6 Little-Known Facts About ICOs To Keep In Mind When Investing

Cryptocurrencies are here to stay, and it is only a matter of time before it breaks into the mainstream. What you might not know is that the total value of all bitcoins in circulation, which currently stands at more than $100 billion, is now larger than the stocks of Goldman Sachs and Morgan Stanley. Mind-blowing.

And while bitcoin is still the most valuable cryptocurrency, the rise of Ethereum and the new way of funding projects that comes with it (yes, we’re talking about ICOs), the narrative is shifting somewhat towards the entire crypto asset class.

Both established companies and entirely new blockchain-based startups can use ICOs to solicit interest from crypto enthusiasts and build new crypto products relatively quickly.

However, as a new tool, ICOs have some aspects that are less explored in the wider media landscape. Let’s look at the six little-known facts that shine some light on the darker side of ICOs.

Any “body” can hold ICOs

One of the most interesting characteristics of an ICO is that any “body” can use this method of raising funds — be it an individual, partnership, a company, or even a Decentralized Anonymous Organisation. As long as the team (or the person) behind the ICO have the technical capacity to create tokens, no inherent restriction could deny them the opportunity to crowdsource a blockchain venture. Additionally, the people running the ICO are not required to identify themselves (and neither are the investors).

The first DAO has already died. Launched in April, 2016, the first DAO, simply called “The DAO”, attracted more than 11,000 investors who contributed more than $150 million worth of ether to the ICO. The project was a smart contract system built on Ethereum and was meant to function as a community-managed venture fund. Sadly, The DAO got hacked, and the project ended after a hard fork was executed to retrieve the lost funds.

Tokens can be very different

The blockchain technology is still very young, and our knowledge about tokens and how we differentiate them is still limited. Every new blockchain and every new application layer will bring about something new, requiring us to reshuffle our thinking. Yet, currently, there are a few ways how to differentiate between tokens.

Native, Intrinsic or Built-in Tokens

These tokens are native to the blockchain, with the best examples being bitcoin and ether. Technical characteristics aside, these are digital currencies, in which encryption techniques are used to regulate the issuance of currency units and verify the transfer of funds.

Native tokens serve a dual purpose: a) as block validation incentives (“miner rewards”); and b) as transaction spam prevention. The logic that supports this is that if all transactions are paid, it limits its potential for spam.

Application or Utility Tokens

The application tokens work on Ethereum and can be easily issued on the application layer through smart contracts. They’re often called complex dApp tokens or complex DAO tokens. These tokens are services or units of services that can be purchased. The simplest way to put them in some context is to look at utility tokens as API keys used to access the service. Utility tokens represent a way to fund projects and are sold in token sales (ICOs) in exchange for digital currencies.

Asset-backed Tokens (and can be Tokenised Securities)

These tokens are the digital equivalent to physical assets. They can be issued onto a blockchain by a company for later redemption. All transactions of these tokens being passed between people are recorded on the blockchain. To claim the asset, the token owner sends it to the issuer, and the issuer sends back the asset.

It’s important to note that tokens can represent any asset: an insurance policy, a fiat currency (dollar, pound, euro, etc.), a promise of a product during a crowdsale, and more.

Red flags exist

When it comes to ICOs, the typical conversation concerns picking out the “right” (potentially most successful) token launch. And no one seems to be talking about the less sexy but equally important — or maybe even more so — aspect of not falling for a scam. It is becoming apparent that the recent “cryptomania” has attracted a wide range of individuals, from those truly in awe of the new technology, to opportunistic con artists keen on making a quick profit. Are there any warning signs you should look out for? Yes, but they are very subtle.

• Lack of publicity. There could be several possible reasons causing the lack of publicity: a) the project is still very fresh and the media hasn’t picked up on it yet; b) the project is not very interesting or has little potential; c) the team behind the ICO doesn’t want the publicity to avoid being snuffed out. As just one piece of a puzzle, this factor will give you more insight when you combine with other red flags (see below).
• Not disclosing the team. While the team running the ICO isn’t actually required to identify themselves, it is more than cheeky to ask for funding without even showing your face. It should immediately be a scorching-hot red flag. Is the team hiding because they are not qualified for the job? Or are they linked to past crypto scams? Don’t follow the crowd, follow your research.
• Poorly written whitepaper. Do you think VCs would invest in a startup that fails to deliver an effective pitch? Or worse — uses someone else’s pitch to get the money? The whitepaper is the ICOs opportunity to shine and convince you to back them with your own assets. Don’t take the poor quality too lightly. If the team can’t be bothered to write a well-researched white paper, why should you bother reading it?

None of these factors screams “scam” if you look at them in isolation. But if you combine all the bits of information available to you and step back to look at the bigger picture, you should be able to identify dodgy ICOs from a mile away.

ICOs are not legal everywhere

China was the first in line to ban ICOs, stating that the fundraising method has “seriously disrupted the economic and financial order.” A committee led by China’s central bank is due to inspect 60 cryptocurrency exchanges and produce a report. In the meantime, ICOs are illegal in China.

The drastic measure was driven by concerns that some ICOs are financial scams and pyramid schemes. The Chinese companies are believed to have raised $383 million from 105,000 investors during the first half of the year.

A recent warning from Singapore’s central bank echoes the same considerations:

“ICOs are vulnerable to money laundering and terrorist financing risks due to the anonymous nature of the transactions, and the ease with which large sums of monies may be raised in a short period of time.”

While Singapore has not taken any legal action yet, South Korea has followed in close footsteps behind China banning ICO token sales in the country. South Korea’s financial regulator decided to ban ICOs as a fundraising tool as the government believes it contributes to such issues as increasing financial scams. “Raising funds through ICOs seem to be on the rise globally, and our assessment is that ICOs are increasing in South Korea as well,” the regulator said to Reuters. “There is a situation where money has been flooded into an unproductive and speculative direction,” Kim Yong-beom, vice chairman of the FSC added.

Tokens could be securities

There’s been quite a bit of confusion shrouding the utility token issued during ICOs, since the SEC announced that any token that can’t pass the Howey test should be considered a security and fall under the 1934 Security Exchange Act. The Howey test consists of the following questions:

• Is it an investment of money?
• Is it in a common enterprise?
• Are its profits to come solely from the efforts of others?

The general understanding is that if a token is issued to finance a future customer’s purchase, then it should not fall under the definition of securities because its purpose is to facilitate the purchase.

Getting scammed is a possibility

It’s a psychological trick. If you deny the possibility of being scammed, your brain will ignore the warning signs — because we see what is convenient to see. Once you acknowledge to yourself that not all ICOs are world-changing ventures, you will have a better chance of filtering out the Ponzi schemes.

What can you do to kick off in the right direction? First of all, do your research. Use sites like TokenMarket, ICOCountdown, and ICOTracker to gather information about upcoming ICOs. Once you have a list of the token sales that capture your imagination, do some digging to learn more about each company, their team, their token and their roadmap. Get involved in discussions with cryptocurrency enthusiasts on Bitcointalk.org or other reputable forums. Make sure you know everything there is to know about the ICO before departing with your crypto coins.