Your Complete Guide to an Initial Stake Pool Offering (ISPO)
DeFi

Your Complete Guide to an Initial Stake Pool Offering (ISPO)

2 months ago

CoinMarketCap Alexandria takes a look at a novel method of raising funds in crypto — initial stake pool offering, and how it works.

Your Complete Guide to an Initial Stake Pool Offering (ISPO)

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In an era of new crypto projects emerging daily, there must be different ways that they can raise funding. From the infamously tainted initial coin offerings (ICOs) of 2017 to the surge of venture capitalism (VC) in 2021 to the launch of different ways of raising funds like initial stake pool offerings (ISPO) — emerging and promising crypto projects have always found the way to raise money to build crypto products.
And what other way to raise funds than to participate in network consensus? If you could find a way to put your idle cryptocurrency to use to ensure that the blockchain that you stake on keeps producing new blocks and getting rewards in return, wouldn’t you want to do so? That is exactly what an initial stake pool offering is. It is the brainchild of Cardano, a proof-of-stake blockchain.

But what exactly is it and how does it work? More importantly, how is it different from other traditional ways of raising funding in crypto? To answer these and many more questions, let’s understand the most typical ways of raising funds in crypto.

Types of Crypto Funding

There are several different ways of raising funds for cryptocurrency projects. Gone are the days where promising entrepreneurs would have to wait in queue for the investor to show up and offer them a deal that would change their lives. While the VC industry has undergone massive changes and is still one of the most reliable ways of raising funds for tech projects, there are now more novel ways that crypto projects rely on thanks to blockchain technology. That said, projects in this space have adopted different methods of raising funds in the space. Let’s take a look at some of the most popular ones listed below.

Initial Coin Offering (ICO)

This is perhaps one of the most original ways of raising funds in crypto. As part of an ICO, funds are raised as the project issues its token to interested investors. Let’s take the example of Ethereum. When it was doing its ICO, it wanted to attract investors to participate in the program based on the technical research the team had done and the yellow paper that had been written. This meant that potential investors could read through Ethereum’s mechanics to understand how the protocol and blockchain would work. This gave investors a fair chance to not only understand the project but also get in early on its tokens by participating in its ICO.

While some of the funds generated through the ICO were lost, there was no doubt that it was a novel way of raising funds in crypto, especially when the space was just emerging. Ethereum’s ICO launched in August 2014 at a price of $0.31 per token, raising over $16 million.

Initial DEX Offering (IDO)

The IDO is a similar process to raising funds like ICO, with the difference being that investors now buy the project’s coins when they are listed on decentralized exchanges (DEXes). On AMMs like Uniswap, Sushiswap and PancakeSwap, investors can easily swap their existing tokens (such as USDT) with the project’s own token.

Security Token Offering (STO)

This is a lesser-known way of raising funds in crypto. It is a public offering of tokenized digital securities, which can be used to represent financial assets like equities and fixed income. But, as part of an STO, a project will list its tokens on exchanges that list securities tokens. The users can buy the tokens on these exchanges.

Initial Exchange Offering (IEO)

An IEO is similar to an IDO with the only difference being that a centralized authority (such as an exchange or a launchpad) acts as a mediator between potential investors and the project. The process of raising funds is conducted on the exchange’s platform (such as Binance) and users can utilize their funds in the exchange to purchase these tokens. Most centralized exchanges (CEXes) such as Binance and FTX often facilitate such fundraising events for emerging projects.

Now that we have reviewed the various ways of raising funds in crypto, let’s understand what an initial stake pool offering is.

What Is an Initial Stake Pool Offering (ISPO)?

MELD, one of the first ever projects to use the ISPO model of raising funds, defined it as a very “liberating” way of raising funds for crypto projects. In their explanatory blog on how it worked, they outlined how users could delegate their ADA tokens to the MELD stake pools and earn rewards. This would come in two types of rewards — one would be 100% ADA rewards and the second was split between 50% ADA rewards and 50% MELD rewards. The project had already allocated about 800M worth of MELD tokens to issue the rewards to the delegators.

What Is MELD?

MELD is a non-custodial crypto bank that lets you lend and borrow both crypto assets and real-world fiat currencies. Users also have the opportunity to earn yield on their $MELD tokens by staking them. The project is based on the Cardano blockchain. The lending process in the project is similar to other lending/borrowing pools in crypto. Users simply borrow crypto assets from the platform by providing a collateral. The lender in this case receives an interest rate for locking up their capital. MELD offers fiat lending on their platform as well.

How Does an Initial Staking Pool Offering Work?

Now to understand ISPO, we must first understand how staking pools work. Staking pools are the simplest ways of generating returns in crypto. Crypto protocols that are following a proof-of-stake consensus model rely on staking pools to ensure the propagation of their blockchain. This replaces miners (in case of proof-of-work blockchains).

The way this works is that instead of miners having to put up computational resources to help validate transactions on the network, users deploy capital (in the form of the chain’s native token). Validators then use this stake to verify transactions and keep producing blocks on the blockchain. But because the staked capital is often locked (i.e., it is not able to be used anywhere else in DeFi), users are issued staking rewards, which is effectively an interest that they get on their staked capital.

In the case of MELD, the staking pools and the rewards that were issued to users (or delegators who staked their capital in these staking pools) were utilized. In essence, they differentiated their utilization of the ISPO model from the other common ways of raising funds in crypto by generating funds in a way that no delegated funds were collected by the ISPO.

Wait, how does this work? Let’s understand.

MELD would act as an “interface” between the staking rewards that were being generated from the staking pools and the rewards that were being issued out to delegators. They would keep the ADA rewards that were generated as part of staking and in return would issue a proportional amount of MELD tokens to users who were participating in the ISPO.

This meant that likely investors who wanted to invest in the project did not have to divert all of their capital into the project and risk it getting devalued. The risk of locking the capital within the project was hedged by the project itself. Since they had absolute control over their assets, users could withdraw their capital whenever they wanted to.

Is an ISPO Different From an ICO?

Yes, an ISPO is fundamentally different from an ICO in that it does not require potential investors to deposit their capital into a project and risk it getting rugpulled. On the contrary, users deposit their capital into a staking pool and the project simply collects the staking rewards from the pool while issuing a proportional amount of its tokens to users in return. This makes things much easier for the investor.

Not only can they deposit and withdraw their capital anytime, but they also have the freedom to participate in as many fundraising events as possible. And all said and done, if the project does not turn out well then the investor can simply withdraw their assets from the staking pool and get all of it back.

Remember that in an ICO, you are putting the entirety of the capital that to invest in a project and none of that is usable elsewhere. With an ISPO, it’s just like putting your capital in a staking pool and earning rewards from it. If the project tanks, then you only lose the staking rewards (but you are able to retain your capital back). However, if the project does well, then you get your entire capital back along with the tokens as rewards.

What Is the MELD Staking Pool?

The MELD staking pool was launched on July 1, 2021, and ended six months later on December 8. All those who wanted to participate had the opportunity to delegate as much ADA as they wanted and for however long that they wanted. Since they were delegating their tokens to a staking pool, they could unstake and withdraw any time that they wanted to.

Exactly 800M worth of MELD tokens were set aside as rewards for all the participants. Two pools were offered as part of this ISPO:

MELD1: This pool consisted of just MELD tokens. In short, if users delegated their ADA in this pool, they were getting their rewards only in MELD tokens and ADA tokens.

MELD2: This pool was split 50% between MELD and ADA tokens. This meant that users were able to get rewarded in both MELD and ADA tokens if they delegated to this pool.

The rewards were airdropped to users on the final date i.e., Dec. 8, 2021. The objective with this fundraising was to utilize the funds for a variety of different purposes.

The ISPO lasted a total of 32 epochs and the funds were to be split for different purposes like this.

The project managed to amass over $1B worth of Cardano in their staking pools during the ISPO.  This was truly ground-breaking in that it showed users’ desire to have more control over their own invested capital.

The primary objective that MELD had with their ISPO was to explore a different way of raising funds in crypto, one that was not explored before. This was particularly useful for the investors who had their capital all locked in with ICOs. ISPOs offered them an alternative way of investing their capital in a project without having to put it at risk.

Examples of ISPOs

Since the success of MELD’s ISPO, they have ballooned into popularity as both projects and investors are now considering utilizing it as their predominant way of raising funds and investing respectively. One of the biggest benefits with ISPOs is that only serious projects tend to undertake them and there are lesser chances of the project rugpulling its investors. MinSwap is another project on Cardano that used the same method for raising funds. Their project’s ISPO consisted of 10 staking pools.

Other proof-of-stake blockchains can also utilize this model of raising funds by offering protocol makers and investors another way of raising funds for various projects in crypto. How successful it becomes in the future is something only time will tell.

How To Participate in an ISPO?

If developers or investors of a project want to use ISPO as a method of raising funds for the project or participating in investments respectively, then they can deploy a staking pool. In that case, the investors will stake their ADA into the pool. They can decide what percentage of the staking rewards they themselves want to receive in ADA and the percentage of rewards that they would like the project to get.

As you can see, this percentage can be set both by the project’s developers and its investors in collaboration, making sure that there is complete transparency. In return, what the developers do is that they promise a proportional amount of the staking rewards in the form of their own tokens. These tokens are usually airdropped to the investors’ wallet at the end of each epoch. This helps ensure that a) the project gets the required funds for the project and b) the investors are able to invest their funds.

You can watch out for ISPOs of upcoming projects on different chains. Since Cardano was the first chain being used for this method, you might find more projects using Cardano as the base model as well. Make sure to keep a track on Cardano’s official webpage to keep a track of emerging projects. Now that we have explored and understood how the ISPO works, it would be helpful to understand how staking ADA generates those rewards. This would further cement your understanding of the blockchain and give you a better idea of where your returns are coming from.

How Do ADA Staking Pools Work?

In a PoS blockchain, stake pools form a crucial building block. While users can stake individually as well, stake pools are those that aggregate users’ funds into a pool which is then deployed on the network. The rewards that accrue from deploying the entire stake pool in the network, then are distributed amongst all those who are deploying to the pool.

But what is this stake? And where are the returns actually coming from?

In a PoS blockchain, users do not need to put up computational resources to validate blocks on the chain. Instead, they must commit their capital to the network. This capital is then used by the network to select the validators who get to validate the next block. Naturally, the higher the capital that you deposit in the network, the more your chances of getting selected to validate. And the higher your chances of getting selected, the higher your profitability from staking.

This is the reason why several investors can all pool their funds together and stake via a staking pool on the network. This ensures that there is a much higher chance of getting selected to validate transactions on the network.

Now, when investors do deposit their capital in the network, they are effectively “locking” it. What this means is that that capital becomes illiquid and is not able to be used elsewhere. This is a fundamental challenge to PoS blockchains that is currently being solved by some emerging liquid staking protocols. However, this is indeed a fundamental challenge to PoS. And while designing the mechanics of these chains, it was decided that a certain portion of the native cryptocurrency of the network would be set aside for staking rewards.

Thus staking rewards are inherently connected to the well-functioning of a PoS blockchain. The security of any PoS network is directly correlated with the amount of capital that is staked. If more capital is staked within the network, then the network becomes extremely resilient to attacks. And if the network is quite resilient to attacks, then the staking rewards are very sustainable as well. And that is why ISPO can be successful. In a typical ISPO, the only capital that you are giving to the project is the returns that you are making on your stake. Your initial stake is completely intact as long as the network is healthy.

Closing Thoughts

ISPOs are certainly a promising method of raising funds in crypto. They are proving to be more reliable than other traditional ways because of the ease and the reliability. It gives you the freedom to unstake your capital whenever you want. Not only does this mean that your capital is safe, but it also means that the project won’t get any funds when all the investors have unstaked.

While this is certainly a promising way of raising funds, what we mustn’t forget is that this is new. And just like ICOs seemed promising at first, the same fate ISPOs can go through as well.

Moreover, this experiment was carried out on Cardano — a protocol where a major portion of ADA tokens are staked within the network. This makes deploying staking pools on the network easier, hence increasing the effectiveness of ISPOs. While we would like to envision this happening for other blockchains as well, we mustn't forget that Cardano does not have as vibrant an ecosystem as some other chains like Ethereum and Solana. Hence, ISPOs may not necessarily be successful on other chains.

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