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Bitcoin ICOs Return 790% In 6 Months?

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Includes: BITCF, BTC-USD, BTSC, COIN, GBTC
by: Lynn Sebastian Purcell
Lynn Sebastian Purcell
Value, contrarian, portfolio strategy, cryptocurrencies
Summary

Existing data suggests you could have “thrown darts” at a list of ICOs and achieved an average return of 790% under six months.

The craze exists because of incredibly high rates of return coupled with low regulation, and will end with legal regulations (not some sort of valuation collapse).

This is a case study: even if you never plan to buy ICOs, knowing how they work is important to understanding the broader network that Bitcoin and Ethereum support.

There is currently an Initial Coin Offering (ICO) craze. So far, they've raised more in 2017 than traditional venture capital offerings, and more than $2.3 billion total.

When I first started investigating ICOs, I planned to write: "ICOs are the penny stocks of the Bitcoin world!" In short, avoid these scams at all costs! Then I checked the available data on these ICOs (all which was reliable), and the average return for all ICOs was 790%, which occurred in just under six months! One could throw darts at board filled of ICO names, and make incredible of money. This made me reconsider (a bit).

I've been an investor for some time, so I don't believe in "free lunches." Yet, I don't think that's what's happening here, exactly. If you read through Warren Buffett's account of how he and Charlie Munger made their first "couple of hundred million," they did it by using Benjamin Graham's methods-including his way of assessing the discount to net current asset value per share of a stock. Almost nothing passes Graham's test anymore, but it worked for a time. Something similar seems to have happened with IPO flipping back in the 1990s (back when you had to actually call your broker...). Anyway, my point is that markets occasionally allow really spectacular returns in an area for a short time, and then close them by valuation changes or the introduction of regulations. I think that's what's happening with ICOs.

My sense is that the ICO craze will end when the SEC (or similar regulatory bodies globally) gets around to regulating these projects better. DAO, a crypto currency that the SEC struck down for failing to register as a security, was only the most audacious case. At least a dozen ICOs either in progress or coming into market right now are obvious securities, and so ought to be subject to SEC regulation. When the SEC (or CFTC) finally begins enforcing its standards, this craze will end.

In the meantime, we can treat the ICO data as a case study. Even if you never plan to invest in ICOs (and I still haven't), understanding how this facet of the cryptocurrency world operates is critical to understanding how the broader network for Bitcoin and Ether works. We'll start with the basics.

What is an ICO?

An Initial Coin Offering (ICO) is like a stock's Initial Public Offering (IPO), as it is the first chance for a prospective investor to buy a coin before it goes to the general market. But it is also like the initial rounds of venture capital fund raising, since the money from the purchase of the coin (by the investors) goes to the developers of the project.

Sia coin illustrates the basic idea well (and note: I own no Sia coin). The Sia project aims to produce a distributed block-chain network for cloud memory storage. Their competitors thus include Amazon, Google and Microsoft. Yet, because Sia uses blockchain technology, they can deliver the same product, with better reliability (blockchains are nearly impossible to hack) at a fraction of the cost. Here's a chart for the price of 5TB of storage.

Provider

Monthly Storage Cost

Download Cost

Sia

$10

$5

Amazon S3

$115

$460

Google Cloud

$100

$550

Microsoft Azure

$120

$435

The ICO for Sia coin, then, was to give the development team enough money to build the technology and implement it. After the ICO closed, they used the money raised to fund their project. The investors effectively bought the "gas" of the blockchain technology. The coin powers the cloud memory storage network (I'm simplifying a little), and users of the network will have to buy the gas every time they use it. The users thus bid up the price of the coin, and making money for the initial buyers of the coin. In short, if the technology gains broader adoption, the ICO buyers stand to make hundreds-fold returns (and the data shows that they do).

How is This Related to Bitcoin (or Ether)?

Suppose that you want to participate in an ICO, then you'll need to buy either Bitcoin or Ether. The reason is that most ICOs fund-raise using these two coins, as they are the most reliable and the most people have access to them. Then you send money in the form of Bitcoin or Ether to the appropriate ICO wallet (they tell you where on their webpage during the ICO time-frame), and after the ICO closes, the development team deposits the new coin in your wallet.

One should note additionally that almost all new coins, about 98.5%, are made using the Ethereum network, powered by Ether. In short, if Sia succeeds, then Ether's network will get a boost because it runs on it. This is why I previously wrote that Ether is well positioned for the growth of the cryptocurrency world in a way that Bitcoin is not (making Ether a better buy).

The Legalities

The tricky legalities enter when one considers the type of coin offered. The Sia coin is a real coin, since it powers a blockchain network. This is why the SEC has looked at this product as a sort of commodity, and of course any derivatives traded on it should be regulated by the CFTC. One difference from share ownership, then, is that the Sia coin gives the owners no claim to the underlying assets of the company. Investors are able to share in the upside profits in a remarkable way, but they do not have the regular downside protection one finds in traditional venture capital offerings. I think the reason most have continued to invest in these projects is thus because the downside protection usually offered to venture capitalists is minimal anyway.

Yet not all coins are real coins. This is to say, not all are technological items that power a blockchain. The BitDice "coin," for example, is effectively a security which pays dividends. There is no blockchain technology. What the "coin" represents is a right to a share of the proceeds of the company's earnings on a quarterly basis (I gather), but with no claim to the underlying assets of the company. It is easy to understand why the owners of BitDice would like this arrangement, but it is unclear to me why investors would like it. They seem to be profiting at the expense of investors misunderstanding of the technology.

It is cases like BitDice, then, that really should be regulated by the SEC. Only a few of the existing coin offerings are truly blockchain technologies, which require a real coin to make the technology run. When regulations are more strictly enforced (it is quite possible to track funds using Bitcoin), then I think these sorts of "coins" will disappear, and much of the craze will end.

All that having been noted (so please do your homework, and don't buy fake coins), let's look at the returns produced by indiscriminately buying every major coin offered over the last 18 months (a few coins have longer time-frames, but quite few).

The Data

What I did was collect all the ICOs tracked on cryptocompare.com. The site presents the most complete set, available in one place, for major (well-published) ICOs. I could add further data to the list (using the coins currently available on coinmarketcap.com for example), but that would only further bias the numbers, as I would only be adding successful companies (they would only be listed on coinmarketcap.com if they continued in existence). Finally, I assumed that an investor only had access to the price of these ICOs on the first day of public trading. Actual ICO investors likely had a buy-in price as a significant discount to the one recorded.

In preparing the data, I also threw out any cases where the percent return was not clear from existing data, or where the ICO was a special case-for example Ether (which has had about 100k% return since 2015). This meant especially that I threw out all ICOs that returned more than 10,000%, because I figure that's the sort of luck that will skew numbers rather significantly. These decisions make the resulting analysis more conservative in nature, which I think is preferable. My resulting N was only 146, but that's a little more than 1/8th the market, and it included quite a few old and young ICOs.

Here's what I got back:

Average % Return

790.52%

Median % Return

140.15%

Average Time

163

Median Time

60

% Winners

61%

I tinkered with the numbers, doubling the number of losses for example, but it just doesn't change the fundamental picture: ICOs make enormous amounts of money over very short periods of time. If you had been investing in them randomly over the past year, say putting $500 in a new ICO each month, then you probably made a nice return on your investment.

The wide variance between average and median returns suggests that there is enormous dispersion among results. So, clearly, not all investments are created equal. Also, the losses tend to be 50%+, meaning that there are a few really terrible cryptocurrency companies out there. I wanted to visualize that data. Here's the result in three histograms, each increasingly zooming in on the largest cluster of returns (bins are at 25% intervals).

Total Frequency Distribution[Source: My Own Chart]

One sees from this chart that ICO returns have a "long tail," which is to say that the return rates are not only a power curve, but that the "tail" of the curve diminishes quite slowly. There tend to be just as many 5000%+ returning coins as 1000%-2000% returning coins. What follows is a closer "zoom" of the data to highlight the point.

ICO Frequency Distribution[Source: My Own Chart]

As one can see, the "long tail" of the power curve is fairly evident. I provide one more chart to highlight the losing coins at the very left of the chart.
ICO Returns Chart[Source: My Own Chart]

Concluding Thoughts

One reason for this astounding return rate is that the cryptocurrency craze is likely driving up all values; a rising tide lifts all boats. I don't doubt that this has quite a bit to do with those return rates. As evidence, consider that if you had invested in Ethereum over the past 12 months (say $500 a month), you would have beaten your return rate on random ICOs (Ether, the coin for the Ethereum platform, returned nearly 2000% over the same period of time).

So, taken as a group, ICOs don't out-perform the established cryptocurrencies. This might be the single best reason to stay clear of them. Why put in all the additional work of researching a company, picking an ICO, and hoping for the best, when you could just buy Bitcoin and Ether and achieve better results? A comparative evaluation, then, suggests that ICOs are not really a special case in the cryptocurrency market. As a result, no special explanation is needed for their performance (and we can have confidence in the representativeness of my sample).

A final reason we witness these results, I think, is that some of these companies really are using a new technology (blockchain) to disrupt an existing sector by beating them on operating costs (as in the case of Sia coin). In short, there are actually some good technology companies here, and their performance is indicative of that. In fact, among the better ICOs, their return range was between 2000% and 90,000% (since 2015).

It's not clear to me that anyone should invest in ICOs, but the reasons for doing so are compelling. Even for those of us that want nothing to do with them, their existence and flaws are important for understanding how the cryptocurrency world currently works. Bitcoin and Ether have emerged as staples in this universe, and that suggests that they cannot simply be abandoned without costs. Stated otherwise, there are costs in switching from these coins to others, as the existing infrastructure for cryptocurrencies relies on these two coins in a way that it doesn't for any other coin (especially competitors for these coins). In this sense, then, the above has been a case study in the broader reliability of the Bitcoin network.

I look forward to your comments as always!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I do own Bitcoin and Ether.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.