Developments in Entrepreneurial Finance. Determinants of Success of ICO Funding Campaigns


Bachelor Thesis, 2020

64 Pages, Grade: 1


Excerpt


Table of contents

1. Introduction

2. Blockchain, cryptocurrencies and Initial Coin Offerings (ICOs)
2.1 Blockchain
2.2 Cryptocurrencies
2.3 Initial Coin Offerings (ICOs)

3. Literature review

4. Methodology and research hypotheses
4.1 Methodology
4.2 Research hypotheses

5. Empirical analysis
5.1 Dataset and descriptive statistics
5.2 Determinants of success

6. Limitations and future research

7. Conclusions

References

Appendix

1. Introduction

An Initial Coin Offering (ICO) or first token sale is the first sale of a new virtual coin or token based on the blockchain technology with the goal of financing a start-up business, blockchain related project or general business venture. Investors, which are usually called contributors in terms of ICOs, can be either categorised as retail (“crowd”) or institutional contributors, which exchange, depending on the campaign, either fiat money or cryptocurrencies and receive a new virtual token instead. ICOs share common features with Initial Public Offerings (IPOs), crowdfunding and Venture Capital (VC) although they differ in certain aspects from all those other financing sources (Dell'Erba, 2017). ICOs, as a new way of financing, were enabled by advances in information technology (IT), since this financing mechanism is completely automated and taken care by a blockchain (Chanson, Wortmann & Risius, 2018). Token sales are therefore not only of interest for the academic disciplines of finance, but also for computer science or information systems. Moreover, ICOs are not only an arguably new topic for the scientific community but also for practitioners, as the first initial token sale was held in July 2013 by Mastercoin, which was later renamed to Omni. This first funding campaign was related to the creation of a new cryptocurrency (called MSC) as well as to a platform. During the public phase of the token sale, a total of approximately 2.3 million USD at the time was raised (Benedetti & Kostovetsky, 2018).

Over the last couple of years, the environment and options young and innovative companies have regarding attracting new capital have changed, which was, to a certain degree, due to advances in technology. While business angels and venture capitalists were the traditional players helping to raise capital for young, innovative companies, new players and options have increasingly emerged like crowdfunding platforms, Initial Coin Offerings, start-up accelerators, business incubators and family offices (Block et al., 2018). Technologies like the internet and blockchain in particular have created a way to receive funds from a large pool of investors. ICOs, as one such example, allow businesses to receive funding from a potentially big group of retail or institutional contributors and are partly responsible for the disintermediation of the financial sector, where mediators' main task can be summarised as to create trust and consent between contracting parties. The popularity of ICOs significantly increased in the year 2017 (PwC, 2018) and has since then helped many start-ups and business ventures to finance their undertakings.

The aim of this paper is to identify the determinants of success of ICO funding campaigns. Success is measured bythe three proxy metrics funding, listing and survival success. Reaching the funding target and being able to retain the raised capital is considered by funding success. Listing success is understood as becoming listed on a cryptocurrency exchange online for trading after the ICO has concluded. Survival success, on the other hand, is defined as being traded on an exchange atthe beginning of July 2020, independent of the exact date of becoming initially listed, but considering a minimum time duration of one year after the ICO. This accounts for success of the business venture and token over a longer time frame. This is also why our ICO sample does not entail any ICOs after June 2019 and means that ICOs have to be traded at least one year after the ICO has ended, to satisfy this last success criterion. Post-ICO performance is thus measured by listing and survival success. By conducting an empirical analysis ofa dataset containing information of 260 ICOs which took place between October 2017 and June 2019, a logit regression model is applied. The results should add tothe already existing and constantly growing but still only sparse literature and research about what makes ICOs successful. The findings should point out which characteristics of ICOs are crucial for achieving success and are highly relevant for businesses, managers and start-ups, wishing to make use of initial token sales for funding purposes. After a thorough literature review about success determinants in ICOs, new hypotheses are formulated. The empirical analysis should then add value to the already existing knowledge on the subject by creating new insights.

In summary, we find evidence for the existence of a white paper and the number of expert ratings for an ICO being positively correlated with funding success. A sub­sample regression considering only ICOs from the year 2018 additionally sheds light on the positive effect of an at least partially available source code online on funding success. Both post-ICO performance metrics, measured as listing and survival success, are positively affected by the number of team members working on the project and are negatively correlated with the ICO duration in days. Positive expert ratings too seem to be reliable signals for all our success metrics. The findings also point out how certain factors have a different influence on funding and post-ICO performance.

The thesis is further divided into the following different sections. In Section 2 concepts and theory behind the blockchain technology, cryptocurrencies as well as ICOs are covered in order to provide a foundational understanding of these topics and for the further factors of success in ICO campaigns. Some selected basic technical details behind the technologies are also touched. The literature review in Section 3 presents an overview of already existing papers and studies conducted to identify the factors influencing ICOs and their outcomes. Studies included here are of empirical nature. The next section, Section 4, provides insights into the methodology used to obtain and process the relevant data as well asfor the empirical analysis. It also includes the formulation of the research hypotheses. Section 5 is about the actual empirical analysis and first deals with the dataset itself and its descriptive statistics, followed by the regression analysis and its discussion of the results. Limitations and future research are outlined in Section 6.The final section, Section 7, concludes the paper and its findings.

2. Blockchain, cryptocurrencies and Initial Coin Offerings (ICOs)

Before existing research about the determinants of success of ICOs is discussed, it is important to be acquainted with the underlying concepts, theories and technologies that enable the use of ICOs.

2.1 Blockchain

In 2008 an unknown author or group of authors under the name Satoshi Nakamoto published the original white paper named “Bitcoin: A Peer-to-Peer Electronic Cash System” (Nakamoto, 2008) and with it proposed the blockchain technology with the intention of using it as a public transaction ledger for the first decentralised cryptocurrency Bitcoin. The basis for cryptocurrencies and ICOs in general is the blockchain technology. A blockchain is, in its core, a database, that is distributed over a network of computers, containing records of growing digital events. Every computer in the network is called a node. Each of these records is a block and many blocks together represent the blockchain. As a copy of the database is shared across all nodes, the network has to constantly check the validity of all the copies and check whether they are the same across different nodes (ZTle & Strazdina, 2018). In many ways the technology has similarities with distributed databases, which are for example used by companies for their day-to-day business tasks.

The central idea behind the blockchain technology is the absence of a central administrator or authority and the direct creation of trust between the contracting parties, which ensure transparency by making use of this distributed ledger technology (DLT). The information is, in other words, not centrally stored but rather distributed with each node in the system processing and verifying every item. The nodes are connected with each other storing, sending and preserving data. Throughthis process the individual nodes create a consensus of all the information or transactions that have happened in the past (Cong & He, 2018). In case the transaction history of a certain node differs from others, the records are markedas wrong and are replaced with a copy of the correcttransaction history.For the same reason, in order for a user to effectively falsify or damage the system of a cryptocurrency, he would need control over the majority of the nodes in the network (Islam et al., 2018), which would be an undertaking regarded as theoretically possible but computationally too expensive to be performed.

The different steps necessary to create a blockchain can be described as follows, where the three basic parts of the technology are records, blocks and the blockchainitself. Initially, a trade or transaction is made and recorded. The record includes the details about the transaction and a digital signature from each of the trading partners. In the second step, the nodesin the network check and verify the record with all its details. Given validity, the record is added to a block, where each block entails a hash code. However, a block does not only contain its own hash but also possesses the hash code of the preceding block. In the last step of how a blockchain works, the block is ultimately connected to the preceding block via their hash codes, resulting in a chain of blocks. The sum of connected blocks, which by themselves represent different records, then forms the blockchain (Murray, 2018).1 New records that have been added to the blockchain are difficult to change due to hashing. A hash is essentially a transformation of an initial input of data or a string. The hash function is responsible for the encryption of the original string. What makes hashing such a save technology from hacking, is the fact that hash functions are designed to work only in one direction, taking a string as input and creating a unique string as their output. It is therefore computationally impossible to know or get the value of the original input by decrypting the hash value back. Moreover, only a slight change of the input data creates a completely new hash value. Examples of prominent hash functions or families of hash functions are the Secure Hash Algorithm 1 (SHA-1), the RACE Integrity Primitives Evaluation Message Digest (RIPEMD) or SHA-3, among many others. Different hash functions have different properties and produce different hash values as output, which make some hash functions safer and more appropriate for certain tasks than others (Di Pierro, 2017). The SHA256 hash function is for example used by the prominent cryptocurrency Bitcoin.

Besides uses of blockchain for cryptocurrencies like Bitcoin, which was the original intent of Satoshi Nakamoto (2008), and the possibility of initial token sales, the technology has the potential for a number of different use cases, which have over time become more numerous. For this reason, the blockchain technology enjoys an enormous interest for use in business applications and has many start-ups, academics and other interest groups working on it. Blockchain is often considered to be a disruptive technology with the potential to transform many of the traditional businesses and processes, like in the banking and insurance industry or healthcare. Use cases of blockchain and cryptocurrencies are categorised by ZTle and Strazdina (2018) as data management, data verification, financial and other. Specific examples, where the blockchain technology is already applied in companies and other organisations, include cloud storage, contract management, work history verification, trade finance, crowdfunding, as well as gaming and voting related uses. Another application of blockchain are smart contracts, which can be deployed in a variety of uses. A smart contract is a self-executing digital contract, that exists between two or more contracting parties. The terms of the contract are directly embedded in the code, making sure the contract is digitally verified and enforced in the supposed manner. Here again, no third party is needed for any reason, as smart contracts are based on a decentralised consensus mechanism. Forthis reason, within the realm of smart contracts, no central authority responsible for creating consensus and thus holding an unequally big share of bargaining or monopoly power exists, but rather only algorithms, ensuring the appropriate execution of the contract (Cong & He, 2018). Initial token sales are one example for such smart contracts.

2.2 Cryptocurrencies

Since its first proposal by Nakamoto (2008), and its subsequent realisation in 2009, the first cryptocurrency Bitcoin has gained a lot of attention from different interest groups like businesses, investors, regulatory agencies and the media. A cryptocurrency is a virtually or digitally existing and decentralised currency that can be used as a medium of exchange (Corbet et al., 2018). Cryptocurrencies are based on the blockchain technology, meaningthey rely on a distributed ledger and cryptography to holdrecords of individual token ownership and to create new coins. While in certain ways similar to fiat money, one of its main differences is the absence of a central authority, like a central bank or government, behind a cryptocurrency. Cryptocurrencies enable cashless and therefore completely intangible financial transactions as well as anonymous transactions. Additionally, the increasing popularity of cryptocurrencies can be explained by low transaction costs and its design as a direct peer-to-peer system. On the other hand, cryptocurrencies are prone to high volatility, which also gives them a highly speculative characterasinvestments (Corbet et al., 2018).Cryptocurrencies, just like fiat currencies, have their own unique characteristics and bring certain pros and cons with them. Due to those unique characteristics, cryptocurrencies have attracted the interest of many companies and were also responsible for the creation of many new FinTech companies, which refer to businesses using novel technologies for their financial services by combining the words “Finance” and “Technology”. Despite all their potential, cryptocurrencies have repeatedly come under scrutiny of governments and the media alike, especially for possible uses of financing terrorism, money laundering and trading of illegal goods and services (Islam et al., 2018), which are sometimes also connected to possible illegal activities in the deep webor simplyscams.

The different ways to obtaina coinfrom a cryptocurrency is by buying itwith the help of exchanging fiat money or another cryptocurrency, or through a special process called mining. Ownedcoins arethenstored in a digital wallet, which can be either online or on some kind of (external) hardware device. Cryptocurrency mining is defined as the process of verifying a transaction and adding it to the distributed ledger,where it is permanently stored. This is done by computationally solving highly complex mathematical problems. As a reward for successful mining, the first miner solving the cryptographic puzzle receives a small amount of coins. This would, on the other hand, mean that the miner provided with the highest computational resources is likely to solve the puzzles first and get the reward. However, the mining process is designed in a way to make it increasingly harder for the same miner to verify and add additional transactions to prevent power imbalances in the system. No single miner should be able to gain control over the majority of the network by repeatedlyverifying new transactions and adding them to the blockchain (Eyal & Sirer, 2014). Incentivisation and a proper design of the rules in the network are therefore crucial to allow for a smoothly running cryptocurrency system that remains decentralised without a single authority or overly powerful users. In order to be able to mine, the cryptocurrency miner requires, besides electricity and internet connection, special computer hardware (Stroud, n.d.).2

According to the website CoinMarketCap (n.d.), which provides general information about cryptocurrencies, there exist just over 5.600 different cryptocurrencies as of end of June 2020 with some of the most prominent cryptocurrencies, based on overall market capitalisation, being Bitcoin, Ethereum3 (which is the most prominent choice of cryptocurrency or platform for ICOs), Tether and XRP.4 New cryptocurrencies emerge almost daily and are increasingly accepted as a method of payment also by large companies, although often only on a regional basis. Examples for such companies and organisations include Wikipedia, Burger King, Microsoft, Amazon, Starbucks, PayPal and Shopify (ICOholder, n.d.).5

Especially since the financial crisis in 2008, caused by the deregulation of the financial industry, and as a result banks giving out more mortgages and trading with derivates, the financial industry was subject to big changes not only in technological advancement and progress but also in regulatory matters. Arner, Barbaris and Buckley (2016) point out how the rapidly changing landscape of finance and the financial system as a whole poses a huge challenge for policy makers. They also propose a new approach for regulators that moves away from the traditional and partly obsolete policies and towards an approach “that sits at the nexus between data, digital identity and regulation” (Arner et al., 2016, p. 2). New regulatory requirements have to take into account the novelty and distinctive featuresof emerging financial solutions and have to find the right trade-off between protecting investors' interests and allowing growth of the sector and economy.

2.3 Initial Coin Offerings (ICOs)

Following the advent of cryptocurrencies also arose the idea of using the technology as a mean of funding in the formof token sales. Companies optingfor an initial token saleto obtain funding for the further development and realisation of their products and services, rely on a token asthe main partof their business idea and future success factor(Fisch, 2019).

According to Dell'Erba (2017), although ICOs are a fairly new phenomenon and while their individual structure might substantially differ from one another, an apparently similar pattern in the ICO process can be seen. In a first step, announcements about an intentional ICO are made online on dedicated forums and social media platforms. The comments of the internet community help with drafting the so-called white paper, which is a document including detailed information about the product, token, time durations, developer team and other features of the ICO and business venture. However, such a white paper is not subject toany regulationsor authorities. A white paper is therefore theoretically no necessity and the subsequent quality and comprehensiveness can vastly differ between ICOs(Dell'Erba, 2017).Preceding the public phase of an ICO,a presale can be conducted, which is a special offer either made to selected investors or the general crowd. This presale helps the team to get a taste of the market demand and might also increase public awareness of the business venture. During this preliminary stage,tokens are usually sold with a special bonus scheme or discount attached to them (Jong, Rosenboom & van der Kolk, 2018). A presale can be structured as a private presale, where only selected investors get the opportunity to receive tokens in advance, or as a general public presale. During the pre-ICO phase, some business ventures also decide to undertake a so-called airdrop initiative, where either randomly or based on some criteria tokensget distributed free of charge between participants. An airdrop can be seen as a marketing initiative to increase ICOawarenessand create a certain momentum.Finally, the last stage of an ICO is the public phase, where tokens are available to be bought by the general crowd of contributors. Some ICOs also require interested contributors to register in advance to be able to participate in the token sale. This practise of listing the contributors is called a whitelist. After the fundraising round has concludedandin case the ICO unsuccessfully reached the soft capor has had other issues that caused it to fail, the capital is generally refunded to the contributors, although not always (Adhami, Giudici & Martinazzi, 2018). Ex-post, tokens can be traded on a secondary market, which are liquid trading platforms and give contributors the opportunity to exit the investment quickly (Howell, Niessner & Yermack, 2018). Once listed on an exchange, tokens can be traded and exchanged for other cryptocurrencies or fiat money.

For the public phase of an ICO a certain time frame, the price for the tokens, the number of tokens available as well as a soft cap and a hard cap can be specified (Myalo & Glukhov, 2019). In case of a capped ICO, the soft cap is the minimum amount that has to be raised, while the hard cap is the maximum amount that can be raised and subsequently used by the business venture. As ICOs are fundamentally smart contracts, the raised funds are only payed to the project in case all terms of the predefined contract are fulfilled (e.g. the soft cap is reached; Chanson et al., 2018). Figure 1 in the appendix shows how the blockchain technology acts as the platform for an ICO.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1 about here

ICO tokens take one of three forms, which are not necessarily exclusive. Firstly, they can take the form ofutility tokens, which offer contributors access to the start­up's or campaign's products and services. They are the most common type. Secondly, the coins can be security or asset tokens, which share characteristics with other financial securities or shares of a business by generally offering part of the company's future profits. Lastly, an ICO can involve the issuance of so-called payment tokens, which can in turn be used as a currency for payments and for currency exchanges (Burns & Moro, 2018). However, it should be noted that no binding classification of those types of tokens existsin the legal sense.Depending on the type of token issued by an ICO, investors' motives and incentives to financially contribute canbe of different nature too.

Moreover, initial token sales have common features with crowdfunding campaigns, IPOs as well as VC. Since ICOs raise capital from a crowd of contributors, they share similarities with crowdfunding campaigns. Crowdfunding contributions can sometimes be interpreted as only voluntary donations to a business venture, although rewards, like getting access to a product, are possible as well. With an ICO, on the other hand, rather comes an inherent interest in a company, which might be of a financial nature. Ownership of a token, which gives investors access to services, the right to vote or the right to profit are examples for rewards, when contributing to a business venture via a token sale. Contributors' rewards, for this reason, differ between ICOs and crowdfunding campaigns. At the same time, initial token sales differ from IPOs since a purchase of tokens normally does not result in ownership rights (Dell'Erba 2017). Compared to the venture capital funding process, ICO funding differs in many aspects as well. The venture capital firm, for example, plays the role of the financial mediator between business venture and investors. A token sale, contrariwise, is characterised by the absence of such a mediator. The biggest commonality between VC and ICOs is arguably that both forms of financing are targeting new business ventures and start-ups.

As of mid-2020, there exists no single platform that tracks all ICOs, which makes it more difficult to keep an overview of the occasionally chaotic ICO market. However, there exist various websites dedicated to tracking ICOs. Most of them depend on users to enter information about such token sales, which is mostly done by the business venture itself (Fisch, 2019). Manually entering information into a database has its potential drawbacks and can be prone to error. Missing values and typing errors while entering information are all possible concerns. The most common problem for listings on these data aggregators is incomplete information. Some of the most well-known, comprehensible and reliable websites about ICOs include ICObench; CoinMarketCap (which focuses on cryptocurrencies rather than solely on ICOs), TopICOList; TokenMarket; ICOCountdown; ICODrops; ICORating and Smith & Crown.6 Some of these data aggregators also have their own Know Your Customerprocess (KYC)implemented, verifying not only the identify of ICO team members and advisors but also of experts publishing their opinions on the websites.

An empirical study conducted by Huang, Meoli and Vismara (2019) reveals that ICOs are more frequently held in countries with a strong and advanced financial system, public equity markets, digital technology landscape and high human capital skills. At the same time, more ICOs are held in countries with a friendlier ICO-related regulatory framework. The two countries with both the highest number ofICOs and highest raised funds are, according to ICObench(n.d.), the US and Singapore. Following top countries for the highest number of ICOsare then the UK, Russia and Estonia, subsequently.7 While regulatory adaptations to the novel funding mechanism are only slow, certain countries, like China and South Korea, banned ICOs, at least for a limited time, altogether. Regulatory responses vary between countries and legislations have often taken a “do no harm” approach, which states thatcountries consciously chose to notregulate new technologies to not hinder its possible advancement of and change in society (CFTC, 2016). Regardless, there is also a high risk for ICOs to be of fraudulent practise (Cohan, 2017), which has led to mistrust and in many cases even genuine ICOcampaigns to be scrutinised, labelled as scams and fail. Regulations of ICOs are insofar needed as to find an appropriate trade-off between the interests of investors, entrepreneurs, as well as future users of the project-related services and products. Regulators have to prevent fraudulent ICOs from taking contributors' money and must protect investors from potential losses due to such scams (Zhang et al., 2019).

3. Literature review

Because the topic of ICOs is a fairly new matter, empirical research and other scientific papers about them are still rather sparse.

[...]


1 See http://graphics.reuters.com/TECHNOLOGY- BLOCKCHAIN/010070P11GN/index.html#:~:text=A%20blockchain%20is%20a%20database,is%20 very%20difficult%20to%20change.&text=The%20records%20that%20the%20network,previous%20 block%20in%20the%20chain. for a more complete explanation of how blockchain works, including visualisations.

2 For more information on the mining process, see https://www.webopedia.com/TERM/C/cryptocurrency- mining.html#:~:text=Cryptocurrency%20mining%2C%20or%20cryptomining%2C%20is,to%20the% 20blockchain%20digital%20ledger.

3 The terms Ether and Ethereum are often, but not completely correctly, used interchangeably. For further reading on the difference, see https://currency.com/ether-and-ethereum-what-is-the difference#:~:text=Ether%20and%20Ethereum%20are%20often%20used%20interchangeably.&tex t=This%20is%20the%20fuel%20that,power%20to%20make%20things%20happen.

4 See the website https://www.coinmarketcap.com/all/views/all/, which contains an up to date and filterable list and ranking of all currently existing cryptocurrencies.

5 For the full list containing further companies accepting cryptocurrencies for their products and services, visit https://www.icoholder.com/blog/places-accept-bitcoin/

6 Links to the websites are https://icobench.com/, https://coinmarketcap.com/, https://topicolist.com/, https://tokenmarket.net/, http://www.icocountdown.com/, https://icodrops.com/, https://icorating.com/ and https://sci.smithandcrown.com/ico-tracker.

7 See https://icobench.com/stats, which considers their own listed ICOs for these rankings.

Excerpt out of 64 pages

Details

Title
Developments in Entrepreneurial Finance. Determinants of Success of ICO Funding Campaigns
College
Vienna University of Economics and Business
Grade
1
Author
Year
2020
Pages
64
Catalog Number
V1191497
ISBN (eBook)
9783346641441
ISBN (Book)
9783346641458
Language
English
Keywords
developments, entrepreneurial, finance, determinants, success, funding, campaigns
Quote paper
Alexander Staffel (Author), 2020, Developments in Entrepreneurial Finance. Determinants of Success of ICO Funding Campaigns, Munich, GRIN Verlag, https://www.grin.com/document/1191497

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