere unable to get funding from VCs.
  • Both IPOs and VCs involve stringent regulatory processes, and blockchain-crypto start-ups are often not prepared for these.
  • Blockchain-crypto start-ups are often wary of giving partial control of their company to external investors, therefore, they often don’t prefer fund-raising avenues like VCs.

These challenges led the blockchain-crypto communities to come up with “Initial Coin Offerings” (ICOs), i.e., an unregulated way to raise funds quickly, all over the world. Read more about this in “The emergence of the ICO”.

How do ICOs work?

Before delving into IEOs, let’s take a few moments to understand how ICOs work, which is as follows:

  • Blockchain-crypto start-ups plan their offering, formulate a business model, and create a technology solution.
  • They assemble a team, create a whitepaper, build a website, and prepare digital marketing materials.
  • The start-up then launches an ICO, explaining to their potential investors about how to invest.
  • The build a crypto token using a blockchain platform like Ethereum and sell it to their investors during the ICO. Note that the company isn’t selling a stake in their company.
  • Operating outside regulations, they raise funds quickly, and from all over the world.

Read “Initial Coin Offering (ICO)” to learn more about ICOs.

The pros and cons of ICOs

Understanding the pros and cons of ICOs will help us better understand why IEOs emerged. ICOs have several advantages, e.g.:

  • Blockchain-crypto start-ups can raise substantial sums of money quickly, and from all over the world, via the ICO route.
  • They don’t give up any control over their company.
  • They don’t need to spend time and money to meet regulatory requirements since they operate outside regulations.
  • Small investors had no other way to invest in this exciting and promising technology, and ICOs gave them an opportunity to invest. Note that IPOs and VCs only allow accredited investors, and not small, retail investors.

While these advantages are notable, there are also disadvantages to ICOs. You can read a good account of them in “ICO pros and cons: Is it worth the hype?”, however, I will summarise the key disadvantages here, which are as follows:

  • Blockchain-crypto start-ups launch ICOs outside of regulations, therefore, they omit all accountabilities that regulators demand. This encourages fraudulent behaviors.
  • The onus is fully on retail investors to analyze whether the ICO is a fraud, and small investors are often ill-prepared to do this due diligence. A large number of ICOs did turn out to be scams, and you can read about it in “New study says 80 percent of ICOs conducted in 2017 were scams”.
  • Many ICO projects promised high profits to their investors, therefore, they essentially sold securities investment contracts. However, they didn’t comply with the stringent securities regulations, instead, they sold their crypto tokens as “Utility tokens”. I have explained this in “Utility tokens vs. security tokens comparison guide”. Regulators like the US “Securities and Exchange Commission” (SEC) have subsequently clamped down on them.

 

How small investors can detect fraud ICOs?

IEOs emerged to address the possibilities of frauds in ICOs, therefore, let’s first see the challenges small investors face in detecting ICO frauds. Small investors need to do the following, to detect such frauds:

  • They need to check the credentials of the ICO project team members.
  • Small investors need to read the whitepaper thoroughly and determine if there is a genuine business case.
  • Investors need to analyze whether the business case at all requires blockchain and a crypto token.
  • They need to view the code in the GitHub repository of the project team and validate if the team is indeed doing any real work.
  • Small investors need to check if the project team is just plagiarizing content and marketing an impractical business opportunity.
  • They need to verify if the ICO project team is meeting the legal and regulatory requirements.

Read more about this in “8 ways to spot an ICO scam”. You can see how hard it is for small investors to spot potential ICO scams, considering they may be new to investing as well as the blockchain technology! IEOs can help here, and let’s see how.

What are IEOs?

IEOs are crowdfunding events where a blockchain-crypto start-up raises funds from common investors through a crypto exchange. IEOs work as follows:

Read How We Helped a Marketing Company to Build a Back-Office Custom Ads Dashboard

  • The start-up plans its project and creates their crypto token.
  • They then work a cryptocurrency exchange to launch an IEO, instead of launching their own ICO.
  • The exchange then conducts the IEO, and investors buy tokens on the exchange, using their accounts on it.
  • Investors can buy tokens using Bitcoin, Ether, or using other means that the exchange provides.
  • The start-up pays a fee to the exchange, and the exchange lists the new token.

Read more about how IEOs work in “IEO”.

The advantages of IEOs

IEOs offer several advantages, which are as follows:

1. Assurance to investors

As I have explained earlier, scam stars took advantages of ICOs, since the onus was fully on investors to spot a scam. With IEOs, investors get the much-needed assurance, in the following ways:

  • A cryptocurrency exchange takes a close look at an IEO, and only then lets the project launch it via the exchange.
  • Crypto exchanges are obviously better equipped to spot scams when compared to small investors.
  • As a result, retail investors know that not only the start-up but even the exchange is putting their reputation at stake when they launch an IEO.

Small investors can, therefore, feel more assured about an IEO. You can learn more about it in “What is an IEO? Initial exchange offering explained”.

2. A potentially higher base of investors for the start-up

In case of an ICO, the blockchain-crypto start-up needs to bring in investors entirely on their own. In the case of an IEO, they can get the following advantages:

  • They can get a potential investor base much larger to start with, and that’s the user base of the exchange.
  • To add to this, start-ups get KYC (“Know Your Customer”) and AML (“Anti Money Laundering”) compliant investors, since the cryptocurrency exchange had already executed the KYC and AML processes when they opened accounts for users.

3. Start-ups and investors get a better deal compared to a hacked ICO

IEOs offer a better deal to investors and start-ups compared to hacked ICOs, and this is due to the following reasons:

  • In case of an ICO, the start-up creates a smart contract and asks investors to send their Bitcoin or Ether to that contract address.
  • However, hackers often manipulate the website and other communications and convince investors to send their digital currencies to another contract address. They subsequently make off with the fund. Such ICO hacks are common, as media reports will show you.
  • In the case of IEOs, investors deposit their money into their exchange accounts, thus negating ICO hacks.

4. Small investors can continue to invest in blockchain start-ups

Unlike IPOs or VCs, IEOs don’t exclude small investors from the opportunity to invest in promising blockchain-crypto start-ups. IEOs retain this advantage that ICOs offered.

5. IEOs prevent price manipulation

Price manipulation has been an unfortunate part of ICOs, however, IEOs offer more transparency, helping in preventing it. You can read more about this advantage in “What is an Initial Exchange Offering (IEO) and how does it work?”.

6. A higher user base and fees for the exchange

The cryptocurrency exchange launching an IEO of a blockchain-crypto start-up can get new users, as a result of the marketing effort by the project team. The exchange also earns fees for the listing of the new token.

7. Higher liquidity

IEO tokens are listed on an exchange since the time of their launch, therefore, there is higher liquidity at play. You can learn more about it in “IEO vs ICO: What are the differences?”.

A few disadvantages to IEOs

IEOs have a few disadvantages too, and these are as follows:

  • Crypto exchanges aren’t secure enough. They operate as centralized banks within the cryptocurrency context, however, they do not follow the stringent regulatory requirements that banks dealing in fiat currencies do. Hackers frequently target crypto exchanges, and crypto traders hardly have any legal recourse.
  • Exchanges vet blockchain-crypto projects before launching IEOs, however, that does not mean that small investors can omit their own due diligence.
  • IEOs often have minimum holding threshold, which can preclude some small investors.
  • Blockchain-crypto projects may often find IEOs expensive since exchanges charge hefty fees.

Read more about these disadvantages in “Initial Exchange Offerings (IEO): Pros and cons”.

Examples of a few IEO platforms

A few crypto exchanges have launched IEO platforms, e.g.:

Note that IEOs do not address the potential regulation-related issues arising from blockchain-crypto start-ups selling utility tokens when they should have issued security ones. Given this, we need to watch how popular IEOs will become in the longer term.

Planning to take advantages of IEOs for your blockchain-crypto idea?

You might have a great idea for a blockchain-crypto project, and IEOs could help with raising the funds you need. However, launching such a project can be complex, since you need to plan meticulously for the development. You can read more about this planning in “What to plan for when undertaking blockchain software development?”. Consider getting help from software development companies for such projects.

Download Our Project Specification Template