ICOs are a relatively new, exciting way for Blockchain startups to raise money (why? Read here). Investors have the possibility to support a project from the very start, which was normally reserved for institutional investors. However, investing in an ICO can be very risky, evident by numerous scams.
In 2017, ICOs have raked in over 5.5 billion dollars, around 5 times as much as traditional VC funding in this area. And despite the bearish sentiment within the market over the past few months, the total ICO capital has already broken last year’s record, and it only took 6 months. On the other hand, before you go investing, keep in mind that half of ICOs launched in 2017 failed a few months later.
Not entirely sure what an ICO is? You can read our explanation here.
What to look for in an ICO?
First and foremost, does the company provide a white paper? If not, turn away and never look back. The white paper should include IT protocols (pay attention to the security aspect), blockchain description (Bitcoin, Ethereum, own creation), monetary policy (supply), pricing, token distribution process (as much detail as possible!), and the overall vision of the project.
Even if the company does provide a whitepaper, all is not well (yet). Evaluate the white paper for the things mentioned below, and only then decide whether a given project is a worthwhile investment.
The first question is whether the project actually offers a solution to a problem. Would the stated problem benefit from Blockchain, or can it be solved by conventional methods? Blockchain is not magic, it cannot solve everything. Additionally, does the company really need to create their own coin/token? Furthermore, is the solution original, or does it follow previous projects? Scam ICOs often promote their project by citing Blockchain advantages and stating that they’re better than competitors without going into detail about how their solution is different from the others.
Transparency is another important aspect. The company should provide the code (usually available on Github) of the project, as well as provide all the relevant documents (at least a whitepaper and terms and conditions).
You should be able to find a whitepaper, terms and conditions, and other relevant documentation on the company website. If you have questions, reach out to the team. Perhaps information is missing because the project just started, and the team is finalising relevant information. If the documents are not provided (or are on the thin side with little information) – don’t invest in the project.
Token distribution and monetary policy
Token distribution (and more broadly monetary policy) is a vital determinant for many investors. There has to be sufficient information provided relating to the distribution of tokens – how much will be given to the team, advisors, crowdsale, etc. Will there be a single cap raise, or a two-stage cap raise involving a presale? If there are two stages, can investors sell after presale, or will a waiting period be established? What will the tokens be used for?
Relating to the overall monetary policy: will the project institute buybacks? If so, it may be a positive signal, as buybacks immediately cause deflation (and can stimulate demand) as well as indicate that the team cares about the value of the token (coin).
While companies can price their tokens as they wish, the supply of the coins/tokens should be automated, or at the very least not in the hands of the issuers. In other words, discretionary pricing is fine, but a discretionary monetary policy is a cause for concern (Catalini and Gans, 2018).
What do you get as an investor
Read the white paper to find out what rewards do you get as an investor; the right to access the platform or service, governance (control), a share of profits, etc.
Here you should remember that control should be connected to profit sharing. Why? Should these two be separated, an incentive is created for the voters to vote in their own interests, for actions and decisions beneficial to them rather than the ecosystem as a whole (Conley, 2017).
Checking out a project’s team is a good indicator of success. First, make sure they exist. And by that we mean make sure that the members haven’t stolen identities from some unsuspecting people. You can easily reverse search their images, using for example TinEye.
Moreover, as some people may have told you, size doesn’t matter. While debatable in some contexts, it definitely applies to the ICO environment. On average, the team comprises of 5 people. Very successful ICOs have been launched by groups of less than 10 people. When it comes to the ICO team, it’s quality over quantity. Check out the ICO website for team details, as well as individual member’s LinkedIn. Look for experience. Firstly, how many blockchain developers are there on the team (if there aren’t any, the project may need a closer look). Have team members created similar projects before (if so, were they successful)? Big names on the team (or as advisors) are fine, but beware of stars’ endorsements – they are indicative of how wealthy the company is, rather than how valuable the project is. Naturally, anonymous team members are a huge red flag. There is simply no reason for team members to stay anonymous.
Find out the current stage of the project. Is only a whitepaper available, has proof-of-concept been introduced, or perhaps the company launched other products already? These suggest a good foundation. You may also check out the project’s investors. All this information should be available on the project’s website.
Social Media and communication channels
The team should have at least one or two communication channels available (usually Telegram and GitHub). Research how often the company posts something, and how relevant the content is to the project. Can a potential investor easily reach the team and do they get satisfying answers from them?
You may want to contact the team and schedule a call or a meeting with them, even if you live in another country. The point is to gauge the team’s reaction. If they do not respond to repeated contact requests, if they are not interested in meeting you or fail to provide you with more information, it may indicate that they simply have nothing to show. This is quite subjective, however. Perhaps they don’t want to meet, as they are inundated with contact requests similar to yours. Listen to their reaction, and decide if their response is acceptable to you.
Interestingly, studies (e.g. Rhue, 2018) have suggested that too many links to social media channels may indicate a lower ROI, as it implies that the team is more focused on marketing and creating hype rather than a valuable product. As with the team, it’s quality over quantity.
Check out the reviews and evaluations from several sources
There are numerous online sources that evaluate ICOs, to name a few: ICOindex, Cryptorated, ICObench, and ICO Drops. You can also check out ICO-Check on Github – this community-driven website conducts due diligence on ICOs. You can easily add a project to be evaluated.
Remember to compare several analyses from different sources, as different companies evaluate ICOs differently and based on various indicators. We would also recommend to first broadly evaluate a project on your own (read the white paper and terms and conditions, stalk the team, decide for yourself whether the monetary policy makes sense and the product offered is something original or just reheated from previous projects) and only then search for other opinions. Be aware that there have been instances of rating sites giving excellent reviews to projects that turned out to be a scam (for example, Benebit).
ICO success factors
There have been a few academic studies that focused on quantitatively analysing ICO success factors. It has been found that, interestingly, reputation does not impact the amount raised. Although it does influence long-term success (Rhue, 2018). This could be a reflection of the ICO hype situation where project received capital for apparently no reason, and then later most of them failed. The study suggests that ICO-specific links are valuable, and signal quality (although, as mentioned earlier, too many social media links are not ideal either). Overall, the social and information aspects are the most indicative of an ICO success. Another research (Adhami, Giudici, and Martinazzi, 2018) has suggested that the chances that an ICO will be successful are higher if the code source is available (70% of those ICOs who didn’t share it have failed), when a token presale is organized, and when tokens investors have access to a specific service or share in profits. Interestingly, the numbers suggest that the existence of a white paper is irrelevant, contrary to the availability of the code. This could be due to a fact that, as mentioned earlier, white papers are not legal documents and provide no certification or audit. Furthermore, as there are no established standards for whitepapers, they vary in length and quality.
Few words about regulation
The challenge in regulating ICOs, or many FinTech innovations for that matter, lies in finding the balance between citizen (customer) protection and innovation. Heavy regulations may protect consumers from scams, but also stifle innovation within the space. Furthermore, should a country ban ICOs (or any financial innovation), other countries may take advantage of it.
South Korea has experienced such a missed opportunity. After the country banned ICOs, companies flocked to Singapore. Thus, South Korea missed out on all the taxation revenue (which went to Singapore instead).
Are ICOs legal in my country?
The legal status of ICOs is unsettled at this point. Majority of countries have issued warnings against ICOs and/or stated that (even though there is no clear regulation yet) companies conducting ICOs are expected to conform with contemporary laws (e.g. UK, Germany). China and South Korea have banned ICOs in any form (although since May 2018 we’ve seen some promising signals from South Korea in this regard). Countries which have issued some form of ICO regulation include Australia, US (SEC considers ICO tokens securities, other regulation differs state to state), Switzerland, and Singapore (possibly the most optimistic stance).
You can find updated regulations based on geographical borders online (e.g. Bitlegal). Furthermore, if you’re thinking of ICO investments in the long term, it might be useful for you to follow the relevant regulatory body of your country.
Here are some bullet points to keep in mind when researching ICOs:
- ICOs are unregulated
- Whitepapers are not legal documents (more of a mission statement)
- When it comes to the team and communication channels, it’s quality over quantity
- Red flags: lack of relevant document (or insufficient information therein), inexperienced team, overall lack of transparency, discretionary monetary policy (supply in the hands of issuers), marketing over code
If you’re still unsure what to look for, or whether a given ICO is legit, take a step back and analyse previous ICO scams. You will quickly see several commonalities between them. We have done some of the work for you and came up with a few lessons learned from the some of the biggest ICO scams to date.
Adhami, S., Giudici, G. and Martinazzi, S. (2018). Why Do Businesses Go Crypto? An Empirical Analysis of Initial Coin Offerings. SSRN Electronic Journal.
Catalini, C. and Gans, J. (2018). Initial Coin Offerings and the Value of Crypto Tokens. SSRN Electronic Journal.
Conley, J. P. (2017). Blockchain and the economics of cryptotokens and initial coin offerings. SSRN working paper.
Rhue, L. (2018). Trust is All You Need: An Empirical Exploration of Initial Coin Offerings (ICOs) and ICO Reputation Scores. SSRN Electronic Journal.