Prior to the advent of Initial Exchange Offerings (IEOs), the crypto fundraising market consisted of Initial Coin Offerings (ICOs), Security Token Offerings (STOs) and Digital Security Offerings (DSOs). However, each mode of offering is plagued by its own set of distinctive issues. It is in this context that the IEO came into the picture.
Under an IEO, the issuer will get an exchange to review the underlying project of its proposed offering. If the exchange is satisfied that the project is authentic, it will enter into an agreement with the issuer under which the exchange will effectively act as a counterparty to the offering by hosting the tokens of the issuer on its platform.
In addition to conducting a due diligence review of the offering, the exchange will also be marketing the tokens to potential investors on behalf of the issuer and be responsible for ensuring proper compliance with the applicable Anti-Money Laundering (AML) and Know Your Customer (KYC) provisions.
From the perspective of issuers, they will find the IEO process to be an easier ride, but the listing fees which are payable to the host exchange may be cost prohibitive, particularly if the host exchange is a household name. As for prospective investors, they can invest with greater confidence, given the fact that the underlying project of an IEO has been screened by the host exchange. Additionally, investors in IEO tokens can rest assured that their tokens will be tradable as IEO tokens on the host exchange immediately after launch.
On the flipside, it should be noted that most exchanges are not currently regulated. In March 2018, the U.S. Securities and Exchange Commission (SEC) issued a public warning that the internal policies and trading protocols of unregulated exchanges may not comply with the standards of the markets regulator, as these policies and protocols have not been reviewed by the SEC.
What is even more alarming is that a market study conducted by cryptocurrency index provider Bitwise Asset Management found that 95% of Bitcoin’s trading volume was made up of fake transactions, most of which were carried out on unregulated exchanges.
Market manipulation activities pose an even greater risk in the case of IEOs given the lack of market liquidity, as the tokens are only available for subscription to users who are registered with the host exchange. Although KYC requirements imposed by the host exchanges as part of their user registration process may be able to prevent market manipulation activities targeting IEO tokens to a certain extent, the SEC’s cautionary notice highlights the distinct possibility that the KYC requirements of unregulated host exchanges may be lacking, which may, in turn, expose the trading of IEO tokens to market manipulation activities.
In summation, IEOs provide an alternative midway option between the free market ideals of ICOs, which turned the crypto fundraising market into a playground for fraudsters, and the regimental regulatory framework to which STOs are subject in most jurisdictions. Nonetheless, IEOs will only be able to fulfil their full potential if host exchanges are subject to mandatory regulations.
Indeed, the all-important first step has been taken by the intergovernmental Financial Action Task Force (FATF), which finalized on February 22nd, 2019 its standards for the regulation, supervision, and monitoring of crypto exchanges. The FATF had urged its member nations, which include Asia-Pacific countries such as China, India, Japan, South Korea, Malaysia, and Singapore, to regulate such exchanges in the same manner as commercial banks. With that, the stage is now set for IEOs to propel the evolution of the crypto fundraising market into a paradigm of market integrity and investor security.
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