New token offering models invigorating crypto project funding

The crypto ecosystem has been riding high in recent months on a new token offering model that has been transforming the way blockchain projects fluidly bootstrap growth and raise community funds.

What is an IDO?

The Initial DeFi Offering is a method for launching tokens using Automated Market Maker-based decentralized exchanges such as Ethereum’s Uniswap. Initial DeFi Offerings have also been referred to as Initial Uniswap Listings, Initial Farming Offerings, and Initial Pool Offerings, although ‘Initial DeFi Offering’ or ‘IDO’ is the description that has caught on.

Decentralized exchanges like Uniswap offer specific advantages for projects seeking to raise funds through token sales including permissionless listing.

There are two types of contracts that make up the Uniswap trading engine and Uniswap-clones like the Binance Smart Chain’s PancakeSwap. One is an Exchange Contract. Exchange Contracts hold a pool of a specific token and a counterparty that users can swap against. The other is the Factory Contract which manages creating new Exchange Contracts and registering new ERC20 token addresses to Uniswap’s registry.

Significantly, there are no listing fees or vetting processes to add tokens on Uniswap. Instead, any user can call the Factory Contract to register a new token. A user seeking to add a token uses a function called ‘create Exchange’ that involves registering the address for an ERC-20 token the user wants to create a market for.

The function will trigger the Factory Contract to check the Uniswap registry to see if an Exchange Contract already exists for that token. If no Exchange Contract for the token is listed, the Factory Contract deploys an Exchange Contract and records the new ERC-20 token.

Liquidity pool-based platforms like Uniswap have increasingly become the system of choice for distributing this new class of DeFi tokens, and trade volume on these decentralized exchanges has boomed in 2020 and 2021.

The advantage of launching a token on an Automated Market-Maker Dex

Volume growth at Uniswap has been rapid. Source: Dune Analytics

Automated Market-Maker exchanges, or AMM’s, don’t use order books like traditional exchanges—where individual buyers are connected with individual sellers. Instead, exchanges like Uniswap use an alternative method to settle cryptocurrency trades

Instead of pairing up buyers and sellers, tokens are bought and sold at a rate determined by a bonding curve. With this mechanism, as tokens are purchased the price goes up, and as tokens are sold the price goes down. In both cases, the exchange rate is determined by a supply curve instead of a market of orders placed by buyers and sellers.

The Exchange Contracts contain pools of a specific ERC20 tokens and a counterparty token (like ETH, USDC etc). If there is simply a supply of both tokens, a trade can occur with a price automatically generated based on supply and demand. The user doesn’t need to worry about connecting with another trader in order to exchange or specify a price.

Since price and counterparties don’t need to be considered and trading happens automatically, launching a project via an Initial DeFi Offering on an AMM powered decentralized exchange is a much easier capital raising process than earlier token offering models like Initial Coin Offerings (ICOs) and Initial Exchange Offerings (IEOs).

Initial Coin Offerings and Initial DeFi Offerings compared

With the Initial Coin Offering model, popularized in 2017-2018, projects generally conducted token sales through a website with custody and token transfers based on trust and not smart contracts or ready-made infrastructure like Uniswap. This required the development and management of a centralized site just to conduct the sale.

Once the sale was conducted another key point of difference with the ICO model was that after the launch sale finished, projects still needed to find an exchange or secondary market for trading their tokens. This was problematic for ICO funded projects as most of the most popular exchanges charged tens to hundreds of thousands of dollars to onboard a new token. Listing on multiple centralized exchanges was often required to gain access to enough active traders to bring sufficient liquidity into trading pairs. It was an expensive and time consuming exercise.

With IDOs, a trading market is created at the same time as a token is launched because creating secondary markets is automatic and permissionless on decentralized AMMs. This results in an active market for trading and liquidity accessible to participants immediately after the initial token sale – solving issues like liquidity and price uncertainty.

ICOs were mainly deployed through Ethereum’s ERC20 protocol standard and quickly became Ethereum’s most popular use case. They were a key factor in ETH’s price rise in 2017. Investors wanting access to unique deal-flow opportunities would accumulate ETH in order to participate in ICOs. This also generated new users and transaction activity on the Ethereum chain, creating a positive feedback loop that drove the price of ETH upwards

IDOs, like ICOs, have also played a part in driving the price of ETH to surge upwards during the most recent uptrend. Tokens launched via IDOs have offered similar aggressive returns to ICOs and have driven users to create Ethereum accounts and to conduct transactions on the network.

It should be acknowledged that there have been other positive tailwinds pushing the price of ETH forward – including the booming DeFi, and NFT sectors, and a growth in blockchain interoperability that has allowed a host of new projects to connect with Ethereum.

This time around the token offering craze is spreading onto other platform blockchains – particularly the Binance Smart Chain (BSC). Since the first major Initial DeFi offering on Uniswap, UMA, on April 23rd, the price of Ethereum has risen 2,227%. Since the first major PancakeSwap IDO, BLINk, on November 20th, the price of BNB has increased 2,313%.

IDO case study: The UMA Protocol

In December 2018 the UMA Protocol (“Universal Market Access”) decentralized financial contracts platform launched. The UMA Protocol specializes in powering priceless synthetic tokens, which are collateral-backed ERC20 tokens that can track anything without needing a continuous on-chain price feed from an oracle. In May 2020 the project launched its first synthetic token ETHBTC. The token tracks the ETH/BTC price ratio, allowing investors the ability to short or long the ETH price against Bitcoin.

In April 2020, the UMA Protocol announced plans to launch a new governance token called UMA via an initial Uniswap listing or Initial DeFi Offering. The token was created to give holders the ability to govern important parameters of the UMA Protocol, as well as to help resolve contract disputes by fulfilling price requests through the project’s Data Verification Mechanism (DVM). The UMA network pays an inflationary reward to token holders that participate in governance and respond accurately to price requests. This reward is not paid to token holders that do not participate, penalizing inactive participants.

To launch the UMA, the project’s backers took 2 million UMA tokens which was 2% of the starting 100 million UMA supply – and opened up a Uniswap liquidity pool. The team added approximately $535,000 worth of ETH to the pool. This gave $UMA an initial price of around $0.26.

The bonding curve model used by Uniswap, meant as early investors lined up to purchase the UMA token, its price quickly moved up. Additionally, some UMA traders decided to front-run others by paying higher gas costs. This led to the UMA price jumping to more than $2.00 only minutes after its launch, before stabilizing at around $1.20.

The next step in IDOs: Token pools and bonding curves with vetting

Another evolution in the Defi offering model arrived with the launch of IDO-specific platforms like Polkastarter, BSCstarter, and Samurai. What separates token launches on these platforms from tokens launched on Uniswap and PancakeSwap, is the vetting process for listing tokens on these platforms.

With Polkastarter for example, the application process is overseen by the Polkastarter team and an overseeing Polkastarter Council, which includes members from Huobi, Polygon, Alchemy, and other investors and entrepreneurs.

BSCstarter is a decentralized fundraising platform for Binance Smart Chain protocols. It differentiates itself from other launchpads by being completely community governed. It has minimal red tape and KYC requirements for projects seeking to tap into its community. Instead, it opts for a system where the BSCstarter community determines which projects are worth listing using their collective due diligence and Do-Your-Own-Research. The system leverages the wisdom of the crowd concept to be the check for potentially nefarious projects.

Anyone can apply to the BSCstarter register for a token launch on the platform. Upon application submission, a pre-sale contract is generated based on the token project’s rule. Community members who own a specific balance of BSCstarter’s native token, START, have an opportunity to perform diligence on the projects that are submitted. They can vote YES or NO and once a vote is cast it cannot be changed.

Projects who receive more Yes votes than No votes and receive at least 10% of the total supply of START tokens as a Yes vote will be approved to start their sale.

Upcoming Initial Defi Offerings

• 16th May 2021- 0x nodes on Samurai/Cyberfi
• 18th May 2021- Ethermon on Polkastarter
• 26th May 2021- Ceres on Polkastarter