ICOs make IPOs look good

We all know that investing in IPO is a losing proposition on average.

Or at least we should know.

Looking at Jay Ritter’s extensive database of IPOs and their performance which is now available up to the year 2019 we can see that IPOs from 2000 to 2017 on average underperformed stocks of similar size by 7.7% in the first six months after the IPO, 11.2% in the first year and 4.8% in the second year. Only thanks to some outperformance in years three and four is the five-year average underperformance limited to 1.4% per year. If we go back to 1980, when his database begins, the underperformance is somewhat reduced because of the strong performance of IPOs in the first six months during the 1990s. Yet, on average, IPOs underperform similar sized stocks in the first year by 5.2% and in the second year by 4.2%. The average annual underperformance in the first five years after the IPO is 3.1%. Investing in an IPO is like buying a lottery ticket linked to a nice story pushed by investment banks. If you find the winning story, you can make a lot of money, but the vast majority of stories are worthless.

Over the last couple of years, Initial Coin Offerings (ICO) have become a favourite playground of speculators and scammers alike. Though sometimes called a digital IPO, ICOs are not like IPOs at all. There are no legal requirements for an ICO (anyone can issue them without providing any meaningful information) and investors do not get an equity stake in the company issuing the ICO. In fact, investors in ICOs have no rights at all. All they are doing is buy a financial product from a business that promises to accept these digital coins in its digital ecosystem (though often it isn’t even clear if or when this digital ecosystem will ever be created in the first place).

Because ICOs are such a new phenomenon we can’t measure their performance over five years as Jay Ritter does in the case of IPOs but we can measure their performance over shorter time periods.

And the results are shocking.

The ICO Market Report 2018/2019 was published in early February and shows the performance of ICOs launched in 2018. Here is live coverage of me when I saw the numbers pop up on my computer:

The report looks at 1,112 ICOs that raised a total of $14.1bn. Within 30 days of their ICO about one third were essentially worthless with loses between 80% and 100% of the money raised. After six months, seven out of ten ICOs were worthless or as good as. Only 7.6% of all ICOs managed to create a positive return for investors in the first six months.

Performance of ICOs in the first 30 and 180 days

Source: Fromberger and Haffke (2020).

I know it is an apples-to-oranges comparison but I nevertheless plotted the distribution of returns of ICOs 30 days and 180 days in with the returns of IPOs after five years. With IPOs, there is a substantial risk of losing more than half your money in the first five years. Two out of five IPOs have more than halved in in price after five years. But one in five IPOs also doubled its value. With ICO you get a worse loss rate and no winning lottery tickets. After just six months, 85% of ICOs had lost more than half their value but only on in 25 ICO managed to double. I cannot think of a single investment product that has worse chances of positive returns than ICOs.

Performance of ICOs and IPOs

Source: Fromberger and Haffke (2020), Ritter (2020).