Premining (Pre-mining), or pre-mining, of cryptocurrencies is when a part or a general supply is generated before its launch. This is the creation of a certain number of cryptocurrencies or tokens before the public launch of the project. This has its advantages and disadvantages.
We can consider this using the example of more traditional finance, for example, when companies create shares, which they distribute among their founders and employees before the company takes part in the initial public offering (IPO).
However, these stocks can be traded privately, whereas in the case of digital currencies, they are created before the launch of the project, which allows their owners to make a profit before they become the subject of trade.
In most cases, these first cryptocurrencies go to the developers and the rest of the team members who helped bring the project to life. The other part goes to ICO investors.
An example is Ethereum, a very popular cryptocurrency. Prior to the official launch, she conducted a preliminary assessment of many cryptocurrencies.
And according to Coinmarketrate.com This shows a big difference with cryptocurrencies such as Bitcoin, since pre-mining usually leads to cryptocurrencies being transferred to a central authority, as is the case with Ripple (XRP). This can lead to problems, since owning a significant part of the total supply gives a certain power over the rest.
There are two camps here: those who advocate such practices, and those who believe that such a situation contradicts the decentralized nature of these decisions.
For the first group, it is an interesting way to encourage the team working on the project, while for the opponents it only concentrates power on them, not on the community.
At the same time, it often happens that the team is not completely honest about the number of coins they have before the ICO. This leads to a reduction in supply, which pushes the price up and allows the first holders to benefit.
As a result, the value of the cryptocurrency falls, after which these people begin to sell their assets in order to obtain financial benefits, which affects those who came later.
How premining works
Premining allows you to create cryptocurrencies even before the launch of the project, when there is not even a working MVP (a minimally viable product).
The idea is to be able to pay for the development of the project with these coins so that the team is focused on the task. To do this, cryptocurrencies are issued for a specific blockchain and sent to the recipients’ addresses or wallets. It can be founders, developers and investors.
After some time, the cryptocurrency becomes public, where it is allowed to trade on exchanges or mine new cryptocurrencies, if this is provided for by the project.
There are many reasons why the project decides to go down this path rather than allow cryptocurrencies to arise over time:
- These cryptocurrencies serve as a form of payment for people working on the development of the project.
- Cryptocurrencies will be ready for the ICO, where investors and backers will receive their cryptocurrencies.
But, its use as a method of deception and obtaining an unfair advantage is not excluded.
Advantages and disadvantages of pre-mining
There are many reasons to think that pre-mining is useful, but there are also many reasons to think the opposite. As with everything in this community, there are always people on both sides with very important arguments.
Proponents of pre-mining claim that without these reserves, developers and early participants would have no incentive to build the project.
In addition, these cryptocurrencies are used to pay for development, being a currency that is used to attract developers and experts of all kinds to bring the project to completion.
It’s like a startup that, without having a lot of money, attracts talented people to work on a project, promising that in the future these shares, in this case cryptocurrencies, will be worth more.
Another legitimate reason is to give early investors a priority place in investments. Offering them cryptocurrencies before the ICO, when the project is officially presented to the public. A way to reward those who saw the value of the idea and took a risk.
All these reasons may be good, but there are also disadvantages and arguments against conducting preliminary development.
- Disadvantages of premining
During the ICO fever, pre-mining took on a negative connotation in the ecosystem. This is due to the fact that many projects privately allocate a large number of coins to a certain group even before the software is launched.
The result was a lack of transparency and a significant concentration of project funds, which led to all sorts of shortcomings, especially related to fraud.
Many of these projects did not disclose information about pre-mining, inflating prices with a “pump and dump” scheme, and then selling their cryptocurrencies to leave end investors with assets that are worth very little.
This applies not only to coins that were created with the aim of deceiving people, but also to others where the development team had good intentions, but still harmed investors.
This type of behavior is very similar to traditional finance, but without all the controls that they are subjected to. This leads to certain negative situations, which served as motivation for the creation of projects such as Bitcoin.
Exchanges can also participate in this practice by requiring developers to pay a certain amount of coins for the placement of their projects.
Finally, even if there were no problems with prices, because the recipients of these cryptocurrencies with premining do not throw their funds into the market, there is a risk of centralization. Because they turn into whales in an unfair way. A situation that could lead to a lot of problems in the future.
Examples of pre-mining cryptocurrencies
There are examples of pre-mined cryptocurrencies that have not affected their investors, while others are just large cases where such a practice has negative consequences.
- ETHEREUM (ETH)
Ethereum, as the second largest cryptocurrency by market capitalization, is known as a pre-mined cryptocurrency.
Before its launch in 2015, 72 million Airwaves were created. Of this amount, about 10% went to the founders, another 10% to the Ethereum Foundation, and the remaining 80%, almost 60 million, were sold publicly.
The decision to mine ETH earlier has been criticized, especially by members of the Bitcoin community. The reasons were that it was beneficial to its founders, allowing them to accumulate more than the rest.
Vitalik Buterin justified this event by saying the following:
“Personally, I am very proud to have contributed to the creation of a precedent that small preminers are legal. It’s a terrifying idea that the people who exploit the boxes burning huge piles of electricity are somehow the only ones who should be profiting from cryptocurrency earnings.”
- CARDANO (ADA)
In the period from 2015 to 2017, Cardano held pre-sale events. 25,927,070,538 ADA coins and 5,185,414,108 ADA tokens were sold there.
- IOTA (MIOTA)
IOTA is a cryptocurrency that works without blockchain technology. Therefore, it was necessary that it be 100% preminated.
But the responsible persons behind the project claim that all the coins were sold before the ICO in 2015. Where the founders and developers did not receive anything, but were forced to buy together with the rest of the people.
- RIPPLE (XRP)
A negative example of premining, which turned out to be not entirely favorable for investors, is Ripple (XRP). At the time of launch in December 2012, 100% of XRP was created.
However, it later became known that RippleLabs, the team behind the project, controlled from 50% to 70% of the entire offer. A situation that led to problems only after one of the team members, McCaleb, left the project in 2014 and started selling a large amount of XRP.
Between 2014 and 2019, it sells for a total of $135 million. After that, he waited until 2020 to sell another 1.2 billion XRP for a total of $ 411 million.
This caused a weakening of confidence in the project and a collapse in the price of this cryptocurrency. For example, from a historical high of $3.40, the price fell to $0.60 in just two months.
Finally, things got worse for the project when, in December 2020, the SEC filed a lawsuit against Ripple for selling more than 14.6 billion XRP for personal purposes. Claiming that people like Garlinghouse and Larsen made $600 million in profits.
Premining is a process in which rounds are created and distributed to a group of insiders prior to the ICO. This is very similar to what happens to the company’s shares before their IPO.
During the ICO hype in 2017 and 2018, this was a wake-up call for investors. Not all projects have become successful by applying the premining process, and therefore, many crypto investors and traders have every reason to distrust it.