31 October 2018

Why ratings for ICOs would make sense6 min read

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Raising finance for innovative projects is key for businesses, but it is also vital for securing a national economy’s power to innovate. Raising risk capital has a particularly important role to play here. For many years, young businesses primarily turned to venture capitalists, angel investors or early-stage investors for capital. Recently, the initial coin offering (ICO) has appeared as a form of finance that can often help bring in cash during the very early days of a project. However, there is still very little experience of the ICO market. A ratings system could possibly help reduce the risks associated with this form of funding. 

An initial coin offering (ICO) is a new, mainly unregulated form of finance-raising that is generally used by businesses whose business model is based on blockchain technology. With an allusion to initial public offering (IPO), the name clearly seeks to highlight similarities with a flotation on the stock exchange. Yet, the methods and processes of an ICO actually have more in common with crowdfunding. In return for providing finance for a project, participants in an ICO are issued with tokens. The Swiss Financial Market Supervisory Authority (FINMA) distinguishes three functional token types: “Payment tokens” are equivalent to cryptocurrencies that can potentially be used as a form of payment. “Utility tokens” permit access to a technology and/or service. “Asset tokens” simply represent assets. These may include shares in a business or its profits, or claims to dividends and interest payments. Asset tokens therefore work in a similar way to shares, bonds, loan agreements or derivative financial instruments. In practice, there are many hybrid forms that cannot be classified in one particular category or the other.

ICO market continues to boom in 2018

The ICO market continues to boom. Coindesk reported that 343 businesses raised USD 5.5 billion using ICOs in 2017, a record that had already been smashed after the first four months in 2018. During this period, 271 businesses have already raised USD 7.1 billion via ICOs (see Figure 1).

Figure 1: Money collected via ICOs by month in 2017 and 2018 (in USD; source: Coindesk)

Black sheep ICOs?

The Wall Street Journal recently published an article in which some 1,450 ICOs were analysed. The results made for somewhat sobering reading. The analysis showed that 271 (or 18.6%) of the ICOs investigated had employed misleading or fraudulent tactics to attract investors. These included plagiarised whitepapers, fake management team information, faked CVs or made-up employees. Equally, more than 20 ICOs promised risk-free profits.

The variety of financing models and diverse performance of ICOs suggest a need to find ways of bringing a little more structure to this market and alternative form of finance raising. One approach could be to use regulation to improve protection for potential investors. FINMA has started to become more active with regard to ICOs, publishing ICO guidelines in February 2018. At the same time, it would be possible to create a system of ratings for ICOs, to attempt to estimate the prospects of an ICO’s success.

Thoughts on an ICO rating system

Ratings are normally used to assess the creditworthiness of a business, private individual or financial instrument. However, when it comes to ICO start-ups, the creditworthiness of the business or probability of default of the financial instrument is not the most interesting aspect. What matters is the prospect of return, rather than the default risk. Therefore, any rating system for start-ups and ICOs would have to differ from a credit rating system for established companies.
There is a range of approaches and factors that can be used to assess an ICO. For example, the platform planned by the Swiss start-up Alethena compiles ratings on the basis of four dimensions “Legal”, “Technical”, “Business” and “Governance”, which in turn are subject to 62 individual factors. The first dimension, “Legal”, comprises factors such as regulatory compliance, the legal structure of the ICO and the political environment. “Technical” evaluates the technical vulnerability and sustainability of the project. The “Business” and “Governance” dimensions consist of a market, product and business model analysis as well as evaluation of the project team (following an approach of “bet on the jockey, not the horse”) and transparency of the source code, financing and roadmap.

One particular characteristic of ICOs is the generation of an ecosystem (referred to as the “tokenomics”). For example, in terms of the structure and specification of the ICO, the type of tokens used and the ways in which they are planned to be allocated and used are relevant. Tokens might not only represent a share in the project (asset token), but also the ability to use a platform (utility token). Therefore, investors may see benefit in “whale restrictions” – i.e. limits to ensure that a single investor cannot hold too many tokens. See Figure 3 for an example of a comparably finely concentrated distribution of tokens. It shows the proportion of different token holders in the US blockchain company BAT.

Further relevant factors could include the level of any soft or hard cap, initial token allocation (crowd, development, founders, etc.) and the implementation of a transparent KYC process. The project status at the time of the ICO may also play a role (e.g. whitepaper, alpha, beta, etc.).

The long-term value of a token can be assessed on the basis of the following questions, especially for utility tokens: Is the aim of the project to create a comprehensive token ecosystem, and has a value been put on that at the time of the ICO (e.g. via a broad token distribution)? What role do networking effects play, and do they resolve issues relating to the required scalability of the project? A further important point with a significant impact on the long-term success of a project is the often tricky to assess “momentum” – hitting the right market at the right time.

Potential investors need to question how innovative the product is. They should also investigate the USP and, if appropriate, assess how easily the product can be replicated. There must also be critical analysis of whether use of blockchain technology is actually necessary and how good the technical implementation of the solution on the blockchain is. Currently, many companies are first thinking about which projects can be pulled on to the blockchain. However, the approach should always be the other way around. The idea for the project should come first. The blockchain only represents the ideal tool for implementation in certain circumstances.


There are already some attempts to rate ICOs. Once the market becomes more mature and (even) larger, these efforts will certainly increase. Ultimately, every market has a powerful interest in ensuring a high level of transparency and credibility. A good, rigorous rating system may help achieve these aims.

The interview was originally published on the IFZ Retail Banking Blog of the Lucerne University of Applied Sciences and Arts on June 18, 2018.


Prof. Dr. Andreas Dietrich

Prof Dr Andreas Dietrich (1976) heads the Institute of Financial Services Zug IFZ and is Head of Studies of the MSc in Banking and Finance and CAS Digital Banking at the Lucerne School of Business. He studied at the University of St. Gallen (HSG), where he also obtained his doctorate. He worked as a research associate at the HSG and completed a research year at DePaul University in Chicago. He has been at the IFZ since 2008. He also has a seat on the board of directors of the Lucerne Cantonal Bank.

Thomas Ankenbrand

Thomas Ankenbrand holds a Master’s degree from the University of St. Gallen and a PhD from the University of Lausanne. He founded several companies and has broad experience as CEO and board member of various companies in the financial industry. He is currently engaged in FinTech and Asset Management research at the Lucerne University of Applied Sciences and Arts.


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