Everything You Need to Know About ICOs
With ICOs (Initial Coin Offerings) being the current talking point of the cryptocurrency and blockchain world, there is no shortage of projects out there competing for your investment. Navigating them can be a minefield – many ICOs have turned out to be frauds – but there is value to be found too. How do you tell the difference? This article will explain how to choose an ICO, understand the different types of tokens, how to spot a scam ICO and will briefly explain the ICO regulations – or lack of them – in the UK.
The first place to start is the same as with any investment; determine your own appetite to risk. How much are you prepared to invest? How much are you willing to lose if things go wrong? ICOs are undeniably risky, so what kind of reward do you expect from an investment to justify the risk? Considering these questions will help you to avoid being swept away in the excitement when you come across what seems to be a dream ICO.
The team and the pitch
When you find an ICO that might be of interest, you should take several steps. Look at the overall quality of the ICO website and its white paper. Does it look professional? Is it well-written? Are the ideas clearly expressed or do they seem confusing and needlessly complex? Are the stats included reputable and do they make sense? All these things will help you to develop a gut instinct about a project.
Next, look at the team involved. If no team is mentioned then that is a red flag. What you want to see is the names, job titles and backgrounds of all the key staff members, plus some links that might help you verify their identities. Look for their social media and LinkedIn profiles if links are not provided. Photos can be helpful too because you can cross-reference them with search engine results to be sure that they are real people.
Beyond establishing that the team is real, you should consider whether their experience and expertise give you confidence that the project will be successful. At least one person, ideally the CTO, should have cryptocurrency expertise, but you also want to see expertise in the sector the ICO is tackling, plus a level of experience that suggests these people have successfully managed challenging projects before.
Considering the idea
Read the white paper to understand the idea behind the ICO. Is the team tackling a genuine problem that really needs the blockchain and a new cryptocurrency? Many ICOs simply take an existing idea and add blockchain to it because of the excitement around the technology, but without a real need then the chance of success is limited.
It also helps if the idea is a new one. There are lots of ‘me too’ concepts in the ICO space and most will fail simply because there isn’t room for them all. Picking an ICO that has a new idea to tackle a genuine need is a strong recipe for success. Has the team provided a proof of concept or case studies? If so, check that it does indeed prove the concept. If none is provided then ask yourself why.
Then consider the target market. Who is the ICO targeting and is it an audience that is large enough for the idea to succeed and receptive enough to make it work? Without users or customers, the best idea is doomed. Likewise, look at the community around the ICO; is it large and active?
Coins and tokens
As well as transparency about the team, you should also expect transparency about the fund or finances of the ICO and the tokens you will receive. What are the kind of tokens in an ICO? There are several types.
1) The kind that most people are familiar with is a digital currency. This is something that has a value and can be used as a medium of exchange. If that’s the case, then make sure you know where it can be exchanged and what value it is likely to have. There are a lot of digital currencies out there competing for users. What makes this one different or better?
2) The second type of token is a security, which is like a share in a company – the kind you would receive in an initial public offering (IPO). There are two complicating factors here: first, securities are regulated in many countries, such as the US, so you need to ensure that you and the ICO are compliant. Few regulators have definitively stated that ICOs fall under their control, but you should be aware that they might. Second, a traditional share in a company might come with certain things such as voting rights or dividends. One thing it will do is give you rights as a part owner of the business. Does the ICO token give you these rights and, if so, how are they guaranteed?
3) A third kind of token is one that provides a utility, such as the right to use the company’s service, subscribe to an app or play a game. If you are treating the token as an investment, then you might consider how likely such a token is to increase in value.
4) Then there’s a token that is a digital reputation of a physical asset or product, for example gold. This is less attractive for many, since you are really investing in the value of the physical thing, which is less likely to increase at the same rate as many ICO tokens. What’s more, in many cases, you might be able to invest in the physical thing without the ICO’s involvement, so it’s worth asking whether the ICO is really providing an essential service. Once again, you will have to weigh up the claims made in the white paper to decide that.
5) Finally, there’s the token that acts as a reward or gives you status in the community. This is symbolic and hard to value, which again makes it less attractive as an investment.
ICOs are unregulated, which means they are a target for scammers. Those investors who are easily blinded by the chance to make a quick profit are lured in and then the scammers make off with the money. Recently, the team behind Pincoin vanished with $660m raised from around 32,000 people. Investors had been promised a mind-boggling 48 per cent return per month.
Pincoin’s website and white paper looked slick and well-produced, so they will have passed the ‘gut’ test for many potential investors. However, there were red flags: there was no information on the team behind Pincoin and no detail on what the ICO was for or what the company would do. Anyone who took the trouble to examine the pitch carefully would have found enough to make them suspicious.
Other than the above, there are a few other signs that might signify a scam ICO. Look at the distribution scheme for the tokens. Are the founders reserving a lot of pre-mined tokens for themselves? That suggests a short-term outlook that, while not necessarily evidence of a scam, does mean the investment will be less successful for anyone other than early investors.
Are there multiple tiers of investment? Is there a reward for bringing in new investors? The latter was a trick employed by Pincoin and is a clear warning of a pyramid scheme – a fraudulent investment scheme where the returns for older members are drawn from the investment of new members. This model always collapses because it quickly runs out of new members to provide the money the system needs.
Typically, ICOs will hold the money raised in escrow – a central, independent service that looks after the money until the transaction is completed. This should ensure that the team behind the ICO cannot access the money until certain goals have been met. Often, this is done by having one team member and two community members hold keys to a digital currency wallet that can be accessed only with two of the three keys. However, there have been instances where the team have ensured that, unknown to the community, they control two keys, such as by setting up a fake ‘neutral third party’.
Examining the details of an escrow system might seem like a lot of effort but remember that ICOs are unregulated, which means that you must do the due diligence that would usually be carried out by a regulatory body. If you don’t, then you are increasing your risk.
However, since you are already on CoinSchedule, you might be aware that we can help. The ICOs listed on our website all have a Trust Score, which is awarded by a proprietary algorithm developed by CoinSchedule. This considers factors such as KYC (Know Your Customer) data, profile information, links and other metrics to award a score from A to E, with A being the best. The Trust Score should not replace your own due diligence, but it is a useful tool to help your decision making.
As has been mentioned already, ICOs are unregulated in most parts of the world. They are banned in China and South Korea and extremely difficult to run in Russia. In many other parts of the world regulators have said that they are watching closely, and regulations are likely to be on the way.
The UK’s Financial Conduct Authority (FCA) issued a statement in September 2017 saying that it was “keeping a close eye” on ICOs. It argues that because of parallels with IPOs, ICOs are likely to fall under the FCA’s jurisdiction and be considered securities in future.
However, the FCA concluded that whether an ICO falls under its jurisdiction can only be decided “case by case”. It settled for warning consumers of the possibility of fraud, lack of investor protection and price volatility, among other concerns. “There is a good chance of losing your whole stake,” the organisation warned.
Nevertheless, if you have absorbed the warning that you have little protection from fraud, then for the moment at least there are no regulatory hurdles facing you as an investor in ICOs. However, this is a situation that is changing quickly and anyone investing in the space is advised to keep monitoring announcements from regulators.