The Interactive Initial Coin Offering (IICO) proposed by Vitalik Buterin, Jason Teutsch, and Christopher Brown in December 2017 offers a multitude of advantages over the traditional Initial Coin Offering (ICO) model. While ICO’s have become the most attractive and scrutinized form of crowdsale today, their implementation has begun to trend towards centralization, limited participant access, and hollow promises.
ICOs remain a novel method for crowdfunding specific projects that would not otherwise receive institutional or traditional investment backing from venture capitalists. A main reason that this has become popular is due to the fact that many ICOs raise enormous amount of funds prior to even having a minimum viable product. This inevitably leads to exit scams, failed projects, and diminished investor confidence in the model. Stemming from their highly lucrative nature, ICOs have attracted the full attention of the SEC, with a cloudy regulatory framework lurking behind obscure recent statements from SEC officials.
Further, the structure of the ICO has led to the creation of an environment where investors are focused more on getting in an out of a token for quick financial gains rather than having a legitimate, vested interest and belief in the platform they are contributing financial support to. This leads to a cascade of effects as the ICO market continues to evolve, leaving considerable room for improvement on the fundamentals of the model itself, and its subsequent effects on mainstream participation. It has now become particularly relevant to really focus on the specific advantages that the IICO provides and the prevailing problems from the traditional ICO model that it aims to solve. Whether or not these differences will be enough to distinguish IICOs from ICOs in the eyes of regulators is yet to be seen.
Read our Beginner’s Guide to ICOs
Structure of the IICO Model
There are two fundamental aspects of the IICO that are the core components of its model and solve the widely acknowledged problems surrounding capped and uncapped sales in the traditional ICO model. These core components of the protocol provide a guarantee of valuation and participation to investors by leveraging smart contracts in order to create a dynamic bidding system instead of relegating sales to either capped or uncapped. If you are unfamiliar with the details of the IICO model, you can find an in-depth breakdown of the mechanics along with Modular’s first implementation here.
IICO: Image from Modular
Essentially, capped sales represent a scenario where the total amount of the token to be circulated is fixed. The benefits of this are that an investor knows the exact valuation of the project that they’re contributing too. However, these sales can sell out in minutes and lead to a variety of problems that will be discussed in detail later.
Uncapped sales represent a scenario where valuation is not fixed, it is based upon user participation. The benefits are that everyone can participate, but on the contrary, investors do not know the valuation of the project and therefore their final token value once the sale is completed.
The Interactive Coin Offering protocol solves these issues through a dynamic participation model where the valuation of the sale reaches an equilibrium through investors placing and removing bids based on other users’ behavior. Thus, investors can participate in a decentralized and fluid bidding system with confidence they are receiving their desired value by voluntarily adding and removing bids or through the protocol removing bids with a set personal valuation cap that is exceeded by the overall sale valuation. As a result, the sale valuation is designed to reach a price equilibrium.
Problems With The Traditional ICO
A significant problem that has arisen in the traditional ICO model is that participation has been limited to groups or individuals who “qualify” for participation in the token sale or the pre-sale of the ICO. There are even some pre-pre sales now that offer absurd discounts, which clearly raise red flags with their funding model.
Qualifications to invest can come in the traditional form of being accredited investors or part of established institutions (think venture capital funds). These confined sales lead to a trend away from decentralization and towards the traditional investing format of a centralized nature where only investors that have substantial capital can reap the rewards from investing early in a potentially successful platform.
Long-term profits of venture capital firms have long been highly lucrative. One of the initial aims of the ICO and now the IICO is to distribute that wealth creation across a broader set of people. Backtracking towards the centralized investing format only creates more problems. Not only that, but the mixing of venture capital designs with ICO crowdfunding assuredly compounded the SEC’s position on regulation for the ICO space.
The whole idea from a purist perspective of these crowdsale protocols, within the confines of the decentralized blockchain space, is to provide an avenue for mainstream investors with limited financial capabilities to be a part of the larger investing paradigm. This creates a dispersion of wealth creation not seen before. It is integral to platforms using a model for fundraising like an IICO or ICO to deliver on promises that contribute to the development of decentralized products and applications while simultaneously remaining accessible and accountable to their investors in a transparent manner.
Limited participation pre-sales of ICO’s can lead to an anchoring of the price prior to the actual public token sale as well as the development of secondary markets where tokens are sold prior to the public sale opening (like with the RCN token sale). This has an adverse effect on the equilibrium price and total evaluation of the sale which can easily be noticed once the token hits major exchanges.
A problem in the initial ICO model that has become very prevalent recently is the creation of ICOs by companies that offer centralized services and products in what has become known as the “Reverse ICO”. These companies are using the system solely for financial gain, and there token sales are performed in a completely centralized manner. These are poorly thought out tokens that have no real use case in the industry and end up hurting investors. With more of an emphasis being placed on utility tokens and tokens directly correlated to their network’s value such as the case with Token Curated Registries, Reverse ICOs stand to be easily identifiable for both regulators and consumers as the industry progresses.
Advantages of the IICO
Where the IICO offers the most important advantages over the ICO model is in mitigating against the manipulation of the sale by whales and sophisticated mining techniques. Specifically, the IICO removes the advantages of budget size in the sale by treating both small and large bids equally. Whales with low personal caps can be pushed out of the sale just as easily as buyers who purchase a fraction of a token. Furthermore, all bids are handled through the contract publicly, thus equally distributing information to all participants and not giving limited access participants in the context of a pre-sale any advantages.
What is a Whale? And how do they Manipulate Cryptocurrency Prices
In traditional ICOs, whales are capable of controlling whether or not their bids are accepted by having the financial means to afford the sometimes massive gas costs associated with attempting to purchase tokens through a capped sale that sells out in minutes. Mainstream investors cannot afford these gas costs, which effectively bars them from participating in the sale and only allows small groups with significant capital to profit. The IICO creates a financial disincentive to act in this fashion by making it impractically costly for miners to censor transactions during the crowdsale.
Whales who attempt to place a bid for a huge number of tokens early in the sale, only to pull them out later in order to obtain an artificially low evaluation, are penalized by locking a portion of their bid into the sale as the sale progresses. In this manner, average investors are protected from price manipulation and the protocol increases the chances of converging to stable bids and valuation. The fees for submitting transactions to the crowdsale smart contract are also flat fees based on the Ethereum gas prices.
Interestingly, a notable effect of implementing an IICO for a token sale is that the developers or company behind the token sale lose a degree of control over the fundraising process. By allowing the market equilibrium valuation to naturally be established, they are inadvertently (possibly intentionally) creating a environment where contributors have a compelling level of trust in the platform as opposed to the ICO model.
For instance, a company or group attempting to pull an exit scam would be disincentivized to use the IICO model since they lose control over the ability to fix the cap or create a pre-sale (or pre-pre sale) for private investors to make out with substantial profits once the sale ends and no product is delivered.
What is an Exit Scam? And How to Avoid Them
Additionally, platforms without a minimum viable product, or at least an open-source repository that shows potential, would shy away from implementing an IICO model as it is more risky for them compared to the traditional model. This inherent advantage of the IICO allows for investors to feel much more confident in a platform that uses an IICO for its token sale.
With the uncertain regulatory environment looming heavily for ICOs, any blanket regulation imposed by the SEC will most likely directly affect IICO’s as well. Despite providing better investor protection through arming individuals with better market information, the SEC is unlikely to show any nuance in regulation of IICOs relative to ICOs moving forward.
It will be fascinating to watch as subsequent iterations of the IICO model are implemented and how prevalent they become. For now, the return to decentralized crowdfunding offered by Interactive Coin Offerings is something worth investigating as an investor and hopefully can help launch a new wave of innovations in crowdfunding structures and implementations that protect investors and comply with regulations that are certainly coming.
Featured Image: Freepik.com