After the token economics are set in stone and the tokens are minted, it’s time to distribute the tokens to the public and/or allow investors to buy tokens. There are several ways to put the tokens in the hands of the users. Additionally, tokens can be distributed by conducting a public sale or other token launch mechanisms. There are different approaches to token sales and we are going to lay out the most common ways to launch a token or to create secondary markets. They all vary in benefits, drawbacks and legal implications.
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Overview Table
Launch Mechanism
Type
Pros
Cons
Risk of being perceived as a security offering?*
Initial Coin Offering (ICO)
Token Sale
- anyone can participate
- high uncertainty/risk of fraud for investors
very high risk
Security Token Offering (STO)
Token Sale
- regulated
- investors get legal rights to underlying assets
- complex set up
- restricted to accredited investors
Security by design
Initial Exchange Offering (IEO)
Token Sale
- less fraud risk for investors
- exchange listing & marketing
- KYC for exchange users required
- potentially expensive
- complex for users to understand & participate
- high price volatility in the beginning
moderate risk
Liquidity Backed Auctions (LBA)
Price Discovery Mechanism
- fair price discovery
- encourages early participation
- incentivizes bots
- early volatility
moderate risk
Fair Launch
Price Discovery on the market afterwards
- maximizes decentralization
- no pre-mine or pre-sale
- no initial funds for development
- can lead to high initial price volatility
low risk
Direct Listing
Price Discovery Mechanism
- exchange listing & marketing
- no funds raised
- potential low liquidity or market maker needed
low risk
If a token launch is classified as a security offering will ultimately depend on many things, such as jurisdiction, how exactly the launch was conducted, how the tokens were generated as well as other factors. This is by no means a legal classification/advice, but rather an overview of how different launch mechanisms have been treated by authorities in the past.
1. Traditional Token Sale Mechanisms
Token Sales are most of the time a clear “investment of money” and oftentimes those early protocols depend on the “essential entrepreneurial efforts” of their founding team, which likely makes them a security under the Howey Test. As such, token sales are most likely to be considered security offerings, which could lead to legal repercussions if unregistered. We are going to outline four different token sale mechanisms: ICOs, STOs, IEOs and IDOs.
Initial Coin Offering (ICO):
An Initial Coin Offering (ICO) is one of the earliest and most well-known token sale mechanisms. It involves the issuance and sale of new cryptocurrency tokens to the public in exchange for existing cryptocurrencies like Bitcoin or Ethereum, or sometimes even fiat currency. ICOs were prevalent during the 2017-2018 crypto boom, but regulatory concerns and a high number of scams led to a decline in their popularity.
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Adoption Rate: ICOs gained immense popularity during the 2017-2018 crypto boom. Many blockchain projects used ICOs as a means to raise funds for their development and marketing efforts. However, the adoption rate of ICOs has declined significantly in subsequent years due to various factors. Regulatory uncertainties, a high number of scams, and investor protection concerns have led to a decreased interest in ICOs.
Timing: ICOs are generally conducted at the early stages of a project's development. They can occur before the project is fully functional.
Initiator of the Sale: The ICO is typically initiated by the blockchain project team or company seeking funds for their project. They create and launch the token, set the terms of the sale, and conduct the fundraising campaign. The sale usually happens on a website hosted and conducted by the founding team.
Flow of Funds: Funds are raised from the public in exchange for the newly issued tokens. Investors participating in the ICO send their contributions, which can be in the form of cryptocurrencies like Bitcoin, Ethereum, or other established cryptocurrencies. The project receives the raised funds in the chosen cryptocurrency or fiat currency used in the ICO.
Who Can Invest: ICOs were originally open to anyone. However, as regulatory concerns grew, some projects limited participation to accredited investors or specific regions to comply with local laws.
Legal implications and Decentralization: The decentralization of ICOs is often a point of debate. While blockchain technology itself is decentralized, ICOs can vary significantly in terms of project governance and control of raised funds. In some cases, the project team holds a significant portion of the total token supply, leading to concerns about centralization of power. Many projects aim to promote decentralization by involving the community in decision-making processes and using raised funds to develop a decentralized network or platform.
Security Token Offering (STO):
A Security Token Offering (STO) is a token sale that involves offering security tokens to investors. These security tokens represent ownership of assets, profit-sharing rights, or other financial instruments, and they are subject to securities regulations in various jurisdictions. Unlike utility tokens offered in ICOs, security tokens have legal backing, making them a more regulated and compliant way to raise funds for blockchain projects.
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Adoption Rate: STOs emerged as a more regulated and investor-friendly alternative to ICOs. They gained attention as a means to address regulatory concerns and provide greater investor protection. While STOs have garnered interest and are seen as a more compliant option for token sales, their adoption rate has been slower compared to ICOs and other token sale mechanisms due to the complex regulatory process in registering tokens as securities.
Timing: STOs are typically conducted when a project aims to raise funds by offering tokens that are classified as securities. The timing may vary, but it often occurs when the project has a clear regulatory-compliant plan and is ready to engage with institutional and accredited investors.
Initiator of the Sale: The STO is initiated by the project team seeking to raise funds through the issuance of security tokens. The team must comply with relevant securities laws and regulations during the entire process.
Flow of Funds: During an STO, funds are raised from investors who purchase security tokens. These funds are typically received in the form of fiat currency or cryptocurrencies like Bitcoin or Ethereum. The project receives the raised funds and is expected to use them for the development and operation of the project in a manner consistent with the offering's terms and regulatory requirements.
Who Can Invest: STOs are generally open to accredited investors and institutional investors. Accredited investors are individuals or entities that meet certain financial criteria defined by regulatory authorities. The criteria may include minimum income or net worth thresholds. Institutional investors can also participate, subject to compliance with relevant regulations.
Decentralization: While STOs are generally seen as more regulated and compliant compared to ICOs, the level of decentralization can vary among projects conducting STOs. Some projects may maintain a certain degree of centralization in terms of governance, control, or token distribution, while others aim to maintain a high level of decentralization despite regulatory compliance. The focus on decentralization in STOs is often related to ensuring a fair and transparent distribution of security tokens and involving the community in decision-making processes.
(Initial) Exchange Offering (IEO):
An Initial Exchange Offering (IEO) is a token sale that takes place on a cryptocurrency exchange platform. Unlike ICOs, where the project team conducts the sale themselves, in an IEO, the exchange acts as the intermediary and conducts the token sale on behalf of the project. This provides more security for investors, as the exchange typically vets the projects before listing, reducing the risk of scams to some extent.
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Adoption Rate: IEOs gained significant popularity as a successor to ICOs. Exchanges started hosting IEOs on their platforms to attract more users and provide a safer token sale environment. IEOs have been well-received by both projects and investors due to the benefits they offer in terms of trust, convenience, and exposure to a large user base.
Timing: IEOs are conducted on cryptocurrency exchanges, and the timing is determined by the exchange and the project team. The exchange typically vets and selects projects to participate in the IEO, and the token sale takes place on a specific date and time set by the exchange. IEOs can be conducted during the launch phase but listings might be done at a later stage on different exchanges.
Initiator of the Sale: IEOs are initiated by the cryptocurrency exchange platform hosting the token sale. The exchange collaborates with the project and facilitates the token sale process on its platform.
Flow of Funds: In IEOs, the funds raised during the token sale flow through the cryptocurrency exchange hosting the IEO. The exchange acts as an intermediary and facilitates the token sale process. Investors participating in the IEO send their contributions to the exchange's designated wallet. The project team receives the funds raised during the token sale through a designated wallet on the cryptocurrency exchange platform hosting the IEO. The project receives the funds through different options for fund disbursement, which can include direct transfers to the project team's wallet, staged releases based on milestones, or holding funds in a smart contract escrow with predefined conditions for release.
Who Can Invest: IEOs are generally open to all users of the hosting exchange. Investors need to create an account on the exchange platform and complete any necessary verification procedures to participate in the IEO.
Decentralization: IEOs offer a more centralized approach compared to ICOs, as the token sale process occurs on a specific cryptocurrency exchange platform. While the underlying blockchain technology may still be decentralized, the exchange's role as an intermediary introduces a level of centralization in the token sale process.
In summary, IEOs gained popularity as a safer and more convenient alternative to ICOs. Conducted on cryptocurrency exchanges, IEOs enable projects to access a large user base and benefit from the exchange's reputation and trust. However, the centralization introduced by the exchange hosting the IEO is a point of debate for proponents of decentralization in the blockchain space.
Initial DEX Offering (IDO):
An Initial DEX Offering (IDO) is similar to an IEO, but instead of being conducted on a centralized exchange, it takes place on a decentralized exchange (DEX). IDOs have gained popularity due to the increasing use of decentralized finance (DeFi) protocols and platforms. Projects conducting IDOs on DEXs offer their tokens directly to the DeFi community, and the fundraising process is typically more accessible and decentralized.
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Adoption Rate: IDOs have gained popularity as a token sale mechanism, especially within the decentralized finance (DeFi) space. While the overall adoption rate of IDOs is still relatively young compared to other token sale methods, they have been increasingly utilized as a means to launch tokens in a decentralized manner.
Timing: IDOs are typically conducted on decentralized exchanges (DEXs) after the project's token has been created. The specific timing can vary, but IDOs often occur when the project has developed a minimum viable product (MVP) or has achieved certain milestones to demonstrate the project's viability.
Initiator of the Sale: IDOs are initiated by the project team themselves, and they take the responsibility to deploy the token smart contract and set the terms for the token sale. However, instead of the project team directly selling the tokens to investors, the IDO occurs directly on the decentralized exchange platform.
Flow of Funds: In IDOs, the funds raised during the token sale typically flow into a liquidity pool or smart contract on the DEX platform. This enhances the decentralized nature of the token sale. Investors participating in the IDO send their contributions to the smart contract or liquidity pool, and the tokens are allocated based on the predefined terms.
Who Can Invest: IDOs on decentralized exchanges are generally more inclusive and open to a wider range of investors compared to traditional token sales. Most IDOs allow any user with access to the DEX to participate, making it more accessible to retail investors. However, certain projects may impose restrictions based on geographic location or other criteria to comply with local regulations.
Legal Implications & Security Laws: IDOs conducted on decentralized exchanges (DEXs) may have fewer regulatory implications compared to centralized exchanges. However, the regulatory landscape for DEXs is evolving, and compliance requirements may vary based on the jurisdiction. Projects conducting IDOs should still be aware of the potential legal implications and seek legal advice to ensure compliance with relevant regulations.
Decentralization: IDOs epitomize the essence of decentralization in the token sale process. The sale occurs directly on a DEX, which operates on a blockchain, removing the need for a central authority or intermediary. Decentralization in IDOs provides a level playing field for investors, as it allows direct interaction between token buyers and sellers without the need for third-party intermediaries. It also aligns with the principles of blockchain technology, promoting transparency and community involvement in the token sale process.
Conclusion:
In this section, we explored the characteristics and differences between four traditional token sale mechanisms: Initial Coin Offering (ICO), Security Token Offering (STO), Initial Exchange Offering (IEO), and Initial DEX Offering (IDO). Each mechanism served as a means for blockchain projects to raise funds and distribute their tokens to investors.
Common Aspects
All token sale mechanisms involve the issuance and sale of tokens to investors or the public.
They enable projects to raise funds for development, marketing, and operational purposes.
The timing of token sales varies, but generally, projects conduct these mechanisms at early stages to secure capital.
The initiator of the sale is the project's founding team, who create and launch the tokens and set the terms for the sale.
The flow of funds differs across mechanisms, with ICOs and STOs receiving funds directly, IEOs channeling funds through exchanges, and IDOs raising funds on decentralized exchanges.
Legal Implications & Security Laws
Each token sale mechanism has distinct legal implications. ICOs, being one of the earliest, faced scrutiny from regulators due to the lack of proper regulations, leading to some being classified as securities.
STOs emerged as a more regulated alternative, ensuring compliance with securities laws and offering a more secure investment option.
IEOs introduced a safer token sale environment as exchanges vetted projects, yet they still faced regulatory considerations: IEOs, while enhancing investor protection through exchange vetting, remain subject to securities laws and regulations. Compliance with licensing, AML/KYC, and securities laws is crucial to avoid penalties or legal consequences.
IDOs, conducted on decentralized exchanges, might have fewer regulatory implications, but the evolving DEX regulatory landscape requires careful attention: IDOs on decentralized exchanges may face fewer immediate regulatory hurdles, but the evolving DEX regulatory landscape introduces uncertainty. Regulatory scrutiny on AML/KYC, liquidity, market manipulation, and smart contract risks underscores the need for careful compliance and legal diligence.
Decentralization & Adoption Rate
The main concern in regards to decentralization for these launch mechanisms, particularly ICOs, IEOs, and IDOs, lies in the degree of central control exerted over the token sale process and subsequent governance. ICOs have often been criticized for allowing project teams to maintain substantial control over funds raised, potentially leading to centralized decision-making. IEOs and IDOs, although striving for more community involvement, can still encounter concerns about centralized initiation, decision-making power, and the degree of influence exerted by the founding team. Ensuring a balance between decentralization and project team influence is a critical consideration to promote transparency, fairness, and long-term sustainability.
The adoption rate of ICOs boomed during the 2017-2018 crypto surge but declined due to regulatory concerns and scams.
STOs, IEOs, and IDOs gained traction as more compliant alternatives, with IEOs becoming popular due to exchange trust and convenience.
2. Price Discovery Mechanisms
In order to avoid conducting a token sale and therefore being labeled a security under the Howey test, there are other ways of launching a token. While these are less likely to fall under the Howery criteria, there is no guarantee this will avoid being deemed a security. This also strongly depends on the exact implementation, who initiates the launch and to what extent the network is decentralized before initiation.
(I) You can learn more about sufficient decentralizationin this article..
We will cover IFOs/Lockdrops, LBAs, LBPs, fair launches and the less common direct listings.
Initial Farm Offering (IFO) / Lockdrop:
In this model, new tokens are distributed via yield farming or locking up tokens. Users provide liquidity to a pool or protocol TVL and in return, they get the new tokens. High APRs are often used to attract liquidity/TVL this way, but sustainability of this model is often questionable, and should hence be used with care/only to bootstrap the protocol.
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Adoption Rate: Lockdrop and IFOs have been around since the DeFi Summer 2021 and have been used by a variety of mostly DeFi related projects. Examples in Cosmos include Astroport DEXs initial launch on Terra.
Timing: IFOs and Lockdrops are usually conducted right when/after the project launches and are therefore part of the project's launch sequence.
Initiator of the Sale: The Lockdrop & IFOs may be initiated by the project team itself. In order to launch the token and conduct the sale/distribution in a more decentralized manner is to initiate the sale via a governance proposal. This will only work however, if tokens have already been launched and are already held by users, e.g. via a prior airdrop.
Flow of Funds: Funds raised from an Lockdrop are directed towards certain protocol functions which the liquidity was intended for. Examples may be liquidity for LP, protocol TVL or lending.
Who Can Invest: Technically anyone can invest. However, certain projects may impose restrictions based on geographic location or other criteria to comply with local regulations.
Decentralization: Due to little to no restrictions into who can participate, this price discovery mechanism has a high chance of distributing tokens into a variety of users hands, however, this is not necessarily a given as it also depends on the terms of the lockdrop, and how appealing it is to a wide user base. If the IFO is not initiated by the founding team or project and the funds flow into a protocol owned pool this mechanism is relatively decentralized.
Liquidity Bootstrapping Pool (LBP):
LBPs are a special kind of balancer pool where the token is paired with a stablecoin or another token with high liquidity (e.g. ETH, ATOM, OSMO) with a high initial weight on the project token that reduces over time. Therefore the initial price of the token is very high and algorithmically decreases over time. This mechanism aims to discourage front-running and whale manipulation, while providing fair and open price discovery.
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Adoption Rate: LBPs have been around since the 2021 bull market but have been used only by very few projects. Examples in Cosmos include White Whale ($WHALE).
Timing: LBPs are usually conducted right before the project launches and are therefore part of the project's launch sequence. They could technically also be held before the protocol fully launches, however after the TGE.
Initiator of the Sale: The LBP may be initiated by the project team itself or there may be a portion of token set in the genesis file that is dedicated to liquidity bootstrapping. In order to launch the token and conduct the sale/distribution in a more decentralized manner is to initiate the sale via a governance proposal.This will only work however, if tokens have already launched and are already in the hands of users, e.g. via a prior airdrop.
Flow of Funds: Funds raised from an LBP are ideally directed towards certain protocol functions which require liquidity. Funds can also flow to the protocol treasury or community pool. Directing funds to the team is usually not recommended as it raises the question if the sale was conducted by a centralized entity, eg. the founding team.
Who Can Invest: Technically anyone can invest, but the complexity of the mechanism makes users often cautious. Further, certain projects may impose restrictions based on geographic location or other criteria to comply with local regulations.
Decentralization: Due to little to no restrictions into who can participate, this price discovery mechanism has a high chance of distributing tokens into a variety of users hands, however, this is not necessarily a given as it also depends on the terms of the lockdrop, and how appealing it is to a wide user base. If the LPB is not initiated by the founding team or project and the funds flow into a protocol owned pool this mechanism is relatively decentralized.
Liquidity Bootstrap Auctions (LBAs):
LBAs are generally combined with another distribution mechanism such as a lockdrop. Lockdrop participants can commit all or part of their funds into a pool (e.g. paired with a stablecoin). This way other users can buy the tokens from lockdrop participants right away by depositing the stablecoin receiving the price depending on the balance of the pool. When the initial LBA phase is over, the final price of the native token is determined by the ratio of native coins to stablecoins and various auction participants receive (locked and vesting) LP shares pro-rata on their deposits. If there is sufficient participation in the LBA, there will be immediate and deep liquidation at the market price.
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Adoption Rate: LBAs have been around since the 2021 bull market but have been used only by very few projects. Notable Cosmos examples include the initial launch of Mars protocol on Terra and Astroport.
Timing: LBAs are usually conducted right before the project launches and are therefore part of the project's launch sequence.
Initiator of the Sale: The LBA may be initiated by the project team itself. The LBP may be initiated by the project team itself or there may be a portion of token set in the genesis file that is dedicated to liquidity bootstrapping. In order to launch the token and conduct the sale/distribution in a more decentralized manner is to initiate the sale via a governance proposal.This will only work however, if tokens have already launched and are already in the hands of users, e.g. via a prior airdrop.
Flow of Funds: Funds generated from an LBA are generally kept in the LP they are raised for, as the LP shares are owned by the users.
Who Can Invest: Technically anyone can invest, but the complexity of the mechanism can be a hurdle for some users. Further, certain projects may impose restrictions based on geographic location or other criteria to comply with local regulations.
Decentralization: Due to little to no restrictions into who can participate, this price discovery mechanism has a high chance of distributing tokens into a variety of users hands, however, this is not necessarily a given as it also depends on the terms of the lockdrop, and how appealing it is to a wide user base. If the LBA is not initiated by the founding team or project and the funds flow into a protocol owned pool this mechanism is relatively decentralized.
Fair Launch:
Historically, in a fair launch, there is no private pre-sale or pre-mine of tokens. Instead, tokens are released to the public in a manner that does not favor any particular party by utilizing third party tolls/mechanisms such as StreamSwap.
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Adoption Rate: Fair launches have been around for a while, but have recently started gaining traction in Cosmos with the launch of Streamswap. In contrast to its initial design, fair launches are also being used with the main purpose of price discovery or OTC deals, while there may have been a private sale of the token.
Timing: Fair launches can either be done before the protocol has launched, or together with the protocol launch.
Initiator of the Sale: The fair launch is ideally initiated via governance, however that requires tokens being airdropped beforehand to ensure decentralization of the decision making. Fair launches can also be initiated by the team, which is not recommended as it the launch is perceived as centralized and controlled by one entity eg. the founding team.
Flow of Funds: Funds raised from an fair launch are ideally directed towards certain protocol functions which the liquidity was intended for or the community pool. Funds can also flow to the protocol treasury or community pool. Directing funds to the team is usually not recommended as it raises the question if the sale was conducted by a centralized entity, eg. the founding team.
Who Can Invest: Technically anyone can invest. However, certain projects may impose restrictions based on geographic location or other criteria to comply with local regulations.
Decentralization: Due to little to no restrictions into who can participate, this price discovery mechanism has a high chance of distributing tokens into a variety of users hands, however, this is not necessarily a given as it also depends on the terms of the lockdrop, and how appealing it is to a wide user base. If the Fairlaunch is not initiated by the founding team or project and the funds flow into a protocol owned pool this mechanism is relatively decentralized.
Conclusion:
In this section, we explored the characteristics and differences between four price discovery mechanisms: IFOs & lockdrops, Liquidity Boostrapping Pools (LBP), Liquidity Boostrapping Auctions (LBA), and Fair Launches. Each mechanism serves as a means for blockchain projects for token price discovery and raising liquidity for the project or token.
Common Aspects
All price discovery mechanisms involve the issuance of tokens to the public.
They enable projects to generate liquidity for the token, or the project and set a price for the token in a public & decentralized way.
The timing varies, but generally, projects conduct these mechanisms at or right before the launch of the protocol/project..
The initiator of the sale can be the project's founding team or protocol governance, for a decentralized launch and/or token sale they are initiated through a governance proposal and decided on by the community
Legal Implications & Security Laws
Each token price discovery mechanism is designed to minimize legal implications by conducting the token launch and price discovery in a manner that is as decentralized as possible. However the legal implications depend very much on the exact way the mechanisms are conducted.
In order to have no central entity that initiates the launch, these mechanisms should be voted on by governance. However this requires the tokens to be in the hand of a variety of users already e.g. via a prior airdrop.
Decentralization & Adoption Rate
In terms of decentralization, IFOs, LBPs, and LBAs are designed to be more decentralized than traditional token sales like ICOs and IEOs. Among these mechanisms, IFOs are considered one of the most decentralized approaches. This is because participants in IFOs lock their existing tokens, and the process is governed by smart contracts, reducing the reliance on centralized control.
In contrast, LBPs and LBAs involve a degree of centralization as the project team or protocol creators often provide initial liquidity or determine the starting price. However, they still promote a more decentralized price discovery process compared to traditional token sales facilitated by centralized exchanges.
Overall, these price discovery mechanisms offer more inclusive and community-driven token distribution approaches, encouraging broader participation and reducing the reliance on centralized entities.
However, it's essential to consider the specific implementation and governance models of each mechanism to determine the level of decentralization in practice. We'll dive deeper into how to launch a network sufficiently decentralized in the following article: Steps to Launching a Sufficiently Decentralized Cosmos SDK Chain.
Note that these are not necessarily exclusive and many projects have done a combination of two or more different launch mechanisms. These are usually held one after another or spaced out over different development stages. Doing more than one obviously increases technical and legal complexity.
