Boston College study: ICO pump and dumps are the smart option
It's a dump or be dumped on world. How should regulators respond to the nature of the beast?
Broadly, there are three ways to participate in new crypto projects.
The first is to carefully select projects that seem to have long-term potential and purchase cheap tokens with the intention of holding them for the long run. The second is to buy into ICOs, shill the heck out of your coins and then dump them once they hit the exchanges. The third is to buy from those dumping coins in option number two.
According to a study out of Boston College by Hugo Benedetti and Leonard Kostovetsky, the overall highest average returns from ICOs, by a very large margin, are from option number two.
Choosing the right pump and dump
The average returns on ICOs are actually pretty good, the study finds, as long as you dump your coins fast enough.
The main caveat is that the vast majority of ICOs never amount to much. Only about 25% ever go on to list on an exchange, so there's about a 75% chance of just wasting money right off the bat. The no-hope coins aren't distributed evenly though, and generally the ICOs that raise the most are also the most likely to get listed on an exchange. This might be mostly because even the worst coin can just buy a listing on a major exchange.
There are no guarantees though. An ICO can still hit the $50 million mark and never go anywhere, or be an exit scam, but more money equals more promise might be a vague rule of thumb.
When to dump
It's difficult to use this study to find the best rule for dumping ICO coins, the researchers note, because the overall inflation of cryptocurrency in December 2017 cut right through the study period and skewed results all over the place.
But given the extreme mortality rate for projects in the long run, the optimal time to ditch coins is, on average, generally as soon as possible after listing. This lets one make sure they've dropped their bags before a project pulls an exit scam, gets busted by the SEC, is revealed to be a Ponzi scheme or, in some cases, dies of natural causes.
Who's pumping and who's getting dumped on?
If you're not a dumper, you might be getting dumped on. Secondary markets like exchanges aren't an ideal place to buy newly listed coins because it's virtually guaranteed that they're currently being dumped at an inflated price.
Overall, the dumpers are institutional traders and insiders with the right connections, while the dumpees are anyone who's not in that group.
This might be especially true in the US where regulations are restricting ICO buying to accredited and institutional traders only, while forcing main-street speculators into the sucker crowd on the secondary markets. Ironically, these restrictions were supposed to protect retail traders from getting duped.
Pre-ICOs are also impacting profitability, with the researchers noting that pre-ICOs have the effect of "reducing underpricing" of ICOs.
In other words, an optimist might see them as a useful way of bringing ICO prices closer to a fair level – the price a coin trades at on the open market. A cynic might see them as a way of further inflating ICO prices to start profiting from those who think they're savvy by participating in an ICO, instead of the open market. As time goes by, it's reasonable to expect pre-pre-ICOs and similar to start cropping up.
Tightly regulated pump and dump schemes
Functionally, ICOs are turning into formal and regulated pump and dump schemes. Just like the more openly nefarious pump and dump groups, they depend on having different layers, with an inner circle buying cheap and then unloading on the outer circles at a higher price.
This isn't in the best interests of legitimate projects either. The creators might want to build something for the long run, but can't do much to stop the pump and dump schemes that are now inextricably tied to the ICO market.
Some are trying to explore the potential of token lockup periods, where ICO participants are unable to sell their holdings for a set period of time after an exchange listing, or where there are additional discounts for those who agree to abide by lockup periods, but these are of limited effectiveness.
Exchanges aren't going to list tokens that can't be traded, so it mostly just has the effect of pushing back the dumping date and creating a delay that makes people lose interest in the project as a whole.
And where there are voluntary lockup options with attached discounts, people will often just not use it even for an extra discount. The additional returns and extra safety from dumping stacks quickly outweighs just about any discount a project might offer for lockup periods.
What's the takeaway?
According to the researchers, people are finding real money in ICOs, which they attribute to all the risks involved. As they point out, investing is all about expecting higher rewards for higher risks, and the loosely-regulated scam-ridden ICO market is undeniably high risk.
"ICO investors are receiving extraordinary compensation for providing capital to an unproven firm and product through unregulated means," they say. "On the one hand, this is consistent with the tight relationship between risk and return that we would expect in markets with rational agents. On the other hand, it flies in the face of many regulators and governments who view token sales as scams that take advantage of unsophisticated investors, and thus must be restricted to sophisticated investors or even banned."
The main catch from a consumer protection standpoint might be that putting ICOs off-limits to "unsophisticated" retail buyers doesn't mean they aren't at risk of scams. It just means they're all but guaranteed to get ripped off, rather than maybe 50% likely to get ripped off.
Reflexively wanting to protect people from the shadiness of the ICO space is understandable, but probably inherently counterproductive. All the outright scams are one problem to crack down on, but the shady layers and inner and outer circles are a much more intractable issue, which extends far beyond cryptocurrency and is just as present in regulated existing markets.
Counterintuitively, the most effective way to clean up the ICO market might be to see it get spread as widely as possible, and made as accessible as possible, and for tokens to list as soon as possible.
Once it's easy for anyone to get involved, and once ICO tokens can start circulating and finding their market value immediately, the pump and dump mechanics might start losing their profitability, which could help bring the markets back down to Earth.
As the SEC has noted, consumer education is at the heart of consumer protection. And as aphorisms have noted, the best way to learn is by doing. The ideal way forward might be to open the market as widely as possible, rather than trying to endlessly build a wall between consumers and business ventures.
Consider the age old Nigerian prince scam. In its heyday of 2009, Nigerian prince email scams netted about US$9.3 billion. These days the same random scam email tactics would only net a fraction of that. That didn't happen because email was restricted, but because after a whole lot of ruined lives, people eventually learned how to spot scams. For some perspective, the ICO market has yet to come anywhere close to that amount in any given year, including scams, legitimate projects and monumental outliers.
The goal should not be to build a permanent wall between consumers and the markets, but to create a world where everyone can spot a scam just as easily as a Nigerian prince phishing email and discerningly participate in a wide-open market.
But you can't educate consumers without breaking some eggs, and the safest time to do that is while the market is still small. If regulators are serious about educating more consumers in the long run, it might be time to get cracking.
Disclosure: At the time of writing, the author holds ETH, IOTA, ICX, VET, XLM, BTC and NANO.