The cryptocurrency market represents a unique chance to analyze a market with an estimated unregulated capital exceeding $13 billion, which was raised via initial coin offerings (ICOs). A recently published paper in the London Business School Review attempts to identify how much confidence investors can have in crypto markets.
The paper analyzes data from more than 750 ICOs that were launched between April 2014 and May 2018. The findings of this study can offer some comfort to investors who prefer to trust in self-regulated markets rather than in traditional regulated markets.
ICO investments and trading:
According to data from coinschedule.com, more than 650 startups (out of the 776 ICOs analyzed in the study) raised around $13 billion from investors from over 50 countries in the period between April 2014 and May 2018. This represents a remarkable sum of money investors entrust to the ICO economy, given the lack of proper regulation and the absence of reliable and robust investor protection policies. Due to the decentralized infrastructure of platforms that host these ICOs, i.e. the blockchain, they are exempt from securities regulations in most countries. Furthermore, there is much debate about whether ICOs qualify as securities at all.
ICOs were clearly inspired by IPOs, or initial public offerings, of company shares listed for the first time on a public stock exchange. However, the major difference is that with an IPO, share floatation is associated with a lengthy, strict, and expensive registration process, which is closely monitored by securities regulators. A company that plans to sell shares on the basis of a no-disclosure regimen, which is commonly adopted by ICOs, would find itself under investigation by securities regulators and would be mostly ignored by investors.
Thus, with the lack of a regulatory framework, how does an ICO perform in terms of investors’ returns? First-day trading profits are impressive with a median profit of 6%. However, as the first-day trading frenzy fades away, the median return during the next 30 days averages minus 30%, which denotes that investors lose significant percentages of their capital.
However, not all ICOs are the same, and, even though the median return is on the negative side, the mean return averages positive 39%. As such, a small number of ICOs have considerably altered the average statistics via generating impressing returns. This can explain why $1 invested in August 2014 in the ICO market index would have grown into $4,621 by May 2018. However, 50% of all ICOs have undoubtedly failed.
Information disclosure and dissemination:
It goes without saying that investors need to be able to identify ICOs that can generate considerable returns and avoid those that cannot. This represents the main focus of the paper: information disclosure and the means of its dissemination. Successful completion of an ICO’s crowdsale, and subsequent low volatility of token price, as well as illiquidity of the ICO’s token are directly related to the amount and quality of information related to the project disclosed by the ICO creators.
Because first-day trading is usually associated with what seems to be an unsustainable premium to the token’s offer price, there seems to be no direct link between information disclosures and the initial trading activities, which denotes that the first-day fever is fueled more by hype rather than by any form of emphasis on the fundamentals. However, when the long term performance, during the 90 day period following the end of the ICO, is considered, the story is considerably different. During this period, less volatility and higher liquidity are positively related to greater disclosure and dissemination of information.
The research study also found evidence that some ICOs intentionally tend to time their crowdsales to cash in on certain “hot streaks” within the cryptocurrency market, which represents the “pump and dump” approach that can be extremely harmful to investors.
How does disclosed information reach investors?
A new form of information intermediaries has emerged in order to provide ratings on the quality of ICOs. Examples of these intermediaries include ICOrating.com, ICObench.com, ICOalert.com, and ICOdrops.com. These services provide assessments of ICOs that are based on in-house analysis and external blockchain experts who are invited to rate various ICOs and provide investors with valuable investment advice. These rating services have emerged in this unregulated market as key monitoring tools that are trusted by investors.
Finally, the paper also found that social media networks represent important means for dissemination of information regarding various ICOs.