Pyramid Scheme Prevails in ICO: Evidence from Primary Market Token Transaction Analyses

18 Pages Posted: 12 Oct 2022 Last revised: 26 Mar 2024

See all articles by Zhenhao FU

Zhenhao FU

Nanjing University

Weijing Gu

affiliation not provided to SSRN

Zhenyu Fang

Nanjing University

Jiaqi Yan

Nanjing University

Xiao Fan Liu

City University of Hong Kong

Date Written: September 21, 2022

Abstract

Initial Coin Offering (ICO) is an innovative financing tool that enables startups to raise funds quickly by selling blockchain-issued tokens as equity. However, ICOs are also notorious for frauds and scams that exploit the information asymmetry between token issuers and public investors. To make things worse, multi-level marketing (MLM), a controversial strategy that can easily turn into pyramid schemes, is commonly used in ICOs. This paper characterizes MLMs in ICOs using blockchain token transactions and differentiates ICOs convicted of pyramid schemes and the ‘successful’ ones with their fundraising procedures. Specifically, we extracted the primary market token transactions of 18 convicted ICOs and 52 matching ones from the Ethereum blockchain, constructed token distribution spanning trees, proposed an array of network metrics for evaluating the trees’ static and dynamic features, and compared the two groups of ICOs with statistical tests and machine learning models. Surprisingly, results show that while only a handful of ICOs was convicted of pyramid schemes, those deemed successful have no significant difference in their primary market token dissemination patterns. Considering that most tokens issued at the ICO stage hardly have any backed value, our findings suggest that pyramid schemes could be prevalent in ICOs. We remind global regulatory bodies that the existence of perennial problems in unregulated markets, such as pyramid selling, should be presumed in the cryptocurrency market and regulated forcefully.

Keywords: cryptocurrency; initial coin offering, transaction analysis, blockchain analytics, multi-level marketing, pyramid scheme

Suggested Citation

FU, Zhenhao and Gu, Weijing and Fang, Zhenyu and Yan, Jiaqi and Liu, Xiao Fan, Pyramid Scheme Prevails in ICO: Evidence from Primary Market Token Transaction Analyses (September 21, 2022). Available at SSRN: https://ssrn.com/abstract=4225546 or http://dx.doi.org/10.2139/ssrn.4225546

Zhenhao FU

Nanjing University

Weijing Gu

affiliation not provided to SSRN

Zhenyu Fang

Nanjing University

Jiaqi Yan

Nanjing University

Xiao Fan Liu (Contact Author)

City University of Hong Kong ( email )

18 Tat Hong Avenue
Kowloon
Hong Kong

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