When it comes to initial coin offerings (ICOs), the saying “here today, gone tomorrow” seems to apply, with the lifespan – from token sale to flameout – roughly that of a quickie marriage consummated in Vegas.
But business models be darned – or be sketchy or be absent. Get in early enough on the ground floor, and the returns? To quote an old Seinfeld episode: They’re real and they’re spectacular.
To which we might add: And built on a shaky foundation?
Timing seems to be everything with ICOs, as with so much else in life. In research that debuted earlier this month, findings from Boston College show that more than 4,000 ICOs – or, to be more specific, ICOs that had projects attached to them – have raised more than $12 billion to date.
Ah, but the timing, again: In tandem with that eye-popping dollar amount, more than half of those ICOs are gone just like that, as they fail, disappear, shut their doors within four months after the token sales are completed.
“Breaking it down by category, 83 percent of the 694 ICOs that don’t report capital and don’t list on an exchange are inactive after 120 days. For the 420 ICOs that raise some capital but don’t list, this figure falls to 52 percent, and for the 440 ICOs that list on an exchange, only 16 percent are inactive in the fifth month,” the paper stated.
The promise and the peril is starkly reflected in one number: Only about 44 percent of the ICOs are still around into month five of the journey, at least as far as Twitter and other online conduits show. No tweets, no ICO, it seems.
All this is barely enough time to see if a business model actually works.
And in an interview with Karen Webster, one of the duo responsible for the paper, Hugo Benedetti, PhD candidate, took note of the gold rush that comes when the timing is spot on.
Consider the fact that Benedetti and co-author Leonard Kostovetsky stated that in contrast to IPOs, “crypto tokens continue to generate abnormal positive average returns after the ICO.”
Make that eye-popping returns – an average of 179 percent, to be exact.
On Timing and Underpricing – or Timing the Underpricing
But to get to that 179 percent lottery ticket? It seems to be due less to enthusiasm for an ICO’s prospects via finished project than underpricing headed into the more widely available realm of secondary trading.
“We find evidence of significant ICO underpricing … even after inputting returns of -100 percent to ICOs that don’t list their tokens within 60 days and adjusting for the returns of the asset class, the representative ICO investor earns 82 percent,” noted the paper.
Benedetti expanded on some of the findings. There’s a bifurcation at work, he said, as investors eye tokens as securities or as utilities. “It all depends on what investment you are trying to do [with the ICO],” he told Webster. “If you start thinking about the separation between the utility tokens … that are eventually going to [be used] for the platform, it’s kind of weird to think in terms of return.” That’s because, as he stated, a token that is attached to a service, for example, means the price of that service keeps going up.
Thus, might it be surmised that it is the speculation, rather than the anticipation of use cases (you know, in the real world), that would spur those triple-digit returns? One tell, perhaps: Benedetti also noted that the research did not bear out any particular verticals as holding investor favor.
As for the surprises that came from the research: “The most surprising thing was that on average, the returns were still positive,” he said. “I really thought that by and large, ICOs would have a negative return … because you see so many articles of failed ICOs … even taking into account all the ICOs that didn’t list, [returns] came out positive.”
The argument that ICOs are initially underpriced is an argument that squares most fully with what is known as “rational finance” theory, said Benedetti. Here, rational finance rests on the idea that early investors are able to get the tokens at a price that reflects the underlying risk of buying in without the benefit of knowing just how and when (or if) platforms will be launched successfully. That can be illustrated by the fact that 75 percent of investors who buy in are purchasing tokens that cannot be used at the time of purchase.
“Another take could be that the market doesn’t know how to price [the tokens],” said Benedetti. In this scenario, investors are not able to buy tokens at the ICO, but can do so in the secondary market, at whatever price the tokens are changing hands.
“So it could be a story that is about larger demand, and what is unmet through the ICO is demand that is going to get filled on the secondary market,” he said.
Beyond timing – the when – it seems that where matters, too. A world map of ICOs would show concentration in North America, Russia and relatively richer nations, such as Singapore, Switzerland and the like – countries where, as the research shows, there exist higher World Bank Rule of Law rankings and higher standards of living. Deeper pockets, to be sure – and, as Webster noted, in Silicon Valley, there’s rarely a shiny new tech bauble related to crypto that investors don’t like.
The Twitter Effect
The Twitter effect? Don’t confuse the social media platform with a hype machine, cautioned Benedetti.
“We are not saying there is a causal effect of Twitter activity on price,” he stated. “But we also felt that some of the ICO projects that were very active on Twitter could potentially be scams … it’s so easy to buy followers on Twitter. And it’s so simple just to tweet all day. We thought that projects would want to disguise themselves as being productive just by tweeting out a lot.”
“And we didn’t find that,” he told Webster. “We found that projects that work and are trading are the ones that have more online presence.”
The Blockchain Debate
No discussion of ICOs is complete without discourse on the bigger picture – which of course includes blockchain. Said Benedetti: There is the basic use case of transferring value, he said, which can help improve the speed and efficiency of financial ecosystems, such as those in the U.S., and where regulations and legacy tech means money takes days to settle between accounts. There’s also the possibility of using blockchain to spur financial inclusion.
But writ large, and viewing blockchain beyond cryptos “as a form of registry and traceability, I think it’s much more empowering,” he said.
From Here … to Where?
Speaking for himself alone, Benedetti told Webster he thinks regulators should, well, regulate. But how to regulate a decentralized network? It’s a virtually impossible endeavor, so education is key, he said.
“If I were the SEC, I would be more concerned with secondary marketplaces, and the so called crypto exchanges,” he said. “This is potentially where you could start regulating and making sure that the exchange is efficient.” Such efforts could include holding periods for the management team to make sure there is no insider trading.
The research, Benedetti said, helps show that some value has been delivered through ICOs, in a market that many thought was headed toward oblivion. The findings should also spur thought about the future of ICOs. The ICO secondary markets will start to look like other secondary exchanges, with advisers and underwriters, he said.
Asked how the markets will evolve, Benedetti stated that the secondary markets will develop quickly as more people are trading, and will trade, there.
Investors looking to allocate their money will look toward a few exchanges rather than hunting down far-flung ICOs spread out over the world. “Once it is listed, it is easy to see what the market thinks of the ICO,” he noted.
No surprise, then, that the next phase of Benedetti’s research involves looking at listings and how they might affect token prices – with an eye toward a fall debut of his findings.