The difference between ICO, STO and IEO
Many people believe that the security token offering (STO) is the new fundraising methodology that is taking over from the initial coin offering (ICO). However, there is a new kid on the block that is quickly gaining popularity in the blockchain ecosystem – say hello to the initial exchange offering (IEO). In this detailed guide, we highlight the fundamental differences between ICOs, STOs, and IEO and where one would be preferable over the other. Let’s dive into the details already! I assume you already understand the basics of cryptocurrency.
Understanding ICO
ICO (Initial Coin Offering) is a fundraising method that works pretty much in a similar manner as the regular IPO (Initial Public Offering) but on the blockchain network. With the emergence of cryptocurrencies and the numerous use cases on offer, many startups have adopted ICOs as a fast and cost-effective way of raising funds to finance their projects.
The ICO is founded on blockchain technology, and many startups find it convenient to raise capital and develop projects around a decentralized application. As an early investor, you are rewarded with bounty programs, gifts, and free tokens through referral programs. It’s a strategy used to make an ICO go viral and reach its target limit within a shorter duration.
Other than the actual funds directed towards the project, ICO marketers often release a share of their total supply toward rewarding their contributors for aiding their funding initiative. Investors can contribute through other cryptocurrencies like Bitcoin and Ethereum or through fiat currencies. There is a minimum investment limit to ensure that the startup maintains a substantial number of soft cap and hard cap participants.
ICO Smart Contract
ICOs use smart contracts to establish an understanding between the startup and the investors. Since investors are putting their money in a project that is yet to be developed in exchange for future profits when the tokens appreciate in value, there must be some way of establishing trust. A smart contract is actually a code that asserts what happens if the project succeeds or fails. For instance, it can state that everyone who bought the tokens before a certain date can sell it for a pre-determined fixed price after some period. When a holder releases tokens to the market, its price is adjusted automatically.
Pros of ICO
- ICO projects are easy to initialize and set up. All you need is to draft a white paper that explains your product offering, create a product website, and establish a backup team to handle the project technicalities.
- Lower launching costs, making it suitable for startups and beginner investors.
- The fundraising process is simple and less complex to implement as compared to IEOs and STOs.
- No government or centralized authority regulation hence preferable for small timers.
- Impressive liquidity within a shorter period.
- Investors take full charge over their funds.
- Provide multiple fundraising programs, including private sales, public sales, and Airdrops.
Cons of ICO
- The fundraising method is susceptible to scams and other security threats
- Not appropriate for long-term investments
Understanding IEO
Since ICOs were marred with scams and fraudulent fundraising activities, the blockchain community began to look into other options of funding various innovative projects. China actually banned ICOs in late 2017 for the very reason. Fortunately, the industry moved with speed to coin the Initial Exchange Offering (IEO). This new methodology allows startups to perform their fundraising without the fear of government or centralized authority regulations.
Just as the name suggests, an Initial Exchange Offering is conducted on a cryptocurrency exchange platform. Contrary to ICOs, the startup looking to raise funds doesn’t deal directly with investors but entrusts a crypto exchange with the task of administering the tokens on its behalf. As the exchange sells the newly issued token on its platform, the token issuer pays a listing fee as a percentage of the coins sold during the IEO. Once the coins are completely sold out, they are listed on the exchange’s platform. Since the exchange earns a percentage of the tokens sold on their platform, they take the initiative to market the coin offering.
IEO participants entrust their funds with the exchange and there is no provision for smart contracts. All they need to do is create an account with the exchange that conducts the IEO and fund their exchange wallet with coins. They can then use the coins to purchase the tokens on offer.
Will IEOs create a fundraising boom?
ICOs created a fundraising resonance in 2017 and partly in 2018. Unfortunately, the majority of the crypto projects funded were created by scammers and dubious startups. Due to such disappointments and ICO ban in some countries, crypto startups had to look for other means to fund their projects.
IEOs provide an improved level of trust between cryptocurrency investors and startups. Since the exchange conducting the crowdsale plays an active role in the fundraising process, the efficiency and transparency of the process are highly improved. IEOs, therefore, have a huge potential of establishing a standard model for raising capital in the crypto space and probably create a fundraising hype.
Pros of IEO
- All participating exchanges are verified by KYC/AML to ensure better security for the investors.
- Participants open their own wallets with the exchange and transfer funds directly to their accounts without going through smart contracts.
- Investors work directly with the exchange.
- The regulatory frameworks make the platforms trustworthy.
Cons of IEO
- It’s more difficult to set up the system and the fundraising costs are higher.
- Low liquidity levels as compared to ICOs.
- Investors are at the mercy of the exchange (they have very little control over what the exchange does with their coins).
Understanding STO
The security token offering (STO) resembles the initial coin offering (ICO) in that the investor is issued with tokens/coins in exchange for his/her investment. However, a security token offering attaches an investment contract into an underlying asset such as bonds, stocks, real estate trusts (REIT), or funds.
Here, the term “security” refers to a tangible, negotiable financial amenity that holds a monetary value. In other words, it’s an investment product that is backed by a real-world asset like property or company.
An STO represents the ownership information of an investment asset that is recorded on a blockchain. For example, when you invest traditional stocks, the ownership details are written on a document and issued in the form of a physical certificate. The same process happens with STOs, only that the ownership information is written on a blockchain and the assets issued as tokens.
STOs can be considered as a hybrid between the traditional IPOs and cryptocurrency ICOs. It typically overlaps with both approaches of investment fundraising.
What are the key differences between STOs and ICOs?
One outstanding difference between an STO and an ICO is the regulatory governance. While ICOs are executed on a decentralized platform without third-party regulators, STOs are asset-backed and comply with government regulations. ICOs often argue that their coins are meant for usage, just like fiat currencies, and not for investment. So, the coins are positioned as utility tokens that give users access to various decentralized applications (DApps). As a result, ICOs circumvent some legal frameworks and don’t often register or adhere to stringent government regulations.
Companies launching ICOs face minimal barriers and are able to quickly release their coins to the market and raise funds across international borders. It’s a lot more difficult and time-consuming to launch an STO since the intention is to provide an investment contract that adheres to the laid-down laws on securities. These platforms take time to carry out some upfront work of complying with relevant regulations. Also, they tend to raise funds only from credible investors who meet some minimum thresholds.
STO Regulations around the world
STO regulations vary depending on individual jurisdictions. In the United States, the Securities and Exchange Commission (SEC) has taken the frontline in defining the security tokens and laying parameters upon which a token can be considered an STO. According to the SEC, an ICO can be classified as a security token if it meets the definition of an investment contract. The regulation was established by the Supreme Court following a landmark case between the Howey Company and SEC.
Pros of STO
- STOs comply with government regulations and deal with real assets, making it a trusted investment tool.
- Offers more security
- Effective for long-term investments
Cons of STO
- High costs of fundraising
- Relatively complex to execute
- Cross-border investment is difficult due to strict regulations
- Lower liquidity due to strict government regulations
There is no doubt that ICOs will continue to play an important role in blockchain and cryptocurrency ecosystems. We cannot overlook the good that ICOs did in birthing Ethereum and other major DApp developments. However, due to the prevalent security loopholes, scammers exploited many unsuspecting investors of their hard-earned cash. That gave rise to other safer alternatives like IEOs and STOs. Whichever fundraising method you choose to work with, it’s important to do some background research about the legitimacy of the coin offering you’re investing in.
