ICO vs. IPO: Empirical Findings, Information Asymmetry, and the Appropriate Regulatory Framework

Initial coin offerings (ICOs) are a new form of fundraising whereby blockchain-related ventures raise public capital in exchange for newly issued digital tokens. The issued tokens may represent a variety of rights, ranging from financial rights – such as dividend and voting rights – to consumptive rights, such as the right to access a service or a product that the issuer will provide. After the fundraising ends, the issued tokens are generally traded on the secondary market.

ICOs have quickly become popular. While the idea of an ICO debuted in 2013,[1] by 2017, over $10 billion had been raised by over 1,000 firms, and by October 2018,[2] over $21 billion had been  raised by over 3,000 firms.[3] This rapid growth can be explained by various factors. From investors’ perspective, cryptocurrencies are a “hedge against volatile local currencies and geopolitical risk,” and their growth might be related to a continuing distrust of the traditional banking sector since the 2008 financial crises.[4] Additionally, growing media attention,[5] combined with astronomical returns for early investors – with returns on investment exceeding 50,000 percent[6] – have attracted investor interest. From issuers’ perspective, an ICO is an attractive alternative source of funding, because it may reduce transaction costs compared with traditional financing methods, it has a global reach, and it enables companies to establish a customer base during the fundraising.[7]

Despite the rapid growth of ICOs, many of their characteristics remain unclear. First, the terminology around the ICO phenomenon is as yet unsettled, and different scholars and regulators tend to use different terms for identical concepts. Second, very few studies have analyzed the valuation of ICOs, which therefore remains unclear. Third, tokens vary dramatically in their nature. They may represent a wide range of rights, from financial rights to consumptive rights, and hence their regulatory status is unclear.

Complicating matters further, various jurisdictions have adopted a range of approaches, from banning ICOs to a crypto-friendly approach. Against that background, empirical and theoretical studies have analyzed various issues related to ICOs, trying to reduce the uncertainty associated with the market. In a new paper, we provide thorough analysis of two key areas: determinants of ICO success and information asymmetry.

Determinants of ICO success

Since its boom in 2017, the ICO phenomenon attracted legal and economic empirical studies, which analyzed determinants of ICO success. Their findings have often been inconsistent, however. One possible reason is that there are no official data sources, and there is evidence of inconsistencies across various data sources.[8] To address this, we aggregate empirical studies using different data sources and methodologies to identify factors that affect ICO success. The most robust finding under this key area is a significant correlation between the quality of disclosure and an ICO’s success.

Information asymmetry

Information asymmetry is one of the most important sources of market friction. In financial markets, it means that potential investors lack information required to assess the true quality of a financial product.[9] This may create a market for questionable investments, deterring high-quality companies from entering that market.[10] Following a growing body of literature in the context of Initial public offerings (IPO),[11] venture capitalists (VC),[12] and crowdfunding,[13] recent empirical studies document significant evidence for information asymmetry and poor disclosure in the ICO realm.

These findings suggest that ICO investors are not entirely rational, and hence that we cannot fully rely on the competitive forces of an economy in this case. Therefore, we argue that regulators should address the sources of informational asymmetries we identify by mandatory disclosure provisions. Based on the empirical analysis, we propose specific disclosure requirements tailored to the unique characteristics of ICOs and the determinants of their success.

First, most ICOs are launched by a blockchain-based venture and, accordingly, there should be a focus on the technological aspects of the project. The underlying code of a venture is the de facto business model of the project, and hence it is essential information required to make an informed decision. However, a requirement to publish the source code prior to the token sale could be problematic for two reasons. One is that this requirement will not be effective unless the code is audited by a reliable intermediary. Our analysis suggests that, while disclosing the source code significantly predicts success, the number of mismatches between promises made in white papers and the actual code do not affect ICO success. These results imply that investors value the disclosure of the source code but are unable to assess its true quality. Therefore, the focus here should not be on the requirement to disclose the source code – which the majority of ICOs disclose voluntarily anyway – but on an intermediary that will audit the source code. The other reason is that, by disclosing the source code, ICOs enable other ventures to copy the technology of issuers, which may then lose their competitive advantage. In line with this, Bourveau et al. find a positive and significant association between source code disclosure and crash risks in the long term.[14] This point should be considered as well when discussing source code disclosure.

Second, we propose to include a requirement to disclose information about presale rounds and their terms. The first justification for this requirement is to prevent ventures from maintaining pump and dump scams. Rational investors who are exposed to information regarding pre-sales would account for this information and demand either a lower price or the implementation of lock-up mechanisms. The second justification for this requirement is semantic, and it stipulates that the term “initial coin offerings” can be misleading if the token sale is not the first offering.

Third, we propose to include a disclosure requirement in relation to the ability to create new tokens after the launch of the ICO. Empirical evidence suggests that the ability to create future tokens is negatively associated with the amount raised in an ICO. These results suggest the investors are able to price this type of information, and hence such a requirement will be effective.

Finally, we argue that ventures should explain in their prospectus why blockchain technology is required for their project. Empirical studies show that most ICOs don’t need blockchain but yet use it to attract investors driven by hype, and that investors are able to distinguish between ICOs that leverage blockchain technology and ICOs that don’t really need to use blockchain.[15] In order for this requirement to be effective, we further suggest that a structured methodology to determine whether blockchain is the appropriate technical solution be developed.[16]


[1] Laura Shin, Here’s The Man Who Created ICOs And This Is The New Token He’s Backing, Forbes (Sept. 21, 2017), https://www.forbes.com/sites/laurashin/2017/09/21/heres-the-man-who-created-icos-and-this-is-the-new-token-hes-backing/#7ec40f611839.

[2] ICO Market Analysis 2018, ICOBench, available at https://icobench.com/reports/ICO_Market_Analysis_2018.pdf.

[3] Paul P. Momtaz, Kathrin Rennertseder & Henning Schröder, Token Offerings: A Revolution in Corporate Finance?, 49 Capco Inst. J. Fin. Transformation 32, 33 (2019).

[4] Ryan Clements, Assessing the Evolution of Cryptocurrency: Demand Factors, Latent Value and Regulatory Developments, 8 Mich. Bus. & Entrepreneurial L. Rev. 73, 78 (2018).

[5] Id.

[6] Top 10 ICOs with the Biggest ROI, Cointelegraph, cointelegraph.com/ico-101/top-10-icos-with-the-biggest-roi#10-qtum–9225-roi; Coin and Crypto, Early Investors are Making 50,000% Returns on ICOs, Hacker Noon (Dec. 5, 2017), hackernoon.com/investors-are-making-50-000-returns-on-icos-32432bc741d1.

[7] See: Saman Adhami, Giancarlo Giudici & Stefano Martinazzi, Why Do Businesses Go Crypto? An Empirical Analysis of Initial Coin Offerings, 100 J. Econ. & Bus. 64, 65 (2018); Jiri Chod & Evgeny Lyandres, A Theory of ICOs: Diversification, Agency, and Information Failure 3 (July 18, 2018) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3159528.

[8] Evgeny Lyandres, Berardino Palazzo & Daniel Rabetti, Do Tokens Behave like Securities? An Anatomy of Initial Coin Offerings 9 (July 18, 2018) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3287583 (document substantial inconsistencies across data sources – especially for the following variables: amount raised, hard cap, the number of tokens available for sale, and the overall number of project-related tokens issued); Lauren Rhue, Trust is All You Need: An Empirical Exploration of Initial Coin Offerings (ICOs) and ICO Reputation Scores 23 (May 16, 2018) (unpublished manuscript) papers.ssrn.com/sol3/papers.cfm?abstract_id=3179723 (finds that reputation scores are inconsistent across different data sources).

[9] Michael C. Jensen & William H. Meckling, Theory of the firm: Managerial behavior, agency costs and ownership structure, 3 J. Fin. Econ. 305 (1976); Paul P. Momtaz, Entrepreneurial Finance and Moral Hazard: Evidence from Token Offerings 6–7 (Feb. 27, 2019) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3343912 [hereinafter: Momtaz, Moral Hazard].

[10] George A. Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q. J. Econ. 488 (1970).

[11] Boyd D. Cohen & Thomas J. Dean, Information Asymmetry and Investor Valuation of IPOs: Top Management Team Legitimacy as a Capital Market Signal, 26 Strategic Mgmt. J. 683 (2005).

[12] See, for example, Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the American Experience, 55 Stan. L. Rev. 1067 (2003).

[13] Gerrit K.C. Ahlers, Douglas Cumming, Christina Günther & Denis Schweizer, Signaling in equity crowdfunding, 39 Entrepreneurship Theory & Practice 955 (2015).

[14] See Thomas Bourveau, Emmanuel T. De George, Atif Ellahie & Daniele Macciocchi, Initial Coin Offerings: Early Evidence on the Role of Disclosure in the Unregulated Crypto Market, 56–57 (July 9, 2018) (unpublished manuscript), papers.ssrn.com/sol3/papers.cfm?abstract_id=3193392; at 40.

[15] See, for example, Chen Feng, Nan Li, M.H. Franco Wong & Mingyue Zhang, Initial Coin Offerings, Blockchain Technology, and White Paper Disclosures (March 25, 2019) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3256289.

[16] On that matter, see: Karl Wüst & Arthur Gervais, Do you need a Blockchain?, 2018 Crypto Valley Conference on Blockchain Technology 45 (2018); Morgen E. Peck, Blockchain world – Do you need a blockchain? This chart will tell you if the technology can solve your problem, 54 IEEE Spectrum 38 (2017).

This post comes to us from Professor Moran Ofir at the Harry Radzyner School of Law, Interdisciplinary Center, in Herzliya, Israel, and Ido Sadeh, a student at the law school. It is based on their recent paper, “ICO vs IPO: Empirical Findings, Information Asymmetry and the Appropriate Regulatory Framework,” available here.

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