08 Aug 2018
Given explosive growth in the ICO market, new research highlights the value of disclosure in this global market
With around US$13 billion (£10.1 billion) raised through initial coin offerings (ICOs) between April 2014 and May 2018, across 50+ countries and by more than 650 issuers, the question of investor protection is now urgent.
The global market continues to grow, typically with more than 100 new ICOs a month. However, some ICOs experience falls of -75% or more within a few months of the issue date.
New research carried out by Emmanuel De George of London Business School, together with Thomas Bourveau of Columbia Business School, Atif Ellahie from the University of Utah, and Daniele Macciocchi, also of the University of Utah, demonstrates the value of disclosure in this fast-growing global unregulated market.
The research team analysed a global sample of 776 ICOs that occurred from April 2014 to May 2018, which formed the basis for their study. 659 of these ICOs completed.
The team explain:
“The burgeoning crypto-token market offers virtually zero protection for investors since issuers are not required to register with any securities market authority. Neither are they required to provide periodic financial or non-financial disclosures.
“Regulating such markets is highly complex, not least since the crypto market operates on decentralised international platforms.
“That aside, regulators, who operate along national lines, face a balance between all-important investor protection and imposing realistic disclosure requirements on small firms. This trade-off is particularly relevant in the crypto market since it is comprised primarily of smaller and early-stage entities in need of financing.
“Those involved in the crypto market frequently oppose securities regulation, pointing out that costly compliance would restrict access to capital. So crypto-market participants argue in favour of self-regulation and a decentralised market.
“Although a degree of self-regulation has grown up organically, and early evidence is that this can be helpful, it naturally raises concerns regarding credibility.
“A key part of the discussion on the nature of regulation, at least for the SEC, is whether crypto tokens qualify as investment contracts under the so-called ‘Howey Test*’. If crypto tokens were designated securities, this would immediately require them to be regulated.
“Irrespective of this debate, it’s hard to believe that the ICO market will remain completely unregulated for much longer and this market is not going to disappear. So the growing number of investors, be they institutional or private individuals, must go into such investments with their eyes wide open and aim to understand the attributes which help to signal more successful ICOs.”
Based on this global study of 776 ICOs, the team highlight characteristics of successful ICOs which potential investors and issuers should bear in mind; their findings should also provide evidence to inform the ongoing regulatory debate on crypto tokens.
Characteristics of successful ICOs include:
- disclosure of the source code
- provision of genuinely informative white papers
- substantial social media activity
- disclosure of vesting periods for founders’ tokens
- issue of tokens that are well rated by crypto-market information intermediaries.
Conversely, issuers with a weaker information environment experience higher illiquidity and return volatility after the ICO.
The prices of some tokens crashed by 75% or more within a few months after their ICOs, and these ICOs tend to have lower quality disclosure and a weaker information environment. This potentially suggests that some issuers strategically time their capital raising for when markets are “hot”.
There is evidence of significant under-pricing in the ICO market—the median ICO return (from ICO offer price to the closing price on the first day of trading) is 49%. However, over the 30 days after the ICO, these returns dissipate quickly, pointing to the role that hype and investor attention play in this market.
The full working paper is available from SSRN.
*The key issue in the US is whether these crypto tokens are viewed as investment contracts by the SEC based on the US Supreme Court’s ruling in SEC v. W.J. Howey Co. in 1946 (the “Howey Test”), and hence would need to be regulated as securities," the research team said. "To date, no specific regulation has been put in place in the US."
The research team comprised Emmanuel De George – Assistant Professor of Accounting at London Business School; Thomas Bourveau – Assistant professor of Accounting, Business Law & Taxation at Columbia Business School; Atif Ellahie – Assistant Professor of Accounting at the David Eccles School of Business, University of Utah, and Daniele Macciocchi – Assistant Professor of Accounting at the David Eccles School of Business at the University of Utah.