ICO Due Diligence: ICOs and Sudden Wealth Syndrome
by Nirav Gala
ICOs have continued their momentum and we are seeing a flurry of ICO that have hit the market in the first month of the year 2018 notwithstanding the crackdown by securities regulators worldwide and class action suits filed by US investors. Newer players have become more cautious and they are altogether avoiding marketing ICOs to US based investors.
But the reality still is that ICOs are not same as IPOs, and they do not provide the same level of protection to investors as the Securities Laws. Currently there is no mechanism to hold the companies staging ICOs accountable for things they say and for fulfilling the promises they make. Hence, it becomes although more important for investors to conduct proper due diligence on ICOs and ask right questions to find out whether ICOs are worthy of their money.
Starting today I plan to publish a series on how to conduct due diligence on ICOs and what questions to ask. Being in Hong Kong provides me an opportunity to meet a lot of companies, who are marketing their ICOs in Hong Kong, every week. So, these insights are based on actual conversations I have with them and my evaluation of these conversations.
ICOs and Sudden Wealth Syndrome
In past few months many companies, who have staged an ICO, have seen the value of the crypto-currencies (BTC and ETH) raised by them grow manifold (on paper of course) which has suddenly increased the amount of funds available at their disposal. This has led many new companies staging ICO to believe that even they could benefit from the appreciation in prices of crypto-currencies. Many of them are planning to hold on to the crypto-currencies, as they think it’s a wise thing to do. Some really adventurous companies also plan to give them to crypto hedge funds to make them more money on the money already raised.
I am unimpressed and it made me wonder that why would companies, who appear to be so passionate about their projects and have worked so hard to raise money, want to do this. It would be highly imprudent to hold on to a very volatile currency as sudden drop in prices could jeopardize the entire project. After further research, I found out that this tendency is not uncommon and it’s called the “Sudden Wealth Syndrome”. This term was coined by psychologist Stephen Goldbart to describe the stress, guilt, social isolation and confusion that often accompanies a giant windfall. This can often lead to people making risky investment decision which have often lead to disastrous consequences.
Securities Laws have strict rules which prevent companies raising public money from diverting the funds raised for purposes other than the ones stated in the offering document. The sole to reason of doing that is to prevent the irrational decision making which often accompanies sudden receipt of large amounts of money and to ensure that the project for which the money was raised see the light of the day. Similar practices need to be introduced even for the ICOs so that the innovative projects for which the funds are raised do actually see the light of the day and are not gambled away by betting on volatile crypto-currencies. A potential solution to this can be DAICO where funds raised are locked in a smart contract and are gradually released only on hitting certain milestones. Of course, for this to happen there is a need to develop stable crypto-currencies which would protect the funds raised against volatility in other crypto-currencies.
ICO advisors need to play an active role here to counsel the companies they advise to adopt prudent risk management policies to protect the funds raised against extreme volatility. Also, the investors in ICO need to publicly condemn imprudent practices and require companies they invest in to adopt prudent risk management policies. Until this happens, investors need to be really cautious about investing in ICOs which raise a lot of money quickly and whose founders want to park the proceeds of ICOs with crypto hedge funds.
Please do let me know in the comments section your views on this phenomenon and also feel free to share any such interesting conversations that you may have come across.
