How Disclosure and Information Intermediaries Strengthen the Credibility of Initial Coin Offerings

The crypto-tokens market has recently emerged as an alternative source of financing for entrepreneurial ventures, with approximately $27 billion raised globally through March 2022.[1] These ventures issue blockchain-based digital “crypto-tokens” to raise external capital through an initial coin offering (“ICO”). In return, a token provides holders with various benefits, such as “utility” value through access to the venture’s current or future product (or service), potential participation in future profit distributions, and the ability to trade the token on crypto-exchanges (e.g., Binance and Coinbase).

The “ICO” designation is inspired by initial public offering (“IPO”) whereby private firms list shares on a public stock exchange and raise external capital. However, the similarities are mostly in name as the IPO process is characterized by strict, lengthy, and costly registration procedures with disclosures overseen by securities regulators. In contrast, the ICO market has emerged without investor protection rules or disclosure regulations, instead relying primarily on voluntary, unaudited, and mostly unverifiable disclosures to reduce information asymmetries between issuers and investors. The cross-jurisdictional and decentralized nature of this online capital market also reduces legal recourse and increases the likelihood of scams. This naturally prompts concerns about the trust investors can place in unverifiable disclosures and the ability of ventures to raise capital in this unregulated market.

We address some of these concerns in a recently published paper where we examine 2,113 ICOs drawn from over 100 countries between March 2014 through October 2018. Specifically, we attempt to answer the following questions: (1) what do the voluntary disclosure practices of ICO ventures look like; (2) does the extent of voluntary disclosure provided by ICO ventures increase their ability to raise capital and (3) what mechanisms exist to lend credibility to voluntary disclosures in this completely unregulated market? We find the following answers:

What Do ICO Ventures’ Voluntary Disclosure Practices Look Like?

The primary source of voluntary disclosure provided by ventures prior to their ICO is a white paper. These white papers vary substantially in length, readability, and content but tend to include information commonly disclosed in IPO prospectuses, such as business purpose, management, executive compensation and governance, and offering-related information. For example, 81 percent of white papers disclose a roadmap or timeline for the development of the product or service, 71 percent provide information on the identities and professional biographies of team members, and 66 percent disclose information on their incentive structure (i.e., allocation of tokens to insiders). The motivation for these more detailed disclosures seems to be to build trust with investors by verifying identity and skills.

Some ICO ventures also try to assure investors by borrowing traditional governance and incentive-alignment practices, such as vesting and lock-ups for insider shares. We document that 26 percent of white papers contain information on vesting restrictions of insiders’ tokens, with vesting periods typically ranging from three to 12 months following the ICO.

However, while 65 percent of white papers contain some information about the expected use of proceeds from the ICO, only 4 percent mention venture-specific risk factors, and less than 2 percent provide any financial information or projections. Perhaps to overcome the natural skepticism of investors to give money to such speculative and early-stage ventures, we find that quite a few ICO ventures voluntarily disclose information through other means, such as releasing technical source code for their software product or tokens through online code repositories (e.g., Github). Thus, technically proficient investors can conduct their own due diligence. Finally, virtually all ventures are active on social media platforms such as Facebook, Twitter, and Medium, perhaps enabling them to communicate directly with the younger generation of investors that are attracted to crypto markets.

Does the Extent of Voluntary Disclosures Help Raise Capital?

Yes. We find that lengthier and more technical white papers that disclose information about company management, token incentive structures, and governance measures (e.g., token vesting and lock-up) positively predict successful capital raising, which suggests that investors value these disclosures when deciding to fund projects. Further, the likelihood of raising capital is higher for ventures that publicly release their technical source code, publish video presentations, and communicate through social media platforms. It seems these supplementary disclosures enable investors to better assess the ICO’s legitimacy and viability, similar to the role played by roadshow presentations, investor meetings, and broker-hosted conferences in the IPO market.

What Are the Mechanisms that Lend Credibility to Ventures’ Voluntary Disclosures in this Unregulated Market?

In our final set of analyses, we examine whether internal governance practices of ICO ventures and external scrutiny from information intermediaries can lend credibility to ventures’ voluntary disclosures. First, we expect voluntary disclosures to be viewed as more credible when insiders have a vested interest in the venture and when there is a mechanism in place to align the incentives of insiders with those of external capital providers. Consistent with these predictions we find that ICOs with more disclosure are more likely to successfully raise capital when they disclose information on insiders’ token vesting or have longer vesting periods for insiders’ tokens.

Second, we examine scrutiny from information intermediaries, such as ICO analysts and rating platforms that have emerged in the absence of formal institutions. ICO analysts are experts in the ICO market (i.e., crypto-experts) who voluntarily contribute their ratings of the overall prospects of ICOs to rating platforms. In some respects, these ICO analyst are similar to equity research analysts, while the rating platforms serve a marketing role similar to underwriters. We argue that these market-based information intermediaries could help investors by facilitating their due diligence and scrutiny of the ICO. We use data from a leading rating platform call ICObench that combines ICO analyst ratings with an algorithm-based rating to create an overall rating for each ICO it covers. To first validate that ICO analysts and rating platforms use voluntary disclosures and can gauge ICO quality, we document that voluntary disclosure is a significant determinant of ratings and that ratings are positively (negatively) associated with post-ICO returns (long-term failure). We then examine their moderating role for the association between voluntary disclosure and capital raising success. Our analysis reveals that: (i) in the absence of information intermediaries, voluntary disclosures play a less prominent role in explaining capital raising success; (ii) ventures that provide little to no disclosure are significantly less likely to raise funds when rated, relative to unrated ventures; and (iii) voluntary disclosure is more strongly associated with the ability to raise funds when the ICO venture is subject to external scrutiny from information intermediaries.

Taken together, our findings suggest that scrutiny from information intermediaries serves a third-party certification role that increases the credibility of ventures’ voluntary disclosures. That is, voluntary disclosure is more important to investors when the ICO is rated by crypto-experts and rating platforms.

Overall, our study finds that, even in the absence of formal securities regulation, preexisting institutions, or audit mandates, other market-based mechanisms (e.g., voluntary disclosure norms and information intermediaries) can evolve to lend credibility to unverifiable voluntary disclosures and help investors separate the good from the bad and the downright ugly. This evidence should be of interest to regulators, academics, and market participants as the crypto-tokens market continues to grow and attract traditional institutions (e.g., banks, audit firms, etc.) and also informs the current debate surrounding potential regulation of the crypto market.


[1] Crypto-tokens are distinct from crypto-currencies such as Bitcoin and Ethereum, which primarily serve as a medium of exchange like fiat currencies.

This post comes to us from professors Thomas Bourveau at Columbia Business School, Atif Ellahie at the University of Utah, and Emmanuel T. De George and Daniele Macciocchi at the University of Miami. It is based on their recent paper, “The Role of Disclosure and Information Intermediaries in an Unregulated Capital Market: Evidence from Initial Coin Offerings” published in the Journal of Accounting Research and available here.