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Initial Exchange Offerings (IEOs) have emerged as a recent phenomenon, attracting attention and scrutiny. IEOs are similar to ICOs, except that the raise is conducted through the exchanges themselves. Each exchange’s IEO structure may differ slightly, but the general principle is the same. The exchange will perform some of the key underwriting functions — marketing, fundraising, and distribution. Upon completion, the project’s token will be listed on the exchange and available for trading. In return for performing these services, the exchange is paid a fee generally denominated in the given token.
Binance pioneered the model with the Bittorrent sale in early 2019, and numerous exchanges have followed with their own — including Bittrex, Huobi, Kucoin, OKEX, and many more. IEOs are an exciting, innovative new phenomenon, but questions remain around long term sustainability and market impact. In this piece I’ll address some of the main themes of IEOs, and their broader impact on crypto markets.
1. IEOs may help the underlying exchange’s token accrue significant value. (Neither I nor Blockchain Capital have positions in any exchange tokens)
Any analysis of IEOs must take into account the deeply intertwined relationship between the offering and the exchange’s own token. BNB holders, for example, are entered into a lottery system to invest in Launchpad projects. Users with less than 100 BNB don’t qualify.
Arguably, the primary driver of ETH’s price appreciation in 2017–18 was the rise of the ICO. ETH was the ‘reserve currency’ of this phenomenon, as projects fundraised largely in ETH, and held that in their treasury. This increased demand for ETH and decreased its float on the open market, and ETH experienced a run up to $1300 in Jan 2018.
This mechanism could repeat itself with exchange tokens. Binance’s lottery system induces demand for the token, and more significantly, employs a lockup that decreases BNB velocity. (The lottery is based on the user’s BNB holdings over the 20 previous days). Over the next few months, I wouldn’t be surprised to see sustained demand and interest in BNB.
2. IEOs are structured to generate FOMO and returns denominated in multiples. They may have had a role in the recent price run up.
In traditional markets, IPOs can serve as valuable indicators of market sentiment. During the dot-com bubble eye-popping first day results of 50%+ price jumps led to more greed, facilitating the cycle of more and more quick IPO flips. Investment banks will often leave a bit of money on the table for IPOs in order to generate a small jump when trading goes live. This generates a consistent track record for the bank, and some nice momentum for the company.
Structuring an IEO is similar — they are carefully constructed to generate price appreciation and momentum for early participants. The amount raised is small for a token sale (usually $3–10m), usually at a relatively modest valuation of $50–100m (again, compared to previous sales).
By selling only 6% of supply at capped valuations, IEOs are able to attract significant FOMO, as purchasers rush into them. The valuation cap helps the projects generate significant returns when it goes liquid, often denominated in multiples. Data provided from The Block demonstrate the IEO model’s success thus far. As this track record and history expands, I’d expect the size of IEO raises to increase.
It’s plausible that the recent price run up in Bitcoin and altcoins was accelerated through momentum from IEOs. Seeing the massive gains in these IEOs, investors rushed towards other projects, seeking to replicate their gains. With these sales reportedly selling out in less than ten seconds, investors may have also seen that as a sign of latent market demand.
Still, it’s difficult to ascertain how big a role IEOs actually had on the recent price movements. I suspect the main driver is a handful of large market orders impacting prices, but it’s certainly possible IEOs played a small role.
3. Generally, the highest quality projects won’t raise money through IEOs.
IEOs perform two key functions, capital raising and exchange listing. Exchanges have broad distribution and large userbases, and can access large amounts of capital quickly. Listing on liquid exchanges is important for token projects, as it ensures liquidity and usually comes along with some hype and some nice price action.
However, if a project able to raise the desired amount on their own, there’s no reason to pay a substantial fee for an exchange to perform the same function. Additionally, high profile tokens will be highly demanded in the secondary market, and exchanges will have an incentive to support it to attract liquidity.
A counterargument is that an IEO guarantees immediate listing on exchange, which can help with short term price appreciation, and guarantee a nice ‘pop’ to generate momentum. While this is true, in the long run sustained value will come from underlying utility and demand, not simply as a momentum trade based on historical appreciation.
4. Long term, IEOs probably won’t drive a resurgent bull market.
The best IPOs can open market windows that were previously closed. The Netscape IPO in 1994 is the most famous — it’s a seminal event that legitimized the nascent web industry. Similarly, Google in 2004 brought life back into the tech industry. As a massively profitable and widely used internet company, it proved to the market that the internet as a social, cultural, and financial phenomenon was not dead.
In 2017, the Filecoin raise had this same effect on the crypto market. Though Filecoin itself is still a work-in-progress, the sale was a massive success, raising a record high $257 million, with top tier VCs participating. More importantly, the SAFT template that Filecoin had pioneered was used by many subsequent projects, culminating in mega-raises like Telegram and EOS.
IEOs, as currently structured are unlikely to be similarly impactful. The ‘top projects’ are unlikely to use IEOs, as they’ll raise capital on their own. While IEOs are highly structured and capped offerings focused on generating returns for their investors, a project’s incentive is to raise as much money at the highest valuation they can get.
Though they’ve achieved success at a small scale, it’s unclear whether IEOs can generate the momentum and hype at a large enough scale to really matter. If the projects have sustained momentum beyond a short term flip, this will amplify IEO’s importance and impact. Bittorrent token could turn out to be a transformative and highly used thing, but it seems unlikely for now.
In summary, IEOs are an interesting new phenomenon, but are not anything revolutionary. They mainly replicate structures that have been used in capital markets over the last few decades. While they may have given some momentum to the market, they’re unlikely to be as impactful the way ICOs were.
The most notable part of IEOs is how they impact exchange token mechanics. The lottery mechanism increases demand and lowers turnover of the coin, potentially having a similar effect as ICOs did on ETH’s price in 2017. The individual offerings are probably red herrings compared to the larger intended effect of generating hype and price appreciation on the exchange token.
A simple mental model one can use is that exchanges like Binance are trying to create a lottery with the highest possible expected value, with a limited supply of lottery tickets (BNB). This E(V) is created through a track record of small, successful sales generating returns, which is why you see the highly structured, supported sales that have happened thus far. A higher E(V) for the lottery will result in price appreciation for the lottery ticket.
IEOs are an exciting new fundraising mechanism and have attracted lots of attention, but will probably remain focused on niche projects for now. Additionally, the main point of the IEO model is not the underlying merits of any individual project, but the financial engineering they enable with exchange tokens. By wrapping these functions together, IEOs can increase demand and utility for the exchange token, which could affect price in a drastic manner. The crypto space has no shortage of financial engineering, and IEOs are a perfect case study.
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