The crypto industry is developing extremely rapidly. It is also true for methods by which crypto projects raise funds to build their products and distribute their cryptocurrencies or tokens to the public.
Initially, there was only distribution of cryptocurrencies to the general public performed by mining (or pre-mining in POS systems), while funds were raised mainly through the investment of venture capitalists.
Later on, since 2013, the first public crypto-native fundraising tool appeared — Initial Coin Offering (ICO) — which became especially popular in 2017. In an ICO, a project team, on their own (through their website or an aggregator platform), sells their tokens to investors in exchange for fiat or high caps cryptocurrencies like BTC or ETH. ICO tokens may have some utility, e.g., give their holders access to an app the project is offering or merely be bought in anticipation of future profits from their increased value.
In its early years, ICOs were almost unregulated and constituted very risky investments. In exchange for their investments, in most cases, investors did not receive any equity in crypto companies, nor did they get any legal guarantees. Although there were indeed successful ICOs (such as Ethereum or NEO), many fraudsters took advantage of the investment rush. In 2017 approx. 80% of ICOs were reported as scams, whereas the 10 most notorious scam schemes stole $687.4 million from inexperienced investors.
As a result, some countries restricted ICOs (e.g., China, India). Other countries’ national frameworks incorporated a distinction between utility tokens and tokens with securities characteristics (e.g., shares, bonds, derivatives). The latter are allowed to be sold to the public only in a new sale format — Security Token Offering (STO). In an STO, crypto assets are considered securities tied to a registered company, and therefore, their issuance and distribution are subject to national securities legislation (e.g., in Canada, Hong Kong).
Another innovative at that time way to attract investors was Initial Fork Offering (IFO). In an IFO, new altcoins, which are native to a blockchain fork, are given for free to holders of parent cryptocurrency to motivate the community to transact them. Generally, forks were advertised as outperforming their native blockchains; however, given the ease with which a fork can be created, hundreds of forks eventually failed, having lost their value.
Then, in 2019, Initial Exchange Offering (IEO) came into the picture. In an IEO, a token offering is hosted and administered by a crypto exchange platform (they can also provide marketing support, post-listing of new tokens, etc.).
During a period when blockchain interoperability was only developing, an IEO was more convenient than other options, as users could purchase different crypto assets with funds directly from their own exchange account and store them there, but not to launch every time a wallet specifically for a particular coin. Besides, an IEO poses reputation risks for crypto exchanges, so they tend to vet the startups they advertise on their platforms. Meanwhile, Exchanges like Binance are said to operate as an ‘underwriter’ by performing due diligence on both the projects and prospective buyers of IEO assets.
Also, it should be mentioned such a widespread distribution and promotional tool as Airdrop, which is in common use to this day. It implies sending, usually gratuitously, tokens to multiple public addresses to draw attention to the tokens. Often, in order to receive an airdrop, some preconditions exist, like holding a specified amount of another cryptocurrency on the address-recipient or fulfilling a task (e.g., retweeting an advertisement).
The year 2020 marked a milestone in fundraising methods in the crypto industry, associated with the explosion of DEXs, in particular AMM, based on which so-called ‘Initial DEX Offering’ (IDO) appeared. An IDO can be launched on DEXs with liquidity pools. Uniswap became a particularly popular platform for IDO execution. On Uniswap, any crypto enterprise can create a new liquidity pool by providing their IDO tokens and ETH (both assets should be of equal value). Thus, an IDO also functions as an initial listing of new assets on the DEX. By this means, the liquidity is established immediately, and users can instantly buy the IDO tokens for ETH and further trade or speculate on them on the DEX. The crypto project does not bear any particular costs associated with the listing, except paying transaction fees.
Apart from the fact that IDOs could be permissionless and ensure consistent liquidity, IDOs implied an innovative approach. In particular, investors, having acquired IDO tokens, could add them to the DEX’s liquidity and start to earn trading fees.
Many DEXs do not control or check IDOs being arranged on them; as a result, these events can be accompanied by some unfair practices such as rug pulls or, as it can happen on the Ethereum network, front-running in the race to be the first buyer (after listing the price of new tokens can explode in a matter of minutes). As an IDO pool is publicly available and there are no limits to the number of tokens to be bought by each wallet, a few wealthy parties can buy up a majority of the IDO tokens.
The next step in developing crypto fundraising is Initial Farm Offering (IFO), a new token sale model, which emerged in the context of DeFi yield farming on BSC. Pancakeswap pioneered in this field, having introduced an IFO launchpad where BSC-based crypto projects can generate funds by pre-selling their tokens (prior to listing). Pancakeswap administers the process and examines applications of crypto projects before starting an official fundraising event. To participate in the sale, users need to obtain CAKE-BNB LP tokens and, during the event, commit them to purchase IFO tokens. When the deal is finalized, participants can claim their IFO tokens distributed based on a participant’s contribution to the IFO pool and the unspent LP tokens (if any). In their turn, the crypto project receives raised BNB. For example, on 10 March 2021, Pancakeswap held an IFO of Belt tokens (BELT) priced at $20/each token, for a target to raise $3,000,000. Eventually, they collected ~ $812,519,700, which is 27,083.99% of the initial target. In several hours, BELT’s price soared to $140 per token, making a 7x profit for those who sold them at that time.
An IFO, as well as an IDO, secures instant liquidity of new tokens, and additionally, it has some other advantages for investors (on the example of Pancakeswap):
· CAKE burning, i.e., half of the total funds collected in the IFO, are burned in CAKE.
· IFO projects go through a review process by the DEX team. Definitely, this does not guarantee that an IFO project will be successful. However, it can help to stave off obvious frauds that flourish on anonymous IDO platforms.
· The users collected IFO tokens can get them to work immediately after the IFO distribution: the new tokens may be added to a pool to stake CAKE (e.g., BELT staking earned CAKE) or to a farm as a liquidity pair (e.g., BELT-BNB) to accumulate the LP tokens and earn fees.
At the same time, the IFO system has its own controversial points. As in the case with IDO, there is an opportunity for whales to influence the market and take over ‘decentralized’ IFO projects. According to some data, during a Yieldwatch IFO, hosted on Pancakeswap on 3 March 2021 (it was offered 8 million WATCH tokens, and the total amount raised was over $560,000,000 — approx. 711 times more than the initial funding goal), only 10 addresses collectively got over 25% of WATCH tokens, while the majority have received a relatively small number of tokens (0 to 100 WATCH per address). Basically, in any type of crypto fundraising, a minority of investors can take advantage at the expense of the majority of individual investors unless there are limits to the number of tokens for each address or other mechanisms applied to the coin offering event.
Another possible ‘centralized’ IFO element is approving projects for IFOs by a DEX’s team. Personally, we find it to be an advantage as it may prevent fake schemes to get easily to the public. Still, some crypto assets offering platforms have seemingly tried to improve this aspect. For example, BSCstarter, a BSC-based fundraising platform, introduced ‘a community-governed launchpad’ for obtaining money for BSC projects. On their platform, by voting, users determine which project will go ahead. However, only wallets with enough START, a native BSCstarter token, can vote (that is, 1,000 START equalled to ~ $19,000 at the time of writing). This again brings us back to the question of possible manipulation.
On the whole, any type of crypto coin offering bears many risks, and not all projects may live up to the investors’ expectations. An interested party should be very cautious and do his or her own research before engaging in any crypto crowdfunding and know the relevant regulations in relation to this sector in their respective jurisdiction.
Currently, crypto assets distribution and fundraising are mainly insufficiently regulated (except STO and IEO in some jurisdictions). Still, it seems to be only a matter of time before the crypto industry is given a comprehensive legislative framework. For example, the proposed EU regulation on cryptocurrencies (‘MiCA’) is designed to provide legal certainty and consumer protection regarding crypto assets not qualifying as financial instruments. According to the proposal, issuers of crypto assets will have to comply with disclosure and other requirements before offering the assets to the public (e.g., establishing a legal entity, preparing a ‘white paper’, and notifying a designated EU regulator of it). Then, apparently, crypto fundraising will undergo significant adjustment.