Cryptocurrencies & Initial Coin Offerings: Are they Scams?

An interview with Daniel Liebau

The volume of Initial Coin Offerings (ICOs) had risen steeply with an all-time high market capitalisation of close to 1 trillion USD in December 2017. Since then the digital asset market has slumped, retreating to approximately 200 billion USD by mid-2018. Stakeholders of the crypto industry have pondered the reasons for this retrenchment and are increasingly focusing on the notion that many ICOs could be scams. A recent industry study even went as far to claim that 80% of all ICOs are indeed scams. In this paper, we investigate the question whether these scams are as common as claimed. We do so by first defining what a scam is and secondly, by drawing on empirical data to assess the number of cases fitting such a definition. Building on Principal Agent Theory and based on the statistical analysis of our empirical data set we attempt to establish the current state of affairs with regards to scams in the crypto-currency world. The results of our study divert from salient beliefs.

Pedro Gete: Initial Coin Offerings (ICOs) and Blockchain have both been hot topics in the financial media. Daniel, you have recently concluded a research project in the space, what is it about?

Daniel Liebau: Thanks for the opportunity to share my research, joint work with my friend and co-author Patrick Schueffel, Professor at HEG Fribourg. Primarily, we wanted to investigate empirically if claims like the one by Nouriel Roubini (“Crypto is the mother of all scams”) can be substantiated. What we found is that this topic is not very well understood and there is loads of opportunity to investigate this further.

Pedro Gete: I understand. So when can a Blockchain based project be called a scam?

Daniel Liebau: We argue that poor economic performance cannot automatically be equated with a scam. It is highly questionable that high failure rates are distinctive to the novel phenomenon of the ICO. Probably a more differentiated view on ICOs and potential scams is necessary. If we

consult the Oxford dictionary a scam is defined as a dishonest scheme; a fraud. A fraud is an unlawful act as it “consists of deceitful practice, resorted to with intent to deprive another of his right…” – intent seems to be the key word here.

Pedro Gete: I see. So how did you go about researching this topic?

Daniel Liebau: A few words on the sample we looked at: it consists of the 2016 cohort of ICOs that started and concluded that year. Each ICO also had to be a public sale – otherwise, we would not have been able to find data on it. So we identified 45 of them. We then ran a search for keywords such as “scam”, “fraud”, “sham”, “deceit”, “con” and “hoax” on LexisNexis, the most

comprehensive historical news database. For any project that got flagged up, we investigated further if there was a court case or any legal proceedings. If there were, we looked even further to understand what the verdict was.

Pedro Gete: Interesting. So what are the results?

Daniel Liebau: The results are fascinating. Far less than the alleged ca. 80% of ICOs are scams in the legal sense of the word. Three were flagged up in our LexisNexis search, two were subject to legal proceedings, but only one (or 2.2%) was found guilty (Bitconnect). Even if we assume the worst-case scenario that twenty-two projects (49%) for which we were not able to obtain

data on the issuing price and/or the current price all turned out to be scams, we would see fundamentally different results from those established previously. Also if one looks at it from a capital allocation perspective, an equally weighted portfolio of all 2016 ICOs would have allocated only 9.3% of the capital to the 22 projects with incomplete data. In summary: ICO investing is an experimental and high-risk activity; and our findings give a more nuanced view of the ICO scam situation.

Pedro Gete: Thanks for sharing Daniel. What are some of the limitations of your research?

Daniel Liebau: Sure – there are quite a few actually. We only looked at the 2016 cohort of ICOs. The low hanging fruit is, of course, to look at 2017 and 2018 data and establish if the percentages change over time. We also looked at historical data only. We recommend to fellow researchers to perhaps work on theoretical research contributing to a ‘Crypto Scam Probability Index’ or CSPI that helps investors identify scams ex-ante.

Pedro Gete: Finally Daniel, what other research topics do you find exciting in the context of Blockchain and Financial Markets?

Daniel Liebau: I do not even know where to start or stop on this. There is a lot of work to do. Investigating the exact consequences for Financial Services companies that want to interact with the Blockchain ecosystem (think KYC and AML) is one large area of opportunity. Similarly, the preservation of privacy in the context of markets is another one. Security Tokens, a digital representation of a security on the Blockchain, and the effects on transaction cost and transparency are exciting beyond small efficiency gains that traditional bankers often think about.

Pedro Gete: Thank you, Daniel, for the interview today. We look forward to more insights in the future.

Daniel Liebau: It was my pleasure to have this chat with you today. See you soon.

Should you want to read more about this topic you can find the full thesis of “Cryptocurrencies & Initial Coin Offerings: Are they Scams? – An Empirical Study” HERE .