Commentary

The Pros and Cons of Premined Coins

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Image Credit: ysbrand/DepositPhotos

Premines are an increasingly common tool in the crypto world—but it’s not all rosy. Premines come with several advantages and drawbacks.

So, what are the pros and cons of premines for developers, users, investors, and the wider crypto community? Keep reading to find out more.

The Pros of Premines

Let’s begin by looking at some of the pros of premines.

1. Resources for the Developer

No coin will be successful if the developer(s) does not devote sufficient time and energy into the project. However, the realities of modern life mean that most would-be coin creators cannot simply quit their nine-to-five job and dedicate their lives to their passion.

A premine allows a developer to sell their premined coins over time and therefore, not only fund their living expenses, but also accumulate resources to spend on areas such as marketing, exchange listings, extra staff, social media content, and so on.

Essentially, a premine helps the developer get paid and consequently improves the probable longevity of the new token.

2. Incentivizes the Developer

Premines are arguably a better incentive for a developer than an ICO.

Whereas an ICO provides an immediate cash windfall (typically in either Ethereum or Bitcoin), a premined coin has no value unless the developers grow the token. Because they hold a significant number of the coins themselves, they have an inherent vested interest.

As such, the risk of the developers walking away after a big payday is significantly reduced. Again, the premine thus helps to improve the potential longevity of the coin.

3. Less Regulatory Scrutiny

ICOs are facing an ever-increasing amount of regulatory pressure. It is hardly surprising; more than $10 billion was plowed into ICOs by investors in 2018, of which a not-insignificant chunk was never seen again.

At the time of writing in mid-2019, ICOs are banned in China, South Korea, Nepal, Bangladesh, Bolivia, Algeria, Morocco, and more. ICOs also face severe restrictions in Russia, India, Jordan, Singapore, Pakistan, Ecuador, Thailand, and Macedonia.

There are suggestions that the United States is set to join the list, but the issue is muddied by the fact that ICO rules differ from state to state.

4. Proof of Concept

ICOs are renowned for raising tens of millions of dollars in funding with little more than a whitepaper, a strong social media game, and some flashy marketing. Very often, there is no functioning prototype.

That makes ICOs high risk for investors—there are no guarantees that the ideas outlined in the whitepaper will ever see the light of day. In contrast, premines necessitate a functioning coin by their very nature. Developers and early speculators can test the coin in the real-world and check whether it’s meeting its goals.

The Cons of Premines

Now let’s consider some of the disadvantages and drawbacks of premines.

1. Increases the Likelihood of the Coin Being a Scam

Although premines are arguably less likely to be a scam than an ICO, they are not without risk. There have been cases in which a development team has dumped its premined coins as soon as there was enough liquidity in the markets. The coins were left to die, and investors were left out of pocket.

The risk is higher when a premine appears unusually large. Anything larger than 15 percent is a significant red flag. Ideally, look for coins with no more than 5-10 percent premined.

2. Dumping Coins on the Market

Even if the developers are honest and the coin goes on to be a success, you’re still left in a position whereby several people hold an excessively large amounts of the token.

This can be seen today in both Dash. More than two million Dash were mined within 48 hours of the project going live in 2014. Today, Dash is a top 20 coin, and those early tokens are worth around $150 million.

With a circulating supply of nine million, those early coins represent more than 20 percent of all the Dash in existence. If the owners decided to cash out and flooded their market with their tokens, the price of Dash would nosedive.

An analogy can be drawn with Bitcoin whales. It’s thought that Satoshi Nakamoto owns around one million Bitcoins. If he (or they!) were to dump their tokens, the value of Bitcoin would crash.

3. Centralized

One of the key tenets of cryptocurrency is decentralization—the idea that no single person, group, or organization is in control of a coin.

Premines go against those ideals. In the early days after a coin’s launched, almost the entirety of a coin’s circulation in is typically in the hands of developers and other insiders.

Take the example of NEXT. It’s a proof of stake system, which means that the more coins you own, the more you can mine and accumulate. It is a self-perpetuating system which favors people who own premined coins.

Alternatives to Premines

If you’d like to invest in new coins but are worried about the potential downsides of premined coins, you could instead look to seek out community- or developer-funded projects.

In both scenarios, you end up with a dedicated userbase which is committed to the growth of the token. Premined coins many never have such a userbase. Without it, they won’t get off the ground in the medium- and long- term.

If you would like to learn more about investing in cryptocurrency, check out our other articles on our top tips for new traders and some of the most important fundamental analysis indicators for crypto.

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Dan Price
Dan has a background in both finance and technology. Previously, he worked for more than five years as a private financial consultant, advising clients on single investments, fund portfolios, long-term savings, and more. Dan holds professional qualifications from the UK's Chartered Insurance Institute, including a Certificate in Discretionary Investment Management and a Diploma in Financial Planning. Dan also writes for Blocks Decoded's sister publication, MakeUseOf. He started at the company in 2014 and has gone on to hold several key positions in the organization. In mid-2017, Dan finally started to invest in crypto. He is a firm advocate of index tracking funds and automated portfolio balancing. He's currently using the Crypto20 token and Hodlbot for exposure to the top 50 coins.
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