Crypto Buyer Beware: How to Avoid Falling for an ICO Scam
The fear of missing out (FOMO) runs rampant in the digital assets universe. With a constant stream of new coins and a 24/7 investment cycle, the market slows down for no one.
This FOMO effect is highly prevalent in the work of ICOs, or Initial Coin Offerings. In fact, these businesses are counting on it.
ICOs are the digital assets equivalent of an Initial Public Offering (IPO) in traditional finance. Investors familiar with the potential returns of IPOs often rush to “cash in” on the ground floor of a new ICO. But are ICOs truly smart investments?
The answer depends on a variety of factors. While ICOs present significant opportunities, they also come with equally significant risks—chief among them, the risk of scams. To navigate this landscape effectively, investors need a solid understanding of how ICOs work.
How Do ICOs Work?
Companies use ICOs to raise funds in a manner similar to IPOs. When you invest in an ICO, you receive the new cryptocurrency being offered. This token may serve a specific function pertaining to the company—such as “in-game currency”—or represent an ownership stake in the company.
How are ICOs Structured, and How Do You Invest?
ICOs generally fall into one of three structures:
- A Static Pool with a pre-set token price and a limited number of tokens available. This structure is used if the issuing company has a specific dollar amount it wants to raise.
- A Dynamic Pool with a dynamic price and a limited number of tokens available. Seeing an ICO with this structure means that the token’s price correlates with the amount of money being raised.
- A Dynamic Pool with a pre-set token price and a dynamic number of tokens available. Under this structure, the price of the token doesn’t change, but the amount of money raised will determine how many tokens are available.
Investors typically use fiat currency or other digital assets to purchase tokens during an ICO. Accompanying the offering is a whitepaper—a document outlining the purpose, goals, and mechanics of the ICO.
Assessing an ICO: What to Watch For
The risk of fraud is much higher with an ICO than with an IPO, primarily because they’re largely unregulated. Quite literally anyone can develop and launch an ICO. That means the level of due diligence potential investors must perform is exponentially greater.
We’ll give our overall take on ICOs down below, but if you’re considering investing your money, here are some things to keep in mind.
The Team’s Track Record
A competent team doesn’t guarantee success, but an inexperienced or dishonest one almost guarantees failure. Verify the team’s credentials and interactions on professional networks like LinkedIn. Beware of fabricated team members or inflated resumes.
Listing on Reputable Exchanges
Again, it’s no guarantee that an ICO has promise, but if the ICO is listed on an American exchange, it’s had at least some minimal due diligence applied to it.
Conversely, the absence of such a listing should raise questions.
The Quality of the Whitepaper
A strong whitepaper should thoroughly address critical elements, including:
- The purpose and concept underpinning the currency
- A clear vision of what success for the currency entails
- The financial model and how it aligns with growth projections
- Competitive differentiators that define its unique market position
Pay close attention to details—errors, vague explanations, or omissions can signal a lack of professionalism or intent. While a whitepaper is a vital component, it is not an infallible indicator of legitimacy. For instance, PlexCoin, a fraudulent venture later shut down by the U.S. Securities and Exchange Commission (1), raised over $15 million based largely on the strength of an impressive but deceptive whitepaper.
Has it Been “Vetted” by the Marketplace?
Marketplace Vetting
Unlike IPOs, ICOs bypass the rigorous scrutiny and trials that traditional public offerings endure. IPOs are tested by time, proven business models, and demonstrated demand for products and services, often undergoing multiple rounds of funding and valuation before reaching the market. ICOs, by contrast, rely on less robust markers of credibility, such as whitepapers, exchange listings, and team credentials.
While these elements can offer some level of insight, they fall far short of the exhaustive evaluations tied to IPOs. As a result, ICOs require investors to approach with heightened skepticism and a critical eye.
Bottom Line: Are ICOs a Solid Investment?
It’s easy to understand the appeal of ICOs. Who among us doesn’t wish we got in on Bitcoin when it was $100? But that in no way means throwing money at any of the dozens of new coins that launch each month is a smart investment.
Institutional investors can afford to take risks, spreading their bets across numerous ICOs in hopes of hitting one big win. Individual investors, however, must approach with caution.
In other words, if you throw enough darts at a board, you might eventually hit a bullseye.
At Bursera, we don’t believe luck is a smart strategy, which is why we’re enormously skeptical of ICOs as wise investments. We would rather pursue consistent and reliable returns for our investors than roll the dice on unproven ICOs and their enormous downside potential.
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(1) “SEC v. PlexCorps, Dominic LaCroix, and Sabrina Paradis-Royer Case No. 17-cv-7007 (CBA) (RML) (E.D.N.Y.),” https://www.sec.gov/enforcement/information-for-harmed-investors/plexcorps