Due Diligence Steps for Crypto Investments

According to leading cryptocurrency price aggregator, CoinMarketCap, there are more than 1,600 digital currencies available as of this time. In reality, there are probably many more than that in existence, as not all of them will have made their way to the price monitoring site.

While many of these cryptocurrencies are attempting to innovate and seek out a niche in the crowded marketplace, others are simply fronts for developers looking to make quick money off gullible investors—still others are outright scams. How does an investor take advantage of the incredible opportunities within the digital currency space while at the same time protect herself against these bad bets? Following the due diligence checklist below is an important part of the process.

Survey the Model

If you've identified a potential cryptocurrency investment, one of the first steps you should take is to research the business model. Look to the company's white paper and see if it holds up under scrutiny. Does the model allow for scalability? Is the timeline for development, launch and expansion reasonable? Are there glaring holes or issues with the developers' plan? Is the business model strong but one of many similar plans in a crowded market? Some cryptocurrencies are copycat strategies that may not be able to set themselves apart.

How's the Team?

In exploring the offerings' white paper and website, look to the development team as well. It pays to take the time to research the members of the team. In some cases, digital token websites have listed "team members" who are not actually involved with the project, while in other cases companies have fabricated individuals completely. Are the team members and their positions on the project real? Beyond that, are they qualified to deliver what they claim to be able to do? You may even wish to do a Google image search for pictures of team members to see if those photos were taken from another site.

Beyond that, you'll want to try to assess whether the team is large enough to tackle the project at hand. Are there any areas that don't seem to be covered by team members? This could spell doom for a project later on.

Partnerships, ICOs and Profits

A hallmark of the digital currency community is partnerships between individuals and ventures. While these can be extremely helpful, they can also lend false credibility to a project that doesn't have the fundamental elements necessary for success. Look into any listed partners to see if the collaborations seem legitimate and if they are actually useful to the project.

Many tokens launch via an initial coin offering (ICO). Look over the plan for the ICO carefully. Does it seem to extend for longer than necessary? Does it promise profits? Are there any glaring omissions when it comes to how the process works? Companies should endeavor to be as transparent about the ICO process as possible.

Finally, you may wish to look into the strength of the company's community within the cryptocurrency space. While it's important to approach this aspect of the research process with a bit of skepticism (as anonymous comments online are not the most reliable sources, for instance), this can be a useful way of determining if there is significant buzz about the project. Are individuals able to provide ideas and feedback? If not, that may be a red flag. Look for members of the team being involved in conversations with the larger community as a good sign.

While there is no guarantee that taking the steps above will protect you fully from a digital currency scam, it is likely to help weed out any potentially bad bets before you make them.

Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns bitcoin and ripple.

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