The Impact of KYC rules on Capital Raised through ICOs - Empirical Evidence
Galia Kondova - School of Business, University of Applied Sciences and Arts Northwestern Switzerland;
Purushoththaman Shanmuganathan - School of Business, University of Applied Sciences and Arts Northwestern Switzerland
-- Blockchain-based financing instruments like initial coin offerings (ICOs), security token offerings (STOs), and initial digital offerings (IDOs) have disrupted the traditional finance industry by providing opportunities for peer-to-peer funding. These new fundraising instruments promise low entry barriers, public tradability and high cost efficiency as compared to initial public offerings (IPOs) or venture capital and private equity fundraising. They are thus particularly alluring to start-ups. Especially young innovative businesses in the information technology sector are exploring the opportunity to raise start-up capital for their ecosystems or products by offering security, utility, or payment tokens to the broad public in a cost efficient way (Kondova and Simonella, 2019).
At the same time, the unregulated nature of the ICOs in particular has resulted in many fraudulent cases. As a result, many world jurisdictions issued regulations in the last two years addressing the fraud cases associated with ICOs. The ICO issuers in turn started enforcing more transparency by requiring potential investors to pass know-your-customer (KYC) procedure (identity verification procedure) and provide their credentials in order to participate in the ICO.
The impact of the introduction of the KYC requirement on the amount of raised capital by ICOs is studied in our recent paper “Knowing Your Customer: Empirical Implications for Raising Capital through Initial Coin Offerings (ICOs)” presented at the World Finance Conference 2020. In particular, the paper applies a multivariate regressional analysis on a sample of 855 ICOs worldwide to study the effect of a KYC procedure in ICOs on the amount of capital raised.
The results provide empirical evidence of a negative impact of the introduction of a KYC procedure on the amount of raised capital in ICOs. One possible explanation of this negative impact could be association with the possibility that a KYC requirement crowds out anonymous (presumably delinquent) investors at the cost of the additional capital raised. Another explanation, however, could be that the additional administrative burden associated with the identity verification procedure under the KYC requirements could discourage potential investors from participating in an ICO. At the same time, the introduction of a KYC procedure in ICOs should be considered as a logical consequence of the stricter legislation on ICOs introduced by major jurisdictions worldwide. Moreover, a KYC procedure in ICOs along with a stricter legislation should be perceived as important instruments to enhance the establishment of a level playing field for all tokenized financing instruments such as ICOs, security token offerings (STOs) and initial digital offerings (IDOs), thus putting the end of the “gold rush” of the ICOs.
The paper also provides evidence of a positive and statistically significant effect of the number of employees, the number of issued tokens, total company ranking, teamranking, the GDP percapita ,and the public interest in Bitcoinon the amount of capital raised in an ICO. On the other hand, the duration of an ICO is found to negatively impact the amount of the raised capital in an ICO.