Initial coin offerings (ICOs) have recently emerged as a popular way to fund blockchain-related startups, raising nearly $12 billion since 2017, according to a report issued by CoinDesk. Through this new form of crowdfunding, an entrepreneur raises capital by creating and selling a virtual currency or “token,” which provides a set of rights to its holders, including access to a platform, and can be resold in the secondary market.
In such initial offerings, information asymmetry between an entrepreneur and outside investors, and the resulting adverse selection, are two inherent problems that could hinder successful fundraising. To overcome asymmetric informational problems, traditional primary market issuances, in particular initial public offerings (IPOs), are delegated to financial intermediaries that perform due diligence, determine the value and riskiness of the businesses, and price and sell the new securities. For example, IPO underwriters conduct a book building process that helps gauge investor demand and price the new equity effectively. However, in blockchain-based crowdfunding, such financial intermediation is absent by design thanks to decentralized bookkeeping enabled by blockchain networks.
In our paper, The Wisdom of Crowds and Information Cascades in FinTech: Evidence from Initial Coin Offerings, we explore what makes ICOs so successful without financial intermediation. We find that in the absence of underwriter-driven intermediation, the ICO market relies heavily on the “wisdom of crowds” – the collective action of a large group of individuals rather than that of a single expert. We show that this mechanism works in two stages: (1) a group of independent analysts certify the quality of the underlying venture before a token sale starts, and (2) a crowd of early investors attract investments by later investors during the fundraising period.
The Wisdom of Independent Analysts
For a comprehensive sample of 1,549 completed ICOs from January 2016 to March 2018, we obtain 9,493 distinct ratings by 316 unique online analysts. These independent analysts were featured by ICObench, which is one of the oldest rating platforms on ICOs and arguably maintains the most comprehensive database on ICOs. Each expert assigns a rating from 1 to 5 to an ICO for team, vision, and product. Their average (median) ratings for team, vision, and product are 3.9 (4.0), 3.8 (4), and 3.6 (4.0), respectively.
We first examine whether favorable headline ratings lead to fundraising success, an event in which an ICO reaches its minimum fundraising target, commonly referred to as the soft cap. A headline rating is a weighted average of all participants’ ratings based on their expertise, years of experience in the field, and available publications. We find that successful ICOs on average had a rating of 3.3 (out of 5) by independent experts, 0.7 points higher than that for failed token sales. Moreover, the probability of a successful fundraising campaign increases by 19.8 percentage points (relative to the success rate of 42.7%) with every one-standard-deviation increase in the average analyst rating, controlling for ICO characteristics. This result supports the positive intermediary role the independent experts play in a market without traditional underwriters.
Most of the independent experts in our sample are repeat analysts, who are likely concerned about their reputation in the long run, and therefore tend to be unbiased in issuing their ratings. Moreover, the number of experts covering a token sale also positively predicts fundraising success. Taken together, these results suggest that outside investors tend to follow a large crowd of informed analysts when making risky investment decisions.
Interestingly, more favorable ratings are associated with higher gross proceeds and a short duration of token sales. However, analyst ratings do not appear to be correlated with underpricing. Any additional demand spurred by a good rating is likely to be fully absorbed in the primary market subscription process. Another plausible reason is that unlike investment bankers, who likely have incentives to underprice IPO stocks, independent analysts do not have financial stakes in startups undergoing an ICO and do not control the pricing process.
Furthermore, we find that a good analyst rating positively predicts 3-month token returns, but it is not associated with shorter-term returns. Analyst ratings focus on team, vision and product, all of which are long-term indicators of the startup quality. This implies that analyst ratings are informative, even beyond the primary market stage, in that any biased ratings could be uncovered in the long run, resulting in a significant reputational cost.
Investor Subscriptions and the Path to ICO Success
The market-based certification by individual analysts not only screens out “lemons,” but also generates an information cascade among token investors during the token subscription period. Unlike in an IPO, each token subscription in an ICO is broadcast to all potential investors through a blockchain network. With a critical mass of supporters, the harnessed wisdom of crowds would quickly result in meeting the pre-specified funding target.
To investigate this channel, we resort to the unique primary market subscription data collected from a leading “block explorer,” a search engine that provides information on every transaction for Ethereum-based ICOs. For each token sale, we download information for all the transactions taking place between the ICO start and end dates. We obtain a transactions sample of over 650 ICOs, and aggregate each ICO transaction by daily frequency.
Our novel data set reveals that successful token sales attracted more than 2,000 backers on average, compared to the 39 supporters in failed ICOs. In successful ICOs, early investors purchase tokens more aggressively, with the first-day per capita subscription at nearly 0.5% of token supply. This highlights the important role large investors play in helping achieve fundraising success.
We find that the average rating from independent experts is a strong predictor of first-day subscriptions. A one-standard-deviation increase in the average rating is associated with a 2.3 percentage point increase in first-day tokens sold. Compared to the sample average first-day tokens sold of 3.9%, the incremental change is remarkable. This suggests that positive analyst ratings help harness initial token demand in the absence of reputable underwriters in this decentralized market.
Moreover, investor subscriptions on the first day strongly predict subsequent token sales and eventual fundraising success, inducing a “cascade” phenomenon. By establishing a direct link between such transaction-based instruments and eventual fundraising success, we provide the first sharp identification on the market-based certification mechanisms that substitute the information services by financial intermediaries.
We find that favorable ratings on the underlying project from a crowd of independent online experts generate aggressive first-day token subscriptions by large investors, which in turn triggers an information cascade that drives subsequent token sales. Analyst opinions also predict long-run token performance in the secondary market. This suggests that the wisdom of the two crowds – informed analysts who are likely to be unbiased due to reputational concerns, and token investors who tend to follow early investors – can substitute traditional underwriters’ intermediary roles in financing blockchain-related ventures.
To prevent the “insanity of crowds,” ICO analysts are required to be independent and possess a diversity of opinions. Potential backdoor networks need be further investigated to ensure unbiasedness. How to set an optimal all-or-nothing threshold to ensure fundraising success without suffering from short-run underpricing is another important mechanism design problem. We aim to address these questions in future research.
 Analysts consider a team strong and trustworthy if it keeps the community updated with project progress and/or has participated in other cryptocurrency-related projects. Vision mostly concerns what a platform aims to achieve in the mid-term and long-term future. When evaluating products, analysts consider the following aspects: (1) product maturity level – working products are easier to evaluate than concepts, (2) technology, both blockchain- and non-blockchain-related, (3) specific problems with their products/services, (4) product roadmap that shows short-term and long-term strategies and growth, and (5) projects’ commitment to understanding the market environment.
 Of these analysts, 165 are founders or senior managers from blockchain-related companies, 96 are advisors to these firms, and 73 are blockchain analysts or followers. Some analysts are also investors, with 58 being cryptocurrency/blockchain investors and 16 being venture capitalists or angel investors. Notably, there are also 52 engineers and technicians, who are potentially able to provide valuable insights into the technical aspects of ICOs. Other analysts are from fields such as finance/business (39), marketing (30), consulting (21), among others. Note that these categories are not mutually exclusive as a given analyst can play multiple roles.
 Underpricing is a phenomenon that the share price jumps on the first day of trading relative to the offer price.