ICO Due Diligence – What to Look For in an Investment

The controversy surrounding Initial Coin Offerings (ICOs) is still in full swing and showing no signs of dying down.

Following in the wake of the Peoples' Bank of China's (PBoC) decision last month to impose a total ban on ICOs, last week saw South Korea implement similar measures. The vice-chairman of South Korea’s Financial Services Commission (FSC) has been quoted as saying that, in regard to ICOs “there is a situation where money has been flooded into an unproductive and speculative direction.” Speculation is rife that other national regulators are considering bans of their own.

ICOs initially sprang up as funding sources for new cryptocurrencies and have proved in many cases to be spectacularly effective ways of raising capital. They work by offering investors a share of the new currency in return for an investment made in legal tender and their success has seen them evolve into becoming fundraisers for other ventures beyond the cryptocurrency sphere. 
Celebrities including Paris Hilton, Floyd Mayweather and more recently Jamie Foxx have been enthusiastic backers of a diverse range of ICOs, taking to social media to promote their investments.

ICO Mania Grips the World

If the misgivings of financial regulators aren’t enough to set alarm bells ringing, then perhaps the involvement of these and other celebrities should do the job instead. The truth is that whilst many ICOs may be legitimate enterprises (and potentially sound investments), they are already attracting the attentions of scammers and criminals.

ICOs are unregulated and therefore are not required by law to submit detailed business plans or even descriptions of what the start-up in question is actually going to do. They are decentralised, with no third party service provider or mediator to monitor the flow of investments, their dividends or their origins. For the uninitiated they present a vey grave risk, with monies lost unlikely to be recovered given the lack of regulation. It’s easy to see why the unscrupulous are attracted to their potential.

The use of celebrities and other ‘influencers’ to promote an ICO or the currency it is offering often results in a so-called ‘pump-and-dump’ scheme. This involves the influencer using their clout to attract investment and thereby inflate the value of the token on offer. They then sell up and make a tidy sum, before the value drops, usually never to recover. They can boast of having made money (quite truthfully) and not be in breach of any regulations or legislation. For them, simply adding #NotaScam or something similar would appear to offer sufficient peace of mind to would-be investors. (Interestingly, Hilton’s Twitter endorsement of LydianCoin now no longer exists. Funny that.)

Doing your ICO Due Diligence

So, how do you spot a fraudulent ICO from a genuine one? This isn’t easily done, but there are a few useful signs to look out for.

Firstly, is there an actual product out there? This may sound ridiculous, but in the case of many ICOs this is often vague or misleading. Take a look at two of Mayweather’s endorsements, Stox.com and Hubii Network. Boasting flashy websites and healthy investments, the definitions of both remain somewhat ethereal. It’s not entirely clear what they’re promising to do, or how they intend to turn a profit. This is not to say that they are scams, but any experienced investor would certainly want to know a great deal more about what is on offer before parting with money.

Secondly, it is worth looking into who is actually behind an ICO. A celebrity like Mayweather or Hilton is not a good indicator – they are almost certainly being paid to promote the platform and may not actually have anything substantial invested in it. However if, like Iconomi there are people with a proven track record involved (in this case the team behind Cashila) then some degree of expertise can be assumed. Reputation counts in this sphere as it does everywhere else.

Essentially, the same questions must be asked of an ICO as of any other enterprise seeking funding. Is the product necessary? What is it aiming to do? Is it offering a solution to a problem that doesn’t exist? Who is behind it and how will they grow the business? If these questions don’t beget satisfactory answers then all but the most foolhardy of investors would stay well clear.

Invest with Caution

Most ICOs have simply announced the formation of a new cryptocurrency and let investors seize on it in the hope that it will turn out to be the new Bitcoin. The currency’s value soars as people invest, but then goes nowhere. Predicting which of these will last the course and establish themselves in an increasingly crowded market is almost impossible.

The moves taken by the Chinese and South Korean governments are designed to protect investors – for a government to take this sort of step, there must be a very clear perceived threat. For investors elsewhere, due diligence regarding ICOs is a must. Whilst cryptocurrencies are a now very much a feature of the financial landscape, it’s worth considering just what is going to make a new one stand out from the crowd.

Perhaps the best adage to remember when evaluating an ICO’s potential is the oldest one going: if it looks too good to be true, then it probably is.