ICO Treasury Management: Why Should ICO Firms Hedge their Crypto Balances?

Many companies in 2017 and 2018 decided to raise capital through an ICO by issuing tokens in exchange of cryptocurrencies like Bitcoin or Ethereum. We find that, while these firms managed to raise billions of dollars in this period, they didn’t manage their crypto holdings price risk, losing on average around 80% of the entire amount raised with the ICO. As a consequence, existing and new ICO companies should start adopting a proper ICO treasury management and crypto hedging program. This will allow them to minimize the risk of losing the capital raised during the ICO, because of the high volatility present in cryptocurrencies (~100% annualized volatility), and to meet their expenses in fiat.

This research paper is structured as follows. The first section gives an overview of the ICO market, with corresponding raised amounts. The second analyzes the volatility in cryptocurrency prices, Bitcoin and Ethereum in particular as they are the major cryptocurrencies accepted by ICO companies. The third section examines the ICO treasury management practices of a sample of ICO firms, showing their inability in managing their reserves properly. The fourth section concludes with key takeaways.

ICO Market Stats

During the period between September 2015 and March 2019, ICO’s companies raised a total of around $24 billion, with an average of $15.5 million per ICO. Table 1 shows the top 20 ICO’s by amount of capital raised.

Top 20 ICO’s by raised amount
Table 1 Top 20 ICO’s by raised amount

Figure 1 shows the top 20 countries where those ICO’s companies are domiciled. It is interesting to note that despite tighter security laws and scrutiny from the SEC, the United States comes first, followed by Singapore and the UK.

Distribution top 20 ICO countries
Figure 1 Distribution top 20 ICO countries

Figure 2 shows the category distribution of the analyzed ICO’s projects. Platform ICO’s come first, followed by cryptocurrency, business services and investments.

Distribution ICO categories
Figure 2 Distribution ICO categories

Table 2 shows the top 10 platforms used by the ICO projects to issue their tokens. As it shows, Ethereum is the major one with the ERC20 tokens, constituting around 90% of the tokens issued.

Distribution ICO token platform
Table 2 Distribution ICO token platform

Figure 3 shows the distribution of accepted cryptocurrencies from ICO firms for their capital raising process. As it can be seen from it, the most accepted cryptocurrency is Ethereum, constituting around 45% of all analyzed projects, followed by Bitcoin at 22%. As a consequence, in this article we will focus on the price risk of Ethereum balances.

Distribution accepted cryptocurrency ICO’s
Figure 3 Distribution accepted cryptocurrency ICO’s

Analysis Ethereum Price Risk

Figure 4 shows the price of Ethereum from September 2016 until March 2019. As it can be seen from it, cryptocurrencies, in this case Ethereum, are very volatile. The price went in fact from around $12 at the start of the considered period, to a maximum of $1400 in December 2018, and back again to around $140 as of March 2019.

Ethereum price
Figure 4 Ethereum price

Figure 5 shows the rolling 60-day volatility of Ethereum. As it can be seen from it, Ethereum is very volatile, with an average annualized volatility of around 112% for the considered period.

Rolling 60-day volatility Ethereum
Figure 5 Rolling 60-day volatility Ethereum

Figure 6 shows the drawdown for a buy and hold strategy in Ethereum. As it can be seen from it, a buy-and-hold investment in Ethereum experienced significant drawdowns, with a max drawdown of 94% and a mean drawdown of 45%. This means that an ICO company who would have raised capital at the Ethereum price peak in December 2018 and who did not liquidate its position, would have lost almost the entire fiat value of their holdings. This would have probably determined the failure of the project, since it would have not been able to meet its expenses in fiat like USD or EUR.

Drawdown buy-and-hold Ethereum investment
Figure 6 Drawdown buy-and-hold Ethereum investment

Table 3 shows the performance statistics of a buy-and-hold investment in Ethereum during the considered period.

Performance stats buy-and-hold Ethereum investment
Table 3 Performance stats buy-and-hold Ethereum investment

As it can be seen from it, Ethereum potentially provides high returns, with a mean annual return of 151%, but at the same very high risk, In fact, the average annualized volatility is 118%, and a max drawdown of 94%.

The previous data shows the importance for holders of cryptocurrencies like ICO companies to have a proper crypto risk management program in place to avoid losing the majority of their holdings values in fiat terms. An example of treasury management program would be a pure passive hedging program, where crypto holders lock-in their initial value of crypto holdings in fiat term. Another more dynamic approach would be an active hedging program, where they decide at which levels they want to hedge their crypto exposure. A last option would be a systematic crypto hedging program, where an algorithm analyzes the crypto data to determine when a bear market is more likely, and decides automatically on the best periods to hedge. The last two approaches would possibly provide both upside potential, and limit on downside losses.

In the next section we analyze the treasury balances of a group of ICO companies and see if they managed to implement a proper crypto risk and treasury management program.

Analysis ICO Treasury Management

In this section we analyze the treasury management reserves and behavior for a sample of around 50 ICO companies which have raised capital with Ethereum. Figure 7 shows the treasury balances for these companies in amounts of Ethereum. As it can be seen from it, many ICO firms still have a lot of their holdings in crypto, exposing them to a large crypto price risk and potential losses in fiat terms.

ICO treasury reserves in Ethereum
Figure 7 ICO treasury reserves in Ethereum

Figure 8 shows the USD value of crypto holdings for the considered ICO companies. As the figure shows, these firms lost the majority of their value in fiat terms, going from around $2.6 to about $400 million.

ICO treasury reserves value in USD
Figure 8 ICO treasury reserves value in USD

Table 4 shows the amount lost by these ICO companies because of change in Ethereum price, excluding the effect of withdrawals. As it indicates, the average ICO company lost around 73% of the value of their crypto holdings due to a improper treasury management practices. This poses into question the ability of these projects in being able to pay their ongoing and future expenses without raising additional capital.

Stats loss ICO crypto holdings due to crypto price risk
Table 4 Stats loss ICO crypto holdings due to crypto price risk

Figure 9 provides an additional piece of evidence in the lack of proper treasury management practices by ICO companies. As the figure shows, there is an inverse correlation (β = -1068.8) between change in Ethereum price and crypto holdings liquidated from treasury reserves. This is the opposite behavior that should be expected by good risk management practices. They in fact do not sell before Ethereum experiences losses, sitting on unrealized losses and hoping for a possible price increase in the future.

Relationship Ethereum price change vs ICO withdrawals
Figure 9 Relationship Ethereum price change vs ICO withdrawals

Figure 10 further validates the previous conclusion. As it can be seen from it, the analyzed ICO firms do not sell their holdings when the price of Ethereum is high, but instead made most of their withdrawals when the price was at its minimum. A good treasury management practice should do the opposite, i.e. sell only when the price is high.

Relationship Ethereum price vs ICO withdrawals
Figure 10 Relationship Ethereum price vs ICO withdrawals

This data shows that ICO firms are not adopting sound treasury management policies. They should as a consequence consider implementing a crypto hedging program, or delegating the management of their holdings to an investment professional.

Conclusion

The previous results highlight the following key takeaways:

ICO Market Analysis: What Really Drives the ICO Capital Raise Process?

Many companies in 2017 and 2018 decided to raise capital through an Initial Coin Offering (ICO). While the process seemed very promising at the beginning, it also showed its limitations around the end of 2018. In fact, many ICO’s were in fact scams, while other failed to deliver the promises towards their investors. In this research paper we analyze the ICO market from 2015 until present. The first section gives an overview of the ICO market. The second section analyzes more in detail the evolution of the ICO capital raising process over time, while the third section analyzes the main factors driving the ICO capital raise. The fourth section concludes with key takeaways.

ICO Market Stats

For this research we used the info on around 3500 ICO’s completed between September 2015 and March 2019. During this period, ICO’s companies raised a total of around $24 billion, with an average of $15.5 million per ICO. Table 1 shows the top 20 ICO’s by amount of capital raised.

Top 20 ICO’s by raised amount
Table 1 Top 20 ICO’s by raised amount

Figure 1 shows the top 20 countries where those ICO’s companies are domiciled. It is interesting to note that despite tighter security laws and scrutiny from the SEC, the United States comes first, followed by Singapore and the UK.

Distribution top 20 ICO countries
Figure 1 Distribution top 20 ICO countries

Figure 2 shows the category distribution of the analyzed ICO’s projects. Platform ICO’s come first, followed by cryptocurrency, business services and investments.

Distribution ICO categories
Figure 2 Distribution ICO categories

Table 2 shows the type of ICO used. Utility is the great majority at 97%, used mainly initially for regulatory purposes to avoid security laws in many countries. Despite the recent hype in Security Tokens Offerings (STO’s), they only represent about 2% of the total ICO’s so far. We’ll need to see in the coming years if they become the predominant form of ICO type.

Distribution ICO project by type
Table 2 Distribution ICO project by type

Table 3 shows the status of the completed ICO’s. It is interesting to note that, while many proponents of the ICO model claim liquidity as one main benefit of ICO’s, only around 20% of the completed ICO’s are actually listed for trading on an exchange. This shows that the vast majority of participants in ICO’s were not able to exit their position. This is similar to investing in an offering in a private early-stage company, where exit strategies at the beginning are limited.

Distribution ICO project by status
Table 3 Distribution ICO project by status

Figure 3 shows the distribution of number of team members for each ICO project. As it can be seen from it, it is a bimodal distribution, with peaks at 1 person and around 8 people.

Distribution number of team members ICO project
Figure 3 Distribution number of team members ICO project

Figure 4 shows the average number of team members over time. As it can be seen from it, there is a steady uptrend in this number, going from around 5 in 2016 to around 15 as of 2019. This possibly indicates greater professionalism and experience in the recent ICO teams compared to the initial ones, and a maturation of the market and its participants.

Number of team members ICO over time
Figure 4 Number of team members ICO over time

Table 4 shows the top 10 platforms used by the ICO projects to issue their tokens. As it shows, Ethereum is the major one with the ERC20 tokens, constituting around 90% of the tokens issued.

Distribution token platform ICO
Table 4 Distribution token platform ICO

Analysis ICO capital raise over time

This section analyzes the ICO raising process over time from September 2015 to March 2019. Figure 5 shows the number of ICO’s vs the price of Bitcoin during the period analyzed. As it can be seen from it, the number of launched ICO’s is highly correlated to the price of Bitcoin. This makes sense, since it is the price increase in Bitcoin during the considered period that gave rise to the popularity of cryptocurrencies and draw more capital in the ICO market.

Number of ICO’s vs Bitcoin price over time
Figure 5 Number of ICO’s vs Bitcoin price over time

Figure 6 shows the total capital raised for each month compared to the price of Bitcoin. A similar conclusion to what previously discussed applies. In fact, the total amount raised is greatly correlated to the price of Bitcoin.

Monthly raised amount ICO’s vs Bitcoin price
Figure 6 Monthly raised amount ICO’s vs Bitcoin price

Figure 7 shows the average amount raised per ICO each month on a log scale. As the figure shows and contrary to what it could be expected, the amount has been relatively constant around $15 million since August 2017. This indicates that, despite the decreased interest in the ICO market and slowdown in total amount raised and project launched, successful ICO companies can still expect to raise around the same level of capital as before the bear the market of 2018.

Average raised amount ICO over time
Figure 7 Average raised amount ICO over time

Figure 8 shows the average duration to complete an ICO. As it can be seen from it, there is a steady increase in the average time required to successfully launch an ICO, going from around 30 days in 2017 to around 100 days at present times.

Average duration capital raise ICO
Figure 8 Average duration capital raise ICO

In the next section we will analyze more in depth the relationship between the price of Bitcoin and the capital raised through the ICO process.

Factor analysis ICO capital raise vs Bitcoin price

Figure 9 shows the relationship between the Bitcoin price and the number of ICO’s launched each month for the analyzed period. As it can be seen from it, there is an almost perfect log-log relationship between the 2 variables (R2 = 0.92). This means that one of the main factor impacting the number of new launches in the ICO market is the price of Bitcoin.

Relationship Bitcoin price vs number of ICO’s
Figure 9 Relationship Bitcoin price vs number of ICO’s

Figure 10 shows the relationship between the Bitcoin price and the total amount raised each month. Similarly to the number of launches, there is a strong log-log relationship between the 2 variables (R2 = 0.81). This makes sense, since many investors remember the losses they had in the bear market and are not willing to invest in new projects because of that. Also, an increase in price of Bitcoin drives more interest in the market, and more capital to invest as a consequence.

Relationship Bitcoin price vs monthly raised amount ICO’s
Figure 10 Relationship Bitcoin price vs monthly raised amount ICO’s

Conclusion

The previous results highlight the following key takeaways: