Informational Efficiency of Cryptocurrency Markets

The trading of cryptocurrencies on unregulated markets provides a natural platform to examine how price discovery occurs in these markets. Using variance ratio (VR) methodology to measure information efficiency over time, we find that Initial Coin Offerings (ICOs) exhibit significant inefficiencies with an average VR of .76 after 100 days, compared to similar market capitalization stocks following an IPO where prices are efficient (VR=1) within a month after the firm starts trading on regulated exchanges. The VRs for ICOs remain below 0.7 for more than three years. The VRs for Bitcoin and Ethereum, the most widely traded cryptocurrencies, approach one only after a year of trading. Using VR methodology, we also compare ICOs to Initial Exchange Offerings (IEOs), which are underwritten by major cryptocurrency platforms (for example, Binance). The IEOs exhibit inefficiencies up to 100 days from the start of trading. However, they are consistently more efficient than ICOs during the first 200 days, suggesting that due diligence by platforms can lead to better price discovery and more efficient prices. The efficiency of ICOs improves with maturity, turnover, market value, and higher prices, measures that are also important determinants of market liquidity and efficiency of stocks traded on regulated exchanges. Other unique features of ICOs that improve efficiency are the four platform types: Ethereum, Neo, and Wave. Crypto algorithm Ethash decreases efficiency. Further, we find that social media activity has a significant impact on the efficiency of ICOs, with the number of subscribers and the number of positive comments leading to more efficient prices.