(Illustration: Sébastien Thibault)

Are cryptocurrencies—those forms of virtual money made famous by Bitcoin—for real? That was the question underlying recent research by Leonard Kostovetsky, assistant professor of finance at the Carroll School of Management. In early 2018, Kostovetsky undertook a study of the shifting (and occasionally shifty) world of initial coin offerings, or ICOs, a cryptocurrency cousin of the stock market IPO. More and more entrepreneurs have been using ICOs to raise funds for new ventures. That’s led to an avalanche of investment from speculators. Last fall, Kostovetsky and a co-author published the results of their examination of more than 4,000 ICOs. Their work was featured by MarketWatch, the BBC, Bloomberg News, the Economist, and the Wall Street Journal. So, are ICOs a game-changing disruption of the international financial system...or just a new Ponzi scheme? I visited Kostovetsky in his Fulton Hall office to find out.

What exactly is an ICO?

It’s a form of crowdfunding for new online platforms that offers coins—referred to as tokens—in return for an investment. The tokens are a type of cryptocurrency in that they exist solely on the Internet, and their activity is tracked and secured by a decentralized network of computers using highly sophisticated cryptology systems.

Who uses ICOs to raise capital?

Thus far, mostly financial technology entrepreneurs who are developing platforms to replace elements of traditional investment and banking systems—new digital currencies, for example, or encryption software. ICOs are also used by video game companies, app developers, and startups in the health care field.

How does an ICO differ from an IPO?

An IPO is a highly regulated event for established companies in which sophisticated investors receive equity in the company. ICOs, on the other hand, are for very early-stage startups. The cost to invest is generally low, and there is little regulation. People who purchase tokens through an ICO do not have any ownership stake in the enterprise. A token is not equivalent to a share of stock.

So, what is the value proposition for the investor?

The idea is that the platform—a new app, say—becomes widely used and demand from users goes up, leading to an increase in the selling price of existing tokens. You sell your token for a higher price than you bought it for during the ICO, giving you a profit.

Some ICOs have produced spectacular results. What did your research reveal?

In our paper “Digital Tulips: Returns to Investors in Initial Coin Offerings,” doctoral candidate Hugo Benedetti and I found that ICOs tended to be underpriced by roughly 50 percent, compared with 20 percent for IPOs. This is due to volatility in the emerging cryptocurrency market, and also because these coin offerings are for untested enterprises. On average, accounting for the many ICOs that failed, investors in token offerings had returns of 82 percent.

What’s the current state of the ICO market?

In 2017, more than 1,000 ICOs were launched, raising more than $6 billion. Beginning in mid-2018, the cryptocurrency market collapsed, losing around 70 percent of its overall capitalization. The number of ICOs declined substantially, as did investment in them. A significant factor affecting ICOs was the Securities and Exchange Commission’s 2018 decision that most tokens are securities and thus subject to SEC rules and regulations. Now venture capital firms, hedge funds, and other institutional investors are taking over the ICO field in this country.

How does the future look for ICOs?

Whether or not they are here to stay depends on future regulations from the SEC and future demand for cryptocurrencies in general. In the last year, the ICO market has dried up, but it is not clear whether this is a temporary readjustment or a signal of the end of ICOs.