What Is An Initial Exchange Offering?
An initial exchange offering (IEO) is a sale of digital assets that takes place through an exchange. An IEO is similar to an initial coin offering (ICO), except that an IEO has the backing of an exchange.
IEOs are also different from security token offerings (STOs), which involve sales of digital assets that have been securitised. STOs have their own benefits and drawbacks. More specifically, the tokens sold through these offerings provide rights to equity in a project, a share of future revenue or some kind of debt. Further, security tokens provide buyers with the same protections granted to anyone who purchases securities.
In an IEO, the exchange acts as the administrator of the digital token sale. As a result, exchanges function in the same way that an investment bank would during an initial public offering (IPO), evaluating potential sales before holding them and in many cases receiving some kind of commission for doing so.
Changpeng Zhao, CEO of Binance, one of the world's largest digital currency exchanges, told The Wall Street Journal through an email statement that his organisation had a group of individuals who were involved in evaluating different projects for potential inclusion on Binance Launchpad, its platform for IEOs.
One benefit of IEOs is that exchanges vet potential projects before their tokens are sold, so these offerings are considered more trustworthy than ICOs. The rationale behind this is that if exchanges are considered credible by the broader community, they will likely want to safeguard their reputation. As a result, they'll stick to backing token sales from projects that appear trustworthy.
"People feel that since the exchange does not wish to be associated with a scam, they're more likely to do their homework before becoming associated with any given project," Mati Greenspan, who works for eToro as an analyst, told The Wall Street Journal.
This situation is different from that of ICOs, in that many entrepreneurs have raised money through these token sales with nothing more than a convincing white paper.
Like every other method of offering securities and other assets, IEOs have their downsides. Critics have found various points of contention, and the most crucial is that exchanges have encountered many challenges of their own that may undermine their trustworthiness.
For one, exchanges have suffered repeated hacks. These marketplaces have lost upwards of US$400 million in the first quarter of 2019 alone, according to data provided by security research firm CipherTrace.
This comes after they lost US$800 million in 2018. A report released late in that year estimated that these marketplaces lose US$2.7 million per day from theft.
By accumulating billions of dollars' worth of digital currency, these organisations can become major targets for nefarious parties. These financial institutions are generally not cyber security companies. Because of this, along with their general lack of security savvy, exchanges can be rather appealing targets for hackers.
A perfect example of this vulnerability is the Coincheck hack, which resulted in the exchange losing digital currency tokens worth close to US$500 million. The exchange, based in Tokyo, Japan, kept the assets of customers in a hot wallet, meaning that these assets were accessible through the internet.
Also, coincheck lacked multi-signature security, which would have required authorisation by more than one party for the assets to be accessed. Because of these failings, Coincheck suffered one of the largest digital currency hacks in history.
Unfortunately, the Coincheck hack is only one example of inadequate security at a cryptocurrency exchange, as these security breaches have resulted in the loss of more than US$1.5 trillion, according to figures compiled by blockchain security firm Ledger.
False Volume Reports
Separate reports have claimed that the vast majority of trading volume reported by cryptocurrency exchanges is fake. Figures prepared by investment manager Bitwise in 2019 for the U.S. Securities and Exchange Commission (SEC) stated that approximately 95% of volume reported by industry data provider CoinMarketCap is false.
Another potential problem for digital currency exchanges is so-called "flash crashes," which take place when digital currencies suddenly plummet in value. In 2017, for example, cryptocurrency trading platform GDAX suffered two of these events.
That same year, Kraken, a major digital currency exchange, suffered a similar situation, when the value of cryptocurrency ether declined by more than 70%, forcing the leveraged bets of traders to be closed out.
In addition to this, the majority of cryptocurrency exchanges have faced allegations that they have poor management, lacklustre security or a combination of both. A Reuters inquiry reported on in late 2017 found that since 2011, more than three dozen exchanges had suffered hacks, and following these unfortunate events, several of these marketplaces shut down.
Investors who hold their cryptocurrency on exchanges should keep in mind that if an exchange goes under, they may never get their digital assets back. The U.S Federal Trade Commission (FTC) has warned about this on its website, stating that "Cryptocurrencies are not insured by the government like U.S. bank deposits are."
"This means that cryptocurrency stored online does not have the same protections as money in a bank account," the FTC statement continues. "If you store your cryptocurrency in a digital wallet provided by a company, and the company goes out of business or is hacked, the government may not be able to step and help get your money back as it would with money stored in banks or credit unions."
Some market observers have criticised IEOs in light of these problems, stating that this kind of token sale gives even more clout to exchanges, which have faced challenges on many fronts. Others have claimed that IEOs may not succeed in solving the problems that have plagued ICOs.
Michael Conn, managing partner of cryptocurrency firm Michael Conn, weighed in on these different methods of offering digital assets. "It's like ICO 2.0," he told The Wall Street Journal. "Frauds are waiting to happen. A lot of people got burned in ICO land and I think a lot of people are going to get burned in IEO land."
Another major criticism of IEOs is that they help centralise offerings of digital assets in the hands of exchanges. Many advocates of blockchain technology and cryptocurrencies are strongly in favour of decentralisation, so consolidating control of digital token sales in organisations that represent a single point of failure is far from desirable.
An IEO is an offering of digital tokens that takes place through exchanges. In this case, the exchange evaluates any projects that are looking to issue digital assets in this manner.
An IEO can be compared to ICOs. These have drawn criticism in the past for offering digital assets to the public in some cases with little more than a white paper, instead of having a product that is already in place.
As a result, some consider IEOs more trustworthy than ICOs, the rationale being that if an exchange has established a good reputation, it wouldn't want to put that reputation at risk. However, there are some critics who point to all the challenges that cryptocurrency exchanges have suffered over the years including expensive hacks, claims of fake volume and concerns about deficient security.
They have voiced their concerns about the prospect of entrepreneurs and the projects they back issuing tokens through such exchanges.
Further, some digital currency enthusiasts have expressed their reservations about IEOs simply because these token sales represent centralised offerings.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…