Initial coin offerings (ICOs), innovative sales that allow investors to purchase newly created digital tokens, have proliferated as digital currencies have risen in popularity. Entrepreneurs have used these offerings to raise money by issuing digital tokens.
For some investors, certain token sales have provided very impressive returns of up to 50,000%. While these figures may seem impressive, many of these token sales fail, and some are outright scams. According to TokenData, more than half of the ICOs that took place in 2017 were failures.
Other research has also produced concerning results. For example, in an inquiry conducted by Bitcoin Market Journal, it was found that 58% of ICOs studied did not report their funding figures, which could indicate failure.
Because there is an abundance of these token sales, and many of them do not succeed, picking out the right ones can be daunting. Fortunately, a wide range of investors, analysts and market experts have weighed in on the subject, providing best practices for evaluating ICOs.
For starters, investors should be sceptical. There are many entrepreneurs who claim that their project will change the world. Of course, not all of these claims will come true. By fostering a healthy scepticism, investors can avoid putting their hard-earned money in to startups that have not fully fleshed out their ideas.
Performing one's due diligence is crucial. Risk is inherent to investment, so conducting thorough research can mean the difference between meeting one's investment goals and not.
In fact, "Do Your Own Research" (DYOR) has become an industry term of sorts, and numerous market observers have thrown their hat in to the ring by offering how-to guides.
One easy way to analyse an ICO is to simply construct a checklist of key variables and then examine them one by one.
The team is a variable that is repeatedly singled out as being crucial to a token sale's success. When looking at this key component, an investor should be able to answer questions like:
- What is the background of the team members?
- Do they have experience in the industry?
- Have they established a track record of success?
Companies should provide elaborate detail on their team members, and investors should confirm that the information is there before putting their money in to a venture.
Tim Enneking, managing director of a digital currency hedge fund that invests in ICOs, has provided more specific guidance on the matter. He maintains that investors should look for teams that not only have a strong track record, but that have built up experience in the market they are looking to target.
When it comes to vetting team members, it can be very helpful to dig deep by looking at their previous projects, websites and social networks. This can help provide a better sense of their background, specifically the people they have known and the work they have done.
Another key variable is the actual idea behind the ICO, and you can determine this by answering the following questions:
- Does the company's plan sound credible?
- How big is the market that the token sale is looking to address?
- Have the entrepreneurs developed a minimum viable product (MVP)?
- Has this MVP been developed to the point where it can be used to solve the problem that the project aims to address?
Another valid concern is how an organisation holding an ICO needs the blockchain—and also digital tokens—for its project (or intended project) to work effectively. This is worth checking out because many companies have been riding on the success of the blockchain.
In other words, these organisations have leveraged the widespread visibility of the blockchain and digital currency to draw interest. If a company is holding an ICO but does not, in fact, need these technologies to function, it may be wise to skip their token sale completely.
Whitepapers frequently contain many important details on a project. This document will likely include the idea behind the project, the underlying technology and also how the token sale will work. The details surrounding sales of digital tokens are frequently complicated, and may require the more in-depth nature provided by a whitepaper to explain.
When considering an ICO, investors should carefully read the whitepaper associated with that particular token sale. The presentation of this document is important. Another important detail is the actual writing, because typos and poor grammar can serve as red flags—and that an ICO should be avoided.
Before reading a whitepaper, investors should have a basic understanding of blockchain technology. The blockchain is a distributed ledger system that was designed to be both decentralised and immutable, and it provides the foundation for the majority of digital currencies.
Some projects will provide more than one whitepaper, including one providing generalised information and another offering more technical information. Ethereum, a platform that can be used to build decentralised applications (DApps) that harness smart contracts, has both.
If an ICO's whitepaper (or whitepapers) fail to provide detailed information on the project involved in the token sale, it could be a red flag.
Token Sale Details
To further sniff out causes for concern, peruse the details associated with a token sale, such as:
- How many tokens does this ICO plan to issue?
- How will they be priced?
- What currencies can investors use to buy them?
If the ICO is planning on having a large number of digital tokens in circulation, and giving them a lofty valuation, it could indicate that the entrepreneurs behind the project have goals that will not likely be met. Investors should also look at what fraction of tokens will go to the team, as this can be quite telling.
Further, if an ICO promises sky-high returns, that is a perfect example of a red flag. The U.S. Securities and Exchange Commission (SEC) actually created a website designed to mimic questionable token sales, and one of the draws it mentions is "guaranteed returns."
Companies holding ICOs usually provide roadmaps that outline their future plans and make it easy for investors to understand how they expect their project to progress.
A clear roadmap is a positive sign, whereas a company that is holding a token sale without providing this information could be a red flag. More specifically, organisations that do not supply a roadmap could be looking to raise money without focusing on creating and following a long-term plan.
Another important variable to examine is the community surrounding a digital token sale. Companies that are holding ICOs should advertise through varying channels in which potential investors can reach out.
If the entrepreneurs holding a token sale, for example, have a Facebook page and a Twitter handle, that certainly helps. Another popular medium for communication is Telegram, and many companies holding ICOs use it to communicate with potential investors. Obviously enough, the responsiveness of these social media handles is quite important.
If a company or project's social media handles are not responsive, it is not a good sign. This could mean that they either don't have the money to hire moderators or the handles have names but no substance behind them.
Another important consideration is an ICO's GitHub page, which can provide some insight into how active its development community really is.
Before investing in an ICO, an interested party should determine which token sales are competitors and take a look at those options. If other organisations are offering similar solutions, investors should analyse the varying ICOs to see what sets them apart from the competition.
ICOs have drawn strong interest from investors, allowing companies to raise billions of dollars by using these innovative sales. Further, some of them have provided very promising returns for investors.
However, many ICOs fails, and some of them are outright scams. As a result, investors can benefit greatly from conducting thorough due diligence. This effort can greatly reduce their chances of buying in to a bad ICO.
Fortunately, many analysts, market observers and other experts have provided guidance on the matter, offering steps that investors can take in order to vet digital token sales.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…