Blockchains and cryptocurrencies have unleashed an avalanche of creativity and ideas. However, not all ideas are created equal. Some may be scams to get your hard-earned money. When you are looking into initial coin offerings (ICOs), you need to understand the fundamentals. According to a public statement by Securities and Exchange Commission (SEC), ICOs have “substantially less investor protection”. So there is a higher probability of fraud and manipulation. If you are thinking about ICO investing, you need to educate yourself and proceed with caution.
What is an ICO?
Initial coin offerings (ICOs) are ways for cryptocurrency-based businesses to raise funds for their ventures. It’s a crowdfunding mechanism. Startups issue coins that can be exchanged for more established cryptocurrencies like bitcoin or ether. The startups can then use the fundings to implement their business ideas. The motivation is that a successful business will increase the value of the initial investment.
The ICO marketplace is currently unregulated which makes it unpredictable. It’s easy for fraudsters and scammers to take advantage of unwitting investors. There has been a number of high profile frauds. After complaints from investors, the SEC froze the PlexCoin funds (around $15 million). Benebit looked like a legitimate company until somebody reported that all the photos of the founders were from a UK boys' school.
The founders ran away with an estimated $4 million. Ponzicoin is an ironic example. People were gullible enough to invest in it even though the fraud is advertised on the name itself. So you should do your due diligence before any ICO investment.
What is a White Paper? And Why it is Necessary.
A white paper provides information about a solution, product or service. Generally, it is intended for potential customers to learn about the product. It’s a marketing tool that is widely used in every industry. While an advertisement might concentrate on aesthetics and targeted messaging to entice customers emotionally, a white paper concentrates on the facts and features of the product to appeal to the customers rationally.
In the ICO world, white papers play a vital role in convincing investors. When a blockchain startup is trying to solve a problem, it doesn’t have the money necessary to implement its solution. So it uses a white paper to lay down a detailed implementation plan to convince the investors for funding.
Evaluating the Validity of ICOs and White Papers
The unregulated cryptocurrency marketplace and the open-ended relationship between startups and investors create fertile grounds for scams. Here are few bad signs that should make you cautious:
Need for Blockchains, Coins or Tokens Unexplained
Not every problem in the world requires a blockchain. A white paper should have a clear explanation of the use case for a blockchain implementation. You should be able to grasp the problem and the solution. If it is too complicated for you to understand, then it is probably too complicated for you to consider for investment.
Also, a new coin or token is not always necessary. A startup might be able to use bitcoin or ether. So if the white paper mentions new coins or tokens, make sure there are valid reasons for creating the new currency.
Underdeveloped Business Models
An ICO is not a donation. It’s an investment in a business. Respectable startups should have clear business plans with definite paths.
Startups often have to change plans, take new directions or pivot. But it doesn’t mean they should start aimlessly. An underdeveloped business model is the sign of an amateur venture. A company who is asking for your hard-earned money should have done due diligence to think through the goals and milestones and come up with an executable plan.
If the white paper doesn't have definite goals and aspirations, it can indicate a lack of authentic effort. Even if it’s not a scam, due to the lack of perseverance of the people involved, it will probably fail as a business.
Use of the Funds Unexplained
The funds collected through an ICO is supposed to be used to build the company. If you notice that a lot of initial coins are being routed to the founders that’s a bad sign. It might be a scam. The founding team should get funds distributed at a steady stream over a long time (5 to 10 years). If the founders are getting the funds at the beginning of the project, they might liquidate the funds and just run.
Carefully study the white paper to understand how the collected money will be used.
Zero Experience of Founders and Advisers
The blockchain is a new technology. The founders might not have years of experience in the field. But if they come out of nowhere, that's suspicious. Make sure all the involved people have worked in related fields. Even if it isn’t cryptocurrency or blockchain related, there should be some logical connection. Cross-check LinkedIn and other social media websites to verify that the names and descriptions are legit.
Find out the kind of work they did before. It’s probably not a good sign if the founders were retail cashiers before starting a crypto-company.
No Post-ICO Strategy or Roadmap
Blockchain companies are software businesses. A legitimate ICO-funded software business should have proof of work in the form of a minimum viable software product or a codebase in a verifiable repository. A roadmap should indicate where things are going. If you see no post ICO strategy, then the business is probably not going to be successful.
Also, a good business keeps its investors well-informed about the next steps. You should be able to easily get the roadmap or strategy for the future through various communication channels.
Investment in any new technology is a risky endeavor. Blockchain ventures are no different. There are a lot of competent and creative entrepreneurs working hard to bring new innovations. But there are also bad apples. Don’t fall for the hype and get yourself into a bind due to the “fear of missing out”. Real investors take their time to investigate and come to their own conclusions. Use your investigative skills to find the promising projects.
If you are looking for blockchain experts for your small business, our engineers and analysts at IoTCoreSoft are ready to help. Contact us today.
Disclaimer: Do not take this article as professional investment advice. We are not a financial institution.