Investors can make good short-term gains from investments in initial coin offerings, as long as they manage to avoid the scams and the failures, a new study has found.
Researchers at Boston College’s Carroll School of Management found that ICOs were “significantly underpriced”, offering investors average returns of 82 per cent over six months.
However, researchers Hugo Benedetti and Leonard Kostovetsky also report that a significant number of ICOs are scams and many of the companies that raise money through ICOs fail.
And they caution that returns from investments in initial coin offerings are likely to decline, as entrepreneurs learn to price their offers more accurately.
Benedetti and Kostovetsky looked at more than 1000 start-ups, which raised US$12 billion over the past couple of years using ICOs.
The best returns come from trading coins within the first six months of the offering. Early returns are, on average, “positive and significant”.
Longer term, around 56 per cent of the businesses that raised money through ICOs failed. Benedetti and Kostovetsky measured the business survival rate by tracking tweets from the start-ups’ Twitter accounts post-ICO. A business that became inactive on Twitter was deemed not to have survived.
Based on this measure, the survival rate is 44.2 per cent. Scams play a part in this low survival rate.
A number of scam cases have come to light recently, including a company called Centra, which raised US$32 million though an ICO. The founders were arrested in Florida in April and charged with fabricating information about the business their company was supposedly involved in.
Also common are “soft scams” where money is raised for a legitimate business purpose but the start-up founders never proceed with the venture (keeping the ICO proceeds for themselves).
Benedetti and Kostovetsky caution that a lot of commentary on ICO investing is distorted by survivorship bias – that is, it only looks at the performance of businesses that have survived. Their study includes data on 1100 defunct cryptocurrencies.
But even with data on failures and scams included in the study, and taking into account that some tokens issued in ICOs are illiquid, they argue that the overall return to investors is high.
They expect this to change over time, saying that because demand for ICO investments has increased and the price of coins offered in ICOs is being pushed up. “Returns have been declining over time, as start-ups have become smarter about pricing coin offerings.”
They argue that the ICO market is more than a speculative bubble and has the potential to change how start-up companies raise money, providing more control to entrepreneurs, greater liquidity to investors and additional investment opportunities to early adopters.
For most commentators, an ICO is somewhere between an initial public offering and crowdfunding.
Like IPOs, ICOs are a form of fundraising but instead of issuing shares, companies issue coins or tokens. Holders may have access to a secondary market where they can trade their coins or tokens.
And like crowdfunding, the coins or tokens are usually used to fund a specific project and giving rights to products or services. Holders may also have rights to returns generated by the project.