Decentralized Fundraising: Initial Dex Offerings (IDO)
When it comes to fundraising for blockchain projects, alternative coin offering models appeal to investors with their pearls and pitfalls. While decentralized finance (the “DeFi”) projects usually raise funds through Initial DEX Offerings (the “IDO(s)”), many small projects prefer the initial coin offering model (the “ICO”) at the first stage. While there is no one right choice, blockchain startups should consider all aspects of the initial coin offering models before deciding on the fundraising method.
In our recent post, we prepared a table showing essential differences among the main coin offering mechanisms, namely ICO, initial exchange offering (the “IEO”), and the IDOs. You may find the relevant post here.
This article will deep dive into the characteristics, pros, cons and launching methodology of the IDOs in greater detail.
What is an IDO?
In general terms, IDO is a coin offering model which enables blockchain projects (especially DeFi projects and DApps) to launch their native coins/tokens through a decentralized exchange for raising funds. This model’s permissionless, trustless and decentralized nature perfectly fits the general concept of blockchain technologies.
IDOs are a kind of crypto-asset exchange and mainly depend on liquidity pools, through which traders can quickly swap tokens and coins without any intermediary. So traders can instantly convert their crypto assets by swapping the liquidity pairs (such as USDT and ETH)1 via only paying small gas fees, and this creates a win-win situation for all participants.
What are the Advantages of an IDO?
Compared to other coin offering models, IDOs’ anonymous and decentralized nature brings many advantages in the train:
No Control Mechanism: Since the fundraising occurs through a DEX, even the project team itself cannot control how the investment round will be shaped. Thus, investors are protected better compared to the ICO.
Open, fair, and accessible fundraising: When a project raises funds with an ICO or IEO, it must pay high acceptance fees to an intermediary exchange and wait for the relevant exchange’s approval to be listed following the vigorous vetting process. On the other hand, even small and less-known startups can launch their tokens via a DEX since it’s cheaper and more accessible than centralized exchanges.
Due to its completely decentralized nature, projects also do not require anyone’s permission in advance, and influential community members are the ones who take the lead and vet projects and tokens via social media channels. In this way, startups may also promote their projects without creating enormous advertisement budgets.
IDOs owe their cheapness to the self-executing smart contracts managing the asset token and liquidity pool. Since sufficient liquidity exists for trading pairs on a liquid exchange, the gas expenses for executing a new smart contract are insignificant. The only fee is the gas fee associated with direct peer-to-peer transactions, which is often less than 0.3 percent.2
Instant liquidity following the IDO: Compared to ICOs and IEOs, which involve long waiting periods after the sale, IDOs provide immediate access to liquidity and trading. The project’s tokens are immediately listed on the DEX, where the IDO occurs. In order to minimize any slippage or volatility, a portion of the raised funds is locked and allocated to the liquidity pools in order to create a liquid market following the IDO. Many altcoins are also accessible through DEX, where transactions may occur without high trading volumes.3
However, it has become common for blockchain startups to (i) lock a portion of the raised fund as liquidity on the DEX, or (ii) offer staking programs to incentivize holding the relevant tokens longer.
No need to trust the project’s own smart contracts: If the project is launched on a well-known launchpad (e.g., BSCPAD, Polkastarter), then users can trust the project with the smart contracts used for the previous successful ones.
Anti-whale measures: Most DEXs’ mechanism prevents a single member from purchasing a large number of tokens in order to avoid any market speculation.
No Sign-up: Users can participate in an IDO anonymously, only with secure wallets connected to DApps such as MetaMask or Binance Chain Wallet. The platforms usually provide a secure wallet and trading support in one interface. Besides that, various IDOs support several wallet types and simplify the users’ experience.4 Therefore, they are not required to create an account for participating in the IDO and eliminate the KYC (know your customer) or AML (anti-money laundering) compliance requirements. This makes all users’ participation possible and prevents any theft or privacy concerns.
No Premine: Unlike the ICOs, premine is not required, and this boosts many users’ confidence as a high premine requirement can discomfort the investors concerned with the emission rate of the token in the long run.5
Transparency and Trustworthiness: Since all transactions are on-chain, everybody can trace and verify the contracts, if public. Besides that, IDOs cannot treat insiders and early investors more favorably since smart contracts do not allow such discrimination.
Community Governance: Most launchpads run through community governance, which means the community (not a few central authorities) determines whether to list a project.
Launching on Different Launchpads Simultaneously: Unlike the IEOs where the project team cannot list its tokens on competing platforms, the projects may launch their tokens on multiple launchpads simultaneously and issue tokens through different smart contract platforms. So that they can reach a broader range of investors, stake in multiple blockchain networks, and provide users with various participation options.
What are the Disadvantages of an IDO?
While IDOs have various advantages, they can turn into disadvantages in some cases, on the other side of the coin:
No KYC or AML Requirements: Users invest in projects only with their secure wallets, and there is no opportunity to validate their identity. This may lead laundering illegal funds and evasion of economic sanctions. For instance, individuals residing in certain countries cannot participate in coin offerings if relevant tokens are regarded as securities.6 Considering governments are also taking a stance towards DeFi technologies, strict regulations may be around the corner. In order to ensure compliance, launchpads may need to adopt/improve their KYC or AML processes in the near future.
Less Vetting / Due Diligence of the Projects: In IEOs, larger centralized exchanges conduct a vigorous vetting process before accepting the project to be listed on the platform. On the other hand, IDOs are completely decentralized, and only vocal community members vet the project via social media channels. In this way, many unreputable (maybe scam) projects can be listed on the DEXs. At this point, it is crucial to select a well-known launchpad to invest, which has KYC checks (as much as possible) and anti-scam screening. To be on the safe side, the investors should also review and analyze the project’s whitepaper and tokenomics individually before participating in an IDO.
Expensive Participation: While everyone can participate in the IDOs, it’s almost impossible to invest a sizeable amount due to sky-high competition. Therefore, users hold many launchpad tokens, enabling them to participate in the project much and get a proper return.
Inequality between Team, Seed, Private and Public Investors: Almost all projects distribute the majority of their tokens to their team, seed, or private round investments subject to different vesting schedules. Vesting periods serve the purpose of price stabilization and prevent pump and dump transactions for the relevant period. However, once the vesting periods are over, there are always massive profit takings at the cost of other public investors unaware of such timelines.
Clue: Vesting schedules are stipulated under the relevant project’s smart contract. Therefore, public investors may also figure out such timelines only by tracking the smart contracts regularly.
Pump and Dump: When there are no anti-whale measures, some investors get large amounts of tokens and increase the token price expeditiously. When they sell the tokens, they receive huge returns at the cost of a price drop. Since such a price manipulation is unpredictable, the project team also cannot know how much they raised through the IDOs.
No Stable Price: Since the trading and liquidity are immediately available after the IDOs, token exchange starts instantly, and only a few investors can purchase the token at the listed price.
Amount of Fundraising: While it can be heard that projects raise funds over $1 billion through an ICO, IDOs cannot raise such amounts.
Provision of Liquidity: Even the well-known DEXs such as PancakeSwap or Uniswap have difficulty providing liquidity and controlling the market compared to the centralized exchanges such as Binance. This may be overcome by training the public and boosting the interest in DeFi technologies.
Steeper Learning Curve: Most projects listed on DEXs may discourage potential investors (especially ones who are new in the crypto sector) due to a lack of knowledge. Therefore, it is crucial to provide trainings and educational sessions in order to get investors familiar with such DeFi projects and DEXs.
What are the Stages of a Typical IDO?
For your reference, we gathered all stages of an IDO from the very beginning of the projects:
Step 1: Designing a Business Strategy and Creating a Marketing Campaign
The first and common stage every blockchain project goes through is creating a business strategy (including fund allocation, maximum supply, challenges, blockchain on which the project will run, plans for maintaining post-IDO momentum and liquidity) and marketing structure that capture potential investors. Needless to say, it is critical for such projects to have a comprehensive and charming website and white paper that can boost investors’ confidence.
Step 2: Finding an Appropriate Launchpad and Decentralized Approval
The projects should find a launchpad and meet its requirements (such as whitelisting) for approval.
Step 3: Vetting Process:
Even though IDOs do not involve comprehensive vetting processes conducted by the exchange, the DEX team performs due diligence before approving any project and thus, eliminates obviously scam projects from the platform in order to protect the investors.
Step 4: Fixing the Token Price
Following the DEX’s approval, the project should determine the price levels according to which the token will be sold. In general, there are two methods to follow:
The project can determine a fixed price for a limited number of sell orders, which escalates with the increase of demand; or
The project can hold an auction with a price dynamically driven by the supply and demand in the market.
Step 5: KYC Check for Investors (if applicable)
In order to minimize the risks associated with the IDOs, many DEXs started to require investors KYC/AML screening before participating in any IDO. Therefore, US citizens are rarely allowed to participate in the IDOs due to security legislation.
Step 6: Investor Whitelisting
When users decide to purchase a project’s token via a decentralized exchange, they should search for the whitelisting requirements of relevant DEX as there is a high competition for token sales, and platforms can allow only a limited number of participants with small allocations. Whitelisting process generally involves some marketing tasks (such as joining the project’s Telegram chat, retweeting, commenting, and liking social media posts to create a marketing storm) or providing wallet addresses.
Furthermore, the users may also be required to hold a certain amount of the launchpad’s native tokens to participate in the IDOs. In practice, most platforms have two pools: (i) the one open for all public where the competition is very rough and (i) one where only holders of the platform’s native token can participate. Recently, the platforms (such as BSCPAD and Kickpad) took this system a step further and decided to give guaranteed allocations (for preventing lotteries) to the participants depending on the number of native tokens they hold. They created tiers to encourage the investors to hold more native tokens in order to be entitled to higher allocation.
Step 7: Investment
Whitelisted investors lock their funds in a smart contract on the platform as an acknowledgement of debt in exchange for the tokens they will receive during the token generation event, which happens shortly after the IDO.7
Step 8: Liquidity Pools and Token/Fund Transfer
When the IDO is completed and the TGE (launching moment of the tokens) occurs, tokens are transferred to the investors’ wallets in exchange for the locked funds that are released to the project team.
In order to ensure liquidity from the beginning, a portion of the raised fund is allocated for the liquidity pool with the project’s tokens, to be returned to the project afterward.
In this stage, the DEX makes the final distribution of all funds through automated smart contracts.
Step 9: Trading
Upon the IDO and TGE are concluded and funds are exchanged between the participants, tokens will be instantly listed for trading on the DEX. The listing is ensured through automated market makers (AMM) such as Uniswap, Sushiswap, Pancake Swap, or Balancer.
Based on the project’s business strategy, a part of the raised fund and investors’ tokens can be locked up for a certain period (vesting period) following the TGE, which can be reviewed from the smart contracts. After the vesting period expires, the project may also adopt a proof-of-stake consensus mechanism to encourage investors to keep the tokens in their wallets for several rewards.
Conclusion
Since ICOs have lots of underlying flaws (such as lack of privacy and security, vulnerability to discrimination, theft, and human error), IDOs raise the public interest with all their pros and provide solutions for many concerns. As a result of this, many IDOs have been completed successfully in the near past, including but not limited to Raven Protocol IDO, Universal Market Access Protocol IDO, and SushiSwap IDO.
Nevertheless, this does not mean IDOs are all lavender and roses. There are still many issues to be solved to employ the system perfectly. In this regard, blockchain startups should take all aspects of different coin offering models into account in order to select the right one for their projects.
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