ICO Red Flags Every Investor Must Know
The Wild West was child’s play compared to the ICO market. If you do not properly vet projects, you are going to get taken advantage of.
The purpose of this article is to help you (an innovative investor) to avoid scams and sticky situations, specifically as it relates to ICOs (Initial Coin Offerings) or Token Generation Events.
Investing in ICOs and navigating the multitude of scammers requires a keen ability to decipher fact from fiction. When I first started investing in crypto, I was very undisciplined and flung money around into every ICO with a decent looking logo.
I began making a list of red flags to vet every project I would consider investing in. I’ve saved significant amounts of time and allocated my capital much more efficiently. I will share this with you.
But first…
Let’s begin with a story.
The scene is Blockchain Cruise 2018. We were sailing the Pacific Ocean with 800 other crypto fanatics on one cruise ship.
There were many of the top trailblazers in crypto, the people you want to know and meet.
A colleague of mine on this trip was engaging with an entrepreneur, let’s call him Bill, who was casually pitching the pre-sale of his ICO as we were waiting in line to board the ship.
Somehow the conversation shifts to the casino, to which Bill says “Don’t mention my name at any casino, I ripped them off for $21 million at the roulette tables!”
Putting aside the feasibility of angling for an edge at a roulette table, under what circumstances would it ever be a good idea to tell someone you are asking for money that you have stolen significant amounts of money?
On board the cruise ship was a casino. That night we laughed as we saw Bill holding court at a roulette table.
So clearly I would never want to invest in a project led by Bill. We can laugh about this but Bill’s project raised $6m in an ICO pre-sale.
Unfortunately for us not all bad actors are so easily spotted. Increasingly, scammers are using more sophisticated methods of luring in novice crypto investors. Many projects are launched specifically to deceive investors and take advantage of an unregulated, frothy capital market.
So how can we protect ourselves against those very ICO projects which were engineered to deceive you and get you to hand over your Bitcoin or Ether?
Here are tell tale red flags when assessing any crypto investment opportunity:
Token Economics (Large Reserves/Ability to Create More)
- One of the first graphics I always flip to in a white paper is the breakdown of the token economics, an allocation table that resembles a cap table.
- The most glaring red flags revolve around excessively large reserves and team allocations. In both such cases, such large allocations inhibit the decentralization of a network.
- Unless there is a specific rationale behind a large reserve, in many cases this creates uncertainty on the part of the investor and the looming question always shifts to dilution. Ripple, although they locked up a significant chunk of their reserves, is an example of such. Ripple’s organization will have access to an exorbitantly large quantity of Ripple (“XRP”) tokens over the course of the next decade. Ultimately this will dilute XRP holders.
- Bonuses are great, but how good is the bonus I am getting relative to the people who are putting money in before and after me?
- If I receive a 20% bonus on my contribution to an ICO but the pre-sale investors got an 80% bonus two weeks ago…does the math still make sense to make this investment?
Why do You Need a Token?
- The short answer is that most projects do not need their own token. In fact, for their users it would likely be easier to use Bitcoin or Ether, rather than the coin they produced.
- Unfortunately the economic incentives are such that projects can raise enormous amounts of capital by creating a token, whether or not the token is necessary. So most projects say why not…
Lack of Quality Developers
- This is one of the lessons that I had to learn the hard way.
- Blockchain engineers are one of the scarcest resources in the labor market today, with most competent solidity engineers having their choice of projects to join.
- Most decentralized projects require a small army of developers, capable of handling a wide variety of architecture and software updates.
- Check out the GitHub activity on any particular project. Even if the code looks like gibberish to you, take notice of the level of activity and frequency of updates. This is invaluable information. It lets you know dedicatied and robust the development team is.
- Ultimately the underlying technology is arguably the most crucial component of any projects ability to succeed. Without sufficient support in this area, most projects are doomed from the beginning.
No Beta, No Demos & No Code
- One of the most relevant risks associated with early-stage investing is product risk. Can the team execute on the product they say they will?
- If there is no working product, no blockchain and the code hasn’t yet been written…then there is another enormous layer of risk right at the beginning of the journey.
- There are some scenarios where this could be the case. There better be an absolute all-star team, vision & market opportunity to make up for lack of any development by the stage of a public ICO.
- Even if it is a very basic beta version of the network, the ability for a team to deliver some semblance of a product prior to the ICO tells me that they can execute.
Unusually Small Community
- Check out the project’s following on Telegram, Reddit & Others
- Simply joining such groups and observing the level of interaction among the community can tell you whether the project will have the adoption necessary to develop a robust ecosystem.
- Recently projects have offered airdrops as a way to supplement their communities. In certain instances, I’ve seen Telegram channels go from 10–15 followers to several thousand overnight simply by giving away free tokens.
- The innovative investor will be able to cut through the noise. If all of the buzz in the channel is about claiming tokens and not focused on the underlying product, its safe to assume people are not truly interested in the project as much as cashing in on a few satoshis.
Incomplete or Incorrect Information on Team & Project
- Although there are more social & networking platforms than any of us can ever sign up for, it is inexcusable for an executive team member of an ICO not to have a thorough profile on either: Linkedin, AngelList, GitHub, Earn.co, etc.
- If you can’t leverage free tools to grow your network, then I am scared of what you will spend money on to try to compensate for that.
- The same goes on the project side. If a team is promising to build a next-generation platform but they can’t even get a clean website or Twitter profile together, then you really need to ask yourself if they are going to be able to execute.
- One practice I like to use is to do a 5 page google search on every team member involved in a project. You would be surprised how much time you can save in vetting projects by doing this.
- To be clear I have not had this happen but to me there is nothing worse than investing hard-earned dollars with a founder who failed to mention his felony fraud conviction.
- There have been many projects that will list a high profile crypto individual as an investor or advisor on a project, who actually has no engagement with the project. Reach out and don’t be afraid to follow up with that person. Check online forums to confirm that the aforementioned person is actually involved in the project.
Ponzi Scheme Model
- Duh right? Unfortunately this is a common theme that pops up in the crypto ecosystem. In the past 6 months alone, projects like BitConnect & OrmeusCoin have been exposed as being ponzi-type operations.
- The tell-tale sign of such a scheme is that initial investors are paid according to the ability to recruit and consistently bring in new investors. Unfortunately, this facet sometimes blurs the line and inexperienced investors overlook such promises in the face of parabolic price growth.
- These projects are ruthless in their tactics. Bots, false stories published, slandering and making fake Twitter look-alike accounts. Quite simply these projects pay off anyone willing to carry their gospel and get others to pile in…unfortunately when the music stops, we all know what happens. If not you can ask Bernie Madoff.
“Decentralized & Blockchain”…Real or Just Buzzwords?
- What benefit does this decentralized network running on its own unique crypto-asset bring that could not be done as efficiently otherwise?
- If you cannot get a clear answer to the aformentioned question, then pass on that project.
- Example of a good answer…Removing middlemen for trustless peer-to-peer (“P2P”) transactions are generally. This makes a lot of sense in something like sports betting, where a bookie takes 10% from each bettor. Therefore, a crypto-asset which facilitates P2P sports betting delivers value in terms of lower fees.
- Unfortunately most of the projects that pitch de-centralization are doing so because they are seeking funding. In practice, de-centralization does not work for most business models.
- The truth is most blockchains remain highly centralized. This is not a knock or a jab but just an observation. Therefore, when a project markets itself as “a decentralized (insert platform)” the questions you have to ask yourself are:
- Will this truly be a de-centralized network? Or is the team just using a buzzword?
- What happens if the blockchain remains highly centralized? This has been an issue for some crypto-assets and not for others.
As always I appreciate any feedback and am looking forward to learning from all of you!
Tom is the CEO of Blockstake, a digital infrastructure provider for blockchain and cryptoassets. Tom also serves as a founding board member of Blockchain Compliance Alliance. You can connect with him on LinkedIn.
