Good or bad investments: What to look for in an ICO

Are initial coin offerings (ICO) on their way to replace traditional VC funding for startups? Well, you shouldn’t hold your breath. Currently, they are still a niche option for tech-savvy investors who are willing and able to do their own due diligence. And while traditional investments are not risk-free, ICOs are significantly more risky in at least one respect: The likelihood that the ICO team will just take your funds and run.

But, as they say: no pain, no gain. If you feel you can accept a somewhat higher level of risk than in traditional currencies (or fiat currencies, in crypto-speak), then taking part in a promising ICO can be an interesting addition to your portfolio.  

And there are certain steps that you can take to alleviate the risks that come with investing in an ICO. I will point out a few aspects that you should consider. (As a side note: I will not discuss the legal aspects of ICOs—these depend on your and the startup’s respective country of residence.)

To gain a good understanding of an ICO’s prospects, take into account the following sources of information:

• Project website

• Blog (on the website or other channels such as medium.com)

• Whitepaper (usually on the website)

• Social media: Twitter, Bitcointalk.org, Reddit, Steemit, the project’s Slack channel

• ICO trackers and rating sites

How far has the project advanced?

Since as an outside investor you don’t get any direct insight into the project, you have to take the publicly available materials as a surrogate marker of the current stage of the project.

The website, for example: When the ICO is starting, the information on the website should be complete—“lorem ipsum” is a bad sign. Profiles of team members should be complete. A sure sign of a project that is only in its early stages is the absence of technical team members—developers and the like. In these cases, often the whitepaper lacks substance as well (see below). This means that it is too early for an investment decision—check back later, if at all.

Does the project have active Twitter and other social media profiles? A discussion thread on Bitcointalk.org? Check out these as well. Note that not everything written about a project on social media is unbiased—most ICO teams run so-called bounty campaigns in which individuals with large followings on social media receive a share of the tokens if they promote the ICO.

If you find an ICO by a company that already has a working product or service, you can consider yourself lucky. These companies have proven that they can deliver, their team has demonstrated that they can work together without killing each other, and thus their chances of further succeeding after the ICO are higher than those of teams with just an idea or a prototype.

Does the whitepaper have substance?

Most importantly, the project’s whitepaper should be complete. Over the course of the last few years, the typical whitepaper has evolved (or some may say, degenerated) from an academic-style document, set in simple LaTeX, heavy on the underlying maths, to the equivalent of a glossy investment marketing brochure and prospectus.

While there is nothing inherently wrong with a bit of color and a few fancy infographics, be wary if you notice that the whitepaper is lacking substance. What does that mean? Current whitepapers often begin with a bit of fluff: What is the founders’ vision, why does the market urgently need their solution, etc. These are in fact important pieces of information, and if the founders can convey them in an accessible and convincing manner, all the better.

The project’s whitepaper should have complete technical, business and investment details.  (Source)

However, the real substance of a whitepaper is in the technical, business and investment details. How do their smart contracts work? What is their technological basis, are they ERC-20 compatible? How are they integrated into the business logic? If the whitepaper doesn’t convincingly explain why the business needs the Blockchain and a token, this does not bode well for the future of the project.

What is the timeframe of the ICO? How much will be raised, and how will the funds be used? A definite maximum of raised funds is called a hard cap. It makes sure that after the ICO, there will be a limited amount of tokens in the world, which usually means that your chances of seeing an increase in value for your tokens are higher.

The whitepaper should explicitly say which percentage of tokens are reserved for whom. Founders should not The founders should also explain as detailed as possible how (and in which percentages) they are going to use the raised funds—for example, development of a desktop app, or geographical expansion of the user base. “Taking a nice long vacation” should not be on the list.

Does the team have a track record?

As mentioned above, previous success is not a guarantee for past success, but somewhat of a soft predictor. So, look at the team’s profiles on the website and check if they have been (provably) involved in prior successes in the crypto world, and if they have solid achievements in other fields, like academia or entrepreneurship. Successful people can fail, too—but someone who has no known track record in the crypto world or the conventional business world is more likely to fail.

If possible, find out if the team members have worked together on previous projects. If the ICO is done by a pre-existing company with a real product, this question will answer itself. Otherwise, you may have to do a bit of googling or just ask the team members. If important founding members have been hired remotely, specifically for this project, they may not work together as well as longstanding business partners. And a word about senior advisors: They’re nice, but not important.

If you take these aspects into consideration when evaluating an ICO investment opportunity, you still won’t be able to eliminate all of the risk—but you can avoid the most obvious of traps. Keep in mind that with this article, I am not endorsing any specific ICO or giving any kind of investment advice—this should only serve as a starting point for you to do your own research. Good luck!

—

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.