While Most Go Bust, are Successful ICOs Underpriced?

ICOs (Initial Coin Offering) have established themselves in the last year as an effective tool to finance technological start-ups, generally linked to the digital world: from January 2017 to May 2018 about 12 billion dollars were collected issuing tokens. As with more traditional equity offerings, there is a secondary market providing liquidity for these digital assets, which are “listed” and can be exchanged for a profit.

The first complete academic analysis on ICO and tokens trading was just carried out by a research team at Boston College; it involved 4,003 ICOs launched in the last 18 months and the transactions carried out on 15 main global aggregators, substantially covering the entire market.

The results are definitely surprising and the most important conclusion is that in the issue phase the tokens are strongly underpriced.

Only 25% of the issued tokens – the research paper demonstrates – arrive to be traded on the market: the remaining 75% of projects have gone bankrupt or are not yet ready for trading.

Out of the 25% listed, only 44.2% survive after 120 days.

Nevertheless, the sentiment remains positive: investors are satisfied with the returns generated by the investment in the surviving tokens, that means they already developed a mature investment strategy in portfolios.

The funding strategy of the companies that have proposed ICO evolves rather frequently, according to the report.

The average ICO size in the time frame examined is $ 11.5 million, with a hard-cap (i.e. a maximum cap) average of $ 43 million. However, this value has been influenced by some highly successful ICOs, and the median is just $ 3.8 million.

The trend at the moment is to offer discounted prices in a pre-placement, which is often divided into two phases (the first one being very private and exclusive): during the first half of 2017 only in 1% ICOs offered a pre-placement, in the second half of 2017 the pre-ICO was proposed in 29% of cases, a percentage that rose to 57% in 2018.

The average duration of the campaign has therefore increased to about 8 months in total. Then, between the ICO and the listing, the average time is 31 days, while the median value is 16 days.

By comparing the difference between the subscription price at ICO and the opening price on a listing platform, we observe an average return rate of + 246% (influenced by some very successful ICOs) and a + 21% median, which in the first closure become respectively + 273% and + 29%.

Warning: this is a value generated by only 25% of ICOs that are successful (remember, only 44.2% of these survive after 4 months) and are listed.

The Boston College analysis calculated the average abnormal returns, i.e. the differences recorded by the performance of listed tokens against a comparison portfolio: for the tokens that survive they are very high and growing over time:

  • on the first day of trading, the abnormal return is on average between 14% and 16%;
  • thirty days after listing, the abnormal return rises on average by a percentage between 41% and 67%;
  • 180 days later, tokens that resist express an even greater abnormal return: between 150% and 430%.

To date, the Boston College research provides some of the most interesting data within the ICO industry: tokens are issued at a considerably lower value than that expressed by the market. The reason is evidently the lack of experience of the operators, due to the particularity of the asset class and its very young history.  Or perhaps, there is an opportunity to manipulate the pricing of a thinly traded digital asset following the issuance.

Indeed, the pre-ICO practice allows price adjustments during the pre-placement phase; in fact the most recent ICOs, which used pre-placement, expressed less radical pricing differences.

It is also interesting to compare the average combined returns by buying and keeping listed token up to 250 days. Compared to investment in Bitcoin made at the time of each token listing: the ICO index shows a significantly higher growth.

Given the particular type of asset and the relevant information asymmetry, liquidity is a problem; at the moment, the analysis shows an average daily trading volume is between $2.5 million and $ 3 million.

Summarizing, the analysis shows that:

  • tokens are issued at a price much lower than the price reached during the negotiation, recognizing a significant discount to the early investors;
  • there is an average  abnormal return of more than 82%;
  • prices of tokens continue to grow after listing;
  • liquidity is not high;
  • failed projects and scams are not diminishing investor confidence in crypto assets.

Even with the remaining questions, these figures show that ICOs have the potential to change how startup companies raise money, providing more control to entrepreneurs, greater liquidity to investors, and additional investment opportunities to early adopters: tokens are becoming a brand new and important asset class.

In light of this analysis, however, it is difficult to deny SEC Chairman Jay Clayton, according to whom all the tokens are securities, unless proven otherwise: when a financial return is offered against money, the nature of financial investment is frankly undeniable. As such, it is logical that the financial authorities want to regulate their issuance and trading.

Alessandro Lerro is an Italian attorney and founder of Lerro & Partners. He is a prominent Italian expert in crowdfunding and is a regular speaker at conferences and workshops. Alessandro is also General Counsel of the European Equity Crowdfunding Association and Board Member of AISCRIS. He is co-author of the recently published book “Crowdfunding for Sustainable Entrepreneurship and Innovation”. The publication  is a pivotal reference source for the latest scholarly research and business practices on the opportunities and benefits gained from the use of crowdfunding in modern society, discussing its socio-economic impact, in addition to its business implications. You may follow Alessandro on Twitter @allessandrolerro.

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