Initial Coin Offerings: Disruptor or Impostor?

Initial coin offerings (ICOs) are dramatically changing how firms raise funds enabling less costly, more transparent, more accessible, and faster access to capital. By issuing tokens, ICOs offer firms an alternative means to raise funds from venture capital, crowdfunding and initial public offering (IPO). In this report, we will follow the widely accepted industry convention and include token generating events (TGE) in our definition of ICOs. However, the global ICO market (excluding cryptocurrencies) is quite volatile as evidenced by the fluctuation in market capitalization so far in 2018. For example, the global market capitalization (market cap) on January 13 was $57 billion but fell to $15 billion on August 26.

The emergence of ICOs shows great promise in improving the efficiency of markets. In some cases, ICOs are used to sell goods and services in advance and are categorized as utility tokens. Other ICOs have similarities to equity in the sense that their investors may receive dividend streams based on the revenue streams of the issuing firms. However, unlike equity holders, token owners do not have ownership interests. These types of tokens are called security tokens. The difference between utility and security tokens is intensely debated globally by ICO issuers and regulators.

Before discussing ICOs, some background regarding the infrastructure required to host ICOs would aid in understanding this asset class. While initially developed primarily as a replacement for payment instruments that use intermediaries to process online payments, Bitcoin created protocols that are being used in many different contexts. Specifically, Nakamoto, the developer of Bitcoin, solved the double-spend problem: the same bitcoin or fraction thereof cannot be used to make multiple purchases by the same buyer. The three main features of Bitcoin are: (i) digital native currency with no central authority, (ii) incentive structure to verify transactions, and (iii) immutable blockchain that makes it nearly impossible to change past transactions.

Cryptocurrencies differ from fiat currencies such as the U.S. dollar and the euro in several ways. First, they are not government-issued and do not have a physical form but reside only in digital form. Second, the most popular cryptocurrencies have their own infrastructure (e.g. Bitcoin and Ethereum), that allow for the exchange of digital assets in a decentralized ledger globally without centralized authorities. Third, in some cases such as bitcoin, there is a preset maximum number of currency units that can be created unlike fiat currencies.

Despite rapid global recognition, we still have a long way to go to classify bitcoin and other cryptocurrencies as a form of money (for more discussion, see Chakravorti, 2017). Generally, money serves as a medium of exchange, store of value and unit of account. For the most part, we will not discuss the speculative nature of cryptocurrencies that receives the lion’s share of coverage in the popular press. Some use cases for cryptocurrencies are emerging such as peer-to-peer (P2P) payments, cross-border payments, and access to electronic payments for the unbanked. Two growing specialized use cases for cryptocurrencies include payments for using decentralized computer networks and purchasing ICOs.

Using a proof of work protocol and an immutable blockchain, Bitcoin developed technology that has been repurposed and expanded. Ethereum expanded upon the benefits of the Bitcoin blockchain by integrating easy to code state-contingent, verifiable, storable, contracts for delivery of funds in exchange for goods and services in the future based on the realized state. These contracts are commonly referred to as smart contracts. In addition, Ethereum made it relatively easy to introduce dApps (decentralized applications) on their platforms. These applications enable the creation of ICOs.

Based on our research of ICOs, we offer the following conclusions. First, from a technology standpoint, cryptocurrencies along with the new infrastructure connecting computers that host dApps will enable more efficient allocation of goods and services. Second, as the infrastructure continues to develop, these platforms must be able to overcome challenges such as achieving scale in terms of faster transactions times. Third, ICOs will disrupt traditional ways to raise funds but will not eliminate other more established means to raise funds. Fourth, in our section on case studies, we conclude that the internal governance of these systems is still in its infancy and governance challenges will need to be overcome. Fifth, given the global nature of this market, coordination among regulators across countries will be necessary.

Our report is organized in the following sections. In the next section, we discuss how ICOs are disrupting funding markets. In section III, we discuss the process to issue ICOs and the necessary underlying infrastructure. In section IV, we discuss the current state of the global ICO market in terms of trends and market cap. In section V, we discuss the regulatory landscape for ICOs. In section VI, we discuss several individual ICOs to better understand challenges and opportunities of this emerging market. In sections VII and VIII, we discuss challenges going forward and offer some conclusions, respectively.