its record ICO,Ethereumalso contributed to raising the visibility of ICOs to the general public. Ethereuminvestors doubled their investment within24hours and earned4,520xtheir investment withinthreeyears, which arguable attracted many novice participants to the market.
ICO market activity gradually increased over the next years, peaking in 2018.
Figure 2.1 shows the distribution of ICOs in our sample and demonstrates the sharp rise in market activity in 2017. An analysis by Fromberger and Haffke (2020) reports a total of3,000ICOs in 2017-18. According to their research, more than 14billion US Dollar were raised by ICOs in 2018 (Fromberger and Haffke, 2020) and the average campaign raised13million US Dollar, approximately440xmore than a conventional crowdfunding campaign in 2020 (Fundera.com, 2020). Mega ICOs during this period raised much more than theEthereum. The largest ICO in history was conducted byEOS, a development platform for decentralized Apps (so-calleddApps), which raised more than4billion US Dollar (Penke, 2018).
The ICO-boom combined with the nature of the market, i.e., risky ventures and the absence of regulation, also attracted scammers. Indeed, our data show that the median ICO has lost90%of value on crypto-exchanges. The rising investor and regulatory scrutiny led to a sharp decline in market activity at the end of 2018, as observable infigure 2.1. Today, few ventures attempt to raise capital on the blockchain (Suberg, 2018).
2.2 The ICO-process
The process at the core of an ICO is relatively simple: a venture attempting to raise capital writes asmart contractin a selected blockchain environment. Asmart contractspecifies the terms and conditions for a new crypto token to be created. For example, the contract specifies the token design, e.g., how many tokens are issued
12 Chapter 2. Context FIGURE 2.1: Distribution of ICO campaigns in the data sample
Note: Above figure shows the monthly distribution of ICO-campaigns in our data sample over the course of our observation period between September 2015 and year-end 2018. Campaigns are counted in the month of listing of the pre-ICO, if conducted, or main ICO-campaign otherwise.
and at what price. The contract is smart as the protocol automatically executes it upon triggering events. For example, all tokens are distributed to investors if, and only if a minimum amount is raised during fundraising. Otherwise, funds are returned to investors. As such,smart contractsenable anonymous transactions between unrelated parties without requiring intermediaries (e.g., banks) to pro-vide legitimization. The development of programmable open-source blockchains, most notablyEthereum, has made it surprisingly simple to programsmart contracts.
Ethereumeven offers a standard token contractERC-20, asmart contracttemplate (Rhue, 2018).
An ICO token is usually offered to the general public in a fundraising campaign, which is investable via company websites and often advertised on several ICO platforms. Ventures publish marketing material to promote their campaign. While no legally binding enclosure requirements exist, companies will often publish a so-called whitepaper, summarizing business plan and campaign design. The
2.2. The ICO-process 13 whitepaperis commonly supplemented with videos and extensive social media communication. Ventures interact with potential investors via social media plat-forms (e.g.,Telegram,bitcointalk).
ICO tokens are often listed on crypto-exchanges (e.g.,Binance), allowing investors to trade tokens, making ICOs a liquid investment. Tokens can be purchased against major cryptocurrencies such asEtherorBitcoin, sometimes also against fiat currency (legal tender issued by governments).
Marketing is commonly the main expense of an ICO. During the ICO-boom, ven-tures competed against many other ICOs. Gaining visibility and signaling quality became increasingly important. In response, many ventures hired ICO servicing companies to assist with optimal campaign design, produced high-quality market-ing content, and hired investor relation teams to keep investors engaged.
The token in ICOs, similar to different forms of crowdfunding, may serve several purposes. Although issuers may freely assign rights to a token, most tokens belong in one ofthreecategories.Utility tokensprovide access rights to a product, service, or platform. Cryptocurrenciesrepresent a storage of value used as a means of pay-ment, independent from the underlying company. Security tokensoffer some form of performance-based reward, comparable to dividends (Amsden and Schweizer, 2018). Most tokens,∼90%in our sample, areutility tokens. The reason is simple:
by offering autility token, a venture operates outside the existing regulatory frame-work, as their tokens are not regarded as an investment. Rather, they pre-sell their product. This places ventures in a comfortable position, as Isenberg (2012) argues: ventures do not have to give up equity, yet still receiverisk-freefunding, as investors have no legal claim if the venture fails. If an ICO issued asecurity token, it would be required to register with theSecurity and Exchange Commission (SEC), which increases both cost and time to market. Thus, as long as investors are willing to invest without acquiring equity, ICOing ventures seem to have little incentive to offer equity.
14 Chapter 2. Context Regulating ICOs is difficult for three reasons. First, as just described, a token technically is not an investment and is not covered by any existing regulatory framework. Second, the regulation of ICOs requires global collaboration. Third, governments struggle between protecting investors and at the same nurturing innovation. Jurisdictions around the world have adopted varying approaches to regulating ICOs. Some countries, such as China, have prohibited (unregistered) ICOs altogether. Other countries, such as Malta, have proactively developed clear regulatory frameworks, reducing uncertainty and risk for ventures and investors alike (Wöckner et al., 2018).