2017 has been called the “Year of the Bitcoin” by many, but another accurate description would be “Year of the ICO.” Throughout 2017, Initial Coin Offerings (ICOs in short) raised a whopping $5.6 billion. While this pales in comparison to the $84.7 billion raised by tech startups in 2017, it’s still a tremendous milestone for cryptocurrencies. Quite simply, investors and the crypto community are putting their faith not only in bitcoin, but newer entrants as well.
So what is an Initial Coin Offering? It’s a fundraising mechanism that allows investors to purchase an emerging cryptocurrency coin before it goes live. Essentially, a smart contract is set up, allowing the funder provide sends funds. In exchange, the funder will receive an equal amount in value of the new cryptocoins. When the coin starts trading, hopefully the value of the coins will increase, netting the funder a profit.
Many of those investing in ICO’s are hoping to strike it rich by finding the “next bitcoin.” They have good reason to be optimistic. Currently, there are over 150 digital coins with a marketcap of $100 million or more, and 30 are worth $1 billion or more.
A savvy investment in the right ICO could yield tremendous returns. However, there are many risks, drawbacks, and concerns. Before investing, it’s important to understand these limitations.
Be Aware of the Risk of Scams
Unfortunately, ICOs are also fraught with danger. Sadly, some unscrupulous parties have used the cover of ICOs to scam people. Looking at $3.7 billion worth of ICO’s, Ernst & Young concluded that as much as 10% of the money rated was stolen.
In some cases, the developers misrepresent various technological aspects of their coins. In other cases, “developers” are flat out lying and have no intention of ever launching the new coin. They simply want to take your money and run.
Following in the footsteps of Satoshi Nakamoto, many of those launching an ICO first start with a white paper outlining the vision and various technicalities of their coins. When E&Y auditors delved into ICO fraud, they were “shocked” by the poor quality of some of them. The key word here, of course, is ‘some.’
By being cautious and thorough, you may be able to protect yourself from any “shocks”.
All Investments Come With Risks
ICOs are generally a high-reward, high-risk proposition. Some coins will emerge as big winners, but many will fail to gain traction. This could happen even if the developers put forward their best efforts.
Risks are always present and are generally correlated with the potential for rewards. The same is true of any investment opportunity, including stocks, bonds, and commodities.
So how do you minimize risks while increasing the potential for rewards? You’ll have to analyze the ICO and its backers very closely. Let’s go over one process for vetting ICOs.
1. Evaluate and Verify the Team
Many ICO evaluators start with the white paper. That’s not a bad idea, but another method is to first examine and verify the team. “Who” is behind the ICO? Initially, you simply want to verify the identity of the team. Have the ICO founders made themselves publicly known? Have they presented at live events, or are they well-known members of the community?
You’re first concern isn’t necessarily skill, but simply verifying that they are real people. Why? It’s less likely that a publicly known person will scam you because you will likely have legal recourse. Beware, however, you need to make sure that people are who they say they are. Check official Linkedin profiles, look for presentations that show the developers, etc.
Once you verify who the development team, you can start to dig into their skills and expertise. However, keep in mind that it’s possible that the next “big” coin might come from someone who isn’t a big wig in the cryptocurrency community.
2. Read and research the white paper
Okay, so you’ve verified the identities of the ICO team. Now it’s time to dig into that white paper. Give it a good, long read. What advantages does this coin offer versus its competitors? What makes it unique? Is the text fluffy or is it well grounded?
After you read the white paper yourself, do some web sleuthing. There are many great online communities and expert websites where writers and community members discuss ICOs. Check to see if there are any analyses or opinions on the ICO and their white paper.
Review the materials closely and examine their claims. Like everything else, however, don’t treat their word as the undoubted truth.
3. Examine the progress and development of the coin
A skilled and savvy writer could put together a compelling white paper. Someone familiar with cryptocurrencies but lacking technical skills might even be able to come up with some truly unique angles and advantages for their hypothetical coin.
That doesn’t mean the coin will ever come to life. Has the project advanced? Has the development team made their milestones? Is it possible to verify? When it comes to any startup, execution is often as important as the idea itself.
The greatest idea in the world will remain an idea until someone comes along and executes it. When examining progress and the potential for execution, it’s a good idea to circle back and reexamine the team. Do they have the proper skill set to execute?
4. Examine the token distribution structure
How are the new tokens going to be distributed? Ideally, new coins will be well distributed among the founders and funders. This ensures that the founding team is invested and tied to the success or failure of the coin. The benefits will also be shared with funders.
There can also be hard caps and open caps. With a hard cap, you can only acquire a limited number of coins. With an open cap, you can acquire as many as you want, however, this might dilute their value.
5. Does the ICO have any major backers?
Are any venture capital firms or notable cryptocurrency figures investing in the ICO? If so, that’s a great sign. Almost certainly, these parties have conducted their own evaluations and have come away impressed.
Again, however, don’t take the ICO developer’s word for it. Just because the ACME ICO team (made up company) claims that the Winklevoss Twins have poured $2 million into their ICO, that doesn’t mean it’s true. See if you can find information on the Winklevoss’s website or another legitimate source.