The cryptocurrency world is full of uncertainty, and the risk swings both ways. Many investors and developers are optimistic about the potential of digital currency to disrupt the technology space. On the other hand, some investors have lost fortunes on fraudulent schemes and ill-conceived ideas. Initial coin offerings (ICOs) are a prime example: for every massively successful token launch, there are many projects that have produced nothing but hype and vaporware.
Whether you're a startup founder looking to raise money, or an investor assessing an untested project, it's essential to know what it takes for an ICO to be successful. While it may be hard to spot the next Ethereum, it is much easier to recognize the warning signs of a potential scam.
Investors should always do due diligence before supporting a new company. This is one of the oldest tenets in the financial world, but it nonetheless bears repeating. For novice investors, it's easy to succumb to herd instinct or fear of missing out. When it comes to ICOs, there are at least four things to consider.
- An initial coin offering is a popular way for startup companies to raise funds in exchange for project tokens. While some ICOs have been enormously successful, it's important to recognize the signs of a risky project.
- The first step to researching an ICO is to check the white paper. A vague or poorly written white paper may be a sign that the project is not fully planned out.
- It is also important to investigate the team and any business partnerships. An experienced team will have a stronger chance of navigating the challenges of a competitive business environment.
- Finally, research how the project plans to allocate its tokens. A poorly planned distribution could indicate that the founders lack strategic vision or long-term planning.
The White Paper
First, it's essential to thoroughly read and analyze the white paper of a prospective investment. This is a document that outlines the aims and strategies of that project in detail. Some projects might have stratospheric ideas but lack a practical approach for achieving those goals. Others may lack crucial details that leave you wondering whether the project is truly feasible.
A good white paper is not a guarantee of success, but an incomplete, hastily written, or otherwise problematic one can be a sign of trouble to come. Glaring issues with spelling, formatting, or grammar can also be red flags. Conversely, if you're preparing a white paper for your own ICO, expect investors to pore over every detail.
A white paper should include a basic roadmap that lays out a set of concrete goals, with a clear and reasonable timeline for achieving them. There should also be a succinct vision statement; companies without one may not have sufficient focus to achieve real success.
The Team and Partnerships
Next, take time to research the people leading the project, as well as any partners or advisors. This is one of the most important factors in launching a new startup. Experienced founders are more likely to avoid the pitfalls facing a new business, and reputable partners can be a sign of market validation.
While most companies prominently list their team and partners, it's important to verify their claims from other sources. Some projects have been known to exaggerate the qualifications of their team, or even fabricate nonexistent partnerships.
The Business Case
Research as much as you can about a new business, including the target market, regulatory environment, and any likely competitors. This is another common pitfall: many new startups struggle to stand out, especially if another company has a first-mover advantage. If a startup is trying to launch an ICO in a saturated market, there should be something that sets it apart from the competition.
It is also important to ask what service the company plans to provide and whether there is enough demand to support it. If a company does not have any competitors, that may be a sign that other businesses do not think the model is a profitable one.
ICOs allow companies to fund their projects by selling tokens to access a network or service. Investors buy the tokens hoping that they will gain value after a successful network launch.
In order to understand a token's potential value, you need to understand how and why it will be used. If there is a clear reason for people to own and use the token, the price will likely stabilize after a successful launch. If the main use for a token is market speculation, it may be susceptible to long-term volatility.
It's also important to know how tokens are distributed. Much like an initial public offering, a company holding an ICO should clearly state the maximum coin supply, as well as the number of tokens allocated to founders, early investors, partners, and the company itself. In some cases, there may also be lock-up agreements that prevent the tokens from being sold immediately after the ICO.
Successful offerings need to strike a balance between a fair distribution and budgeting for the future. If a small group of owners controls a large share of the supply, there is a risk to other prospective investors that the price could fall when these owners decide to sell. On the other hand, if a company does not reserve enough tokens in its treasury, it may run into trouble paying future expenses. While there is no single model for token ownership and distribution, you should look for a plan that balances long- and short-term considerations.
The Bottom Line
There are many factors to consider before investing in or launching an ICO. The best way to avoid falling victim to a scam is to do thorough research. The more you know about the industry as a whole, the easier it will be to spot suspicious projects. You'll also learn how to spot investment opportunities with a higher possibility for success.