Initial Coin Offering Investment Guide
The use of smart contracts in the blockchain has opened the market to new cryptocurrencies. The Initial Coin Offering (ICO) craze of 2017 was a blow-back of smart contracts entering the cryptosphere, with startups offering tokens to fund their ideas. Before 2017, ICOs had already been gaining ground in the circles of technology and entrepreneurship, yet the end of 2017 is when it took a brave step forward and entered the mainstream consciousness.
The flurry of new coins and tokens meant that investors were spoiled for choice, as there are too many whitepapers and websites to thumb through to find the best ideas. In spite of the miasma of new ICOs, some managed the break records. The Tezos ICO raised an unprecedented $200 million dollars in funding. This amount eclipsed the amount that venture capitalists and initial public offerings (IPO) can muster, especially since initial coin offerings are so easy and cheap to launch. Unlike their counterparts in the traditional investment world, initial coin offerings do not come with payment schedules or interest payments. The lack of which means that developers do not need to pretend they are defector accountants, and can work on the project instead.
In spite of this optimism, ICOs are not without their risks. Governments around the world have warned their citizens to move away from initial coin offerings, as they cannot regulate them. The move by governments to ban ICOs was prompted due to the amount of scam companies that touted themselves as legitimate businesses. Most of those companies were nothing more than a crude snatch n grab to defraud investors.
In response, the Securities and Exchange Commission (SEC) ruled that the tokens issued during an ICO were classified as securities, and thus were under its jurisdiction of control. This meant that citizens of the United States were required to register as investors before buying any tokens. Other countries took a more aggressive stance; China and South Korea banned ICOs, while the majority of other countries issued warnings and put this fundraising method under review.
In spite of the fledgling amount of regulation that ICOs have attracted, the technology that powers the coins is powerful and disruptive for the entire industry. For this reason, there is always a possibility that an ICO could yield incredible returns for its early investors.
But how can you determine what ICOs are legitimate from those that are not? And which companies will offer you the best returns? These are two of the most important questions you should ask yourself before putting any money into an initial coin offering, and there are more to be answered.
Before Investing In An Initial Coin Offering:
Below, you can see the most important features of an ICO to look out for, which should be considered as signposts that can guide you make the best investment decision possible.
The Bitcointalk.org forum is one of the oldest and most reputable platforms in the space of cryptocurrencies. It was started by Bitcoin’s founder, Satoshi Nakamoto. Originally a forum to discuss the launch of the Genesis block for Bitcoin, it has since evolved to include all other coins. Founders of new cryptocurrencies can post a project announcement thread (ANN) in Bitcointalk. This thread allows members to ask questions and have their questions answered by the startup founder.
Due to Bitcointalk’s ubiquitous reputation, it could be a red flag when a developer avoids certain questions about the project or refuses to collaborate. Taking this a step forward, sending the founder a personal message can gauge how responsive they are.
Bitcointalk displays the rank and number of past messages each member has. If a member is new to the website or has a negative reputation, then this is something to keep in mind, but does not always mean that the ICO should be avoided.
Read through the posts left by other members carefully, especially those that contain negative feedback. Doing a quick search for the keywords scam or MLM will quickly reveal how legitimate the company is.
Stage of the project & Venture Capital Involvement
Consider the stage of the project before you invest. Do you only see a whitepaper or beta version? Will there be a finished project but with limited functions? Because when you put money into an ICO, you are essentially investing in a piece of software. For this reason, you’d want to see at least some of the code working before you invest.
Also, pay special attention to projects that have VC backing. Companies like Blockchain Capital or Fenbushi invest in high-profit startups. You can see if they are backed by one of these companies on the ICO’s homepage.
Is A Blockchain Required To Reach Its Goals? What Are The Tokens Used For?
For each new ICO, there is a token that’s created along with it. This then poses an important question: what will the token be used for? And why couldn’t they simply designate Bitcoin or Ethereum as the platform’s currency? The same questions need to be asked for why they will be using a blockchain to facilitate the goals of the business.
There should be a clear reason for why they are issuing tokens, besides as a source for revenue.
And how will a blockchain deliver value to its customers? What problem will a blockchain solve, or improve on an existing process?
Unlimited or Hard Cap
Economically, one of the most important things to consider when investing in an ICO is if it has an unlimited (open) cap or a hard cap on the amount of coins that will be issued. An unlimited or open cap allows people to send as much money as they’d like to its founder’s wallet address. The problem is what happens later: the more coins there are the less valuable each of them becomes via an inflated supply. On the other hand, some coins have a hard cap on how many tokens will be issued. A hard cap means that if a company’s idea takes off, the coins will be scarce and can later be sold for a significant profit.
So, from an investor’s point of view, a hard cap will almost always be better than an unlimited capped ICO. The only likely reason that a founder would set an open cap is if they wanted to get as much funding as possible, presumably to make off with their investor’s money.
But, not every open-cap ICO is a fraud. The project Bancor raised $150 million dollars in just 3 hours, although it resulted in no percentage gains of value for its investors.
Another caveat is that you don’t want to be the only person investing in the project either. If only a handful of people invest their money in an ICO, exchanges will have little interest in facilitating their trade. This would make these tokens harder to sell later.
Token Distribution – When And How
Something to look for is level of content distribution between its team members. Any figure higher than 50% should be considered suspicious. A legitimate project will show a correlation between its token distribution to the roadmap. This is because each phase of the project requires a certain level of funding.
Keep an eye out for the token distribution stage. Some projects will eject their tokens just moments after the ICO has ended. While other projects need a beta version first before sending the tokens to its investors. You can see this effect with the percentage gain of Ethereum. One year after Ethereum was released, it gained 5000%. While other projects such as Augur gained 1,500% in just a year.
Quality of Code and Github
If you have any programming experience, then you should make use of it when evaluating an ICO. You’ll be able to figure out the quality of the programmer and founder by the code posted. And if you are not technical at all, this will still be possible for you to get a feel for the competence of the team. Code should be well commented and organized.
Also, the length per function is another factor. A function that has more than 50 lines of code should raise red flags. Modularity matters as it makes the code more readable and up to date.
A good thing about ICOs is that the code tends to be open source. This means can increase the amount of trust between developers in the community, as well as collaboration for suggestions or improvements. It also opens the ability for commit logs, which is when a bit of code is pushed to Github’s code library.
Read the Whitepaper
The whitepaper is the most important piece of information released by an ICO. The document contains the ICO’s manifesto, mission statement, roadmap, token distribution and more. Due to how important whitepapers are, they need to be very well-written and contain all the relevant information for you to make an investment decision.
Usually, the content and presentation of a whitepaper can either make or break a company, and it goes a long way to showing whether a group is serious about their project. So, as an investor, you should read whitepaper as the first step in the investment process, and only invest money once you understand its business case fully. Also, it’s important to look at the little things. Some firms can exaggerate facts about their project, or the perceived demand for their product. Following a due diligence process and fact checking then becomes a pivotal skill for ICO investors.
Learn More About The Project Developers
Related to checking the whitepaper for facts and inconsistencies, you should also read about the team behind the project. You may find that most of the team members will be new to market, so they won’t have a significant background in either the blockchain or startups. However, you come across some people who have worked on similar projects in the past.
Once you have identified who the members are, the next step is to do a form of background check for each person. You should be looking to verify the members’ expertise and credentials, as well as experience in the industry. A new team that lacks experience is certainly a red flag.
Also, some ICOs are held by established companies that want to issue tokens to raise capital income. If this is the case, then review the parent company and how the ICO will fit into its mix of products or services. There should be a clear synergy between what the business is doing already to what their ICO will allow them to do. Do they have existing customers they can sell their idea to already? Do their products allow for an easy upsell or cross-sell for the ICO product? If this is the case, it should be taken as a positive sign. Investing in established companies typically leads to greater payoffs later down the road.
You may see situations where the start-up companies will not disclose the names or positions its team members. This is another red flag. If the company is not transparent about who is working for them and who is managing it, why would you buy tokens from them? Usually, if a company is hiding this information from its investors, then it means that the venture is most likely a scam. Any legitimate company would do everything they could to prove that they are honest and reputable.
What Are The Long-Term Uses For The Tokens?
Tokens that are sold off for the singular purpose of raising money don’t offer investors a lot of value. In this case, investor only benefits from the resale value of the token, but then their value might not be worth it. A good ICO should give additional benefits to investors, such as a way to get premium or additional services from the company.
So it’s recommended that that you look at the long-term value of the tokens you are interested in. The tokens should offer more to you than a higher resale price, and something more to the company than just a way to raise funds.
Read What Other People Think
When it comes to investing in an ICO, reading through the second hand opinions left by other people is important. It’s not uncommon to see initial coin offerings posting threads in different forums that cater to cryptocurrencies. You can also see them post on social media such as Facebook and Twitter. With these platforms, you can read through the comments and feedback left by other investors, and ask your questions to the management team.
Read through all of the presentations the team has posted, and keep an eye out for red flags along the way.
Consider The Road Map And Future Plans
Companies that take the time to develop realistic road maps are always a better choice. You need to understand when the project started and where it’s going in future. How long will it be until the project starts making money? And what are the founder’s plans after the ICO has ended?
A red flag here is if a company wants to offer a service for a limited amount of time, with no further investments or ideas planned beforehand. This means that the founders are thinking only in the short-term, making these projects poor choices for potential investors.
When you put money into an ICO, you are attempting to stretch your dollars as a far as possible to get a decent return. A good ICO investment consists of putting money into companies that are transparent about how your money will be used, and how they intend to grow your funds for you.
Important information here is that they need to disclose the number of tokens released, and how many of those tokens will be sold during the pre-sale and post-coin offering stages. Also, what percentage of the proceeds will go to the team members, and how much are they paying their affiliates (if any). A startup that is in this for the long-run will be happy to share all of these details and more, and will even provide graphs and charts to show how the funds will be distributed.
Page And Image Design
The website of a business is the company face for potential clients and investors. Due to this fact, it’s recommended to examine how a website is set up, and what kind of user experience it offers. While you shouldn’t expect to see a website that looks like it cost a million dollars to setup, a quality startup will invest in a quality website.
While this may seem trivial at first, the quality of the site will be determinant factor in the success of the company. Just like the whitepaper, a lack of attention to detail with the website means that the founders are either unwilling or unable to invest in page design or market for their business. This could then set a dangerous trend for how they conduct their ICO once the funds have been raised.
Mining Should Not Be A Priority
If you come across an ICO that has an emphasis on mining and pushed throughout all aspects of the ICO, this is usually a red flag. This means that its developers did not design any other feature to represent the ICO in coins, and know that mining could help drag in new investors.
It’s worth restating that mining is only a process that helps the currency function. Mining is not the actual use of a currency, nor is it the sole feature.
Just as we described the differences between a soft cap and hard cap, when putting money into any asset it’s vital to see what the market capitalization is. If you value your investment dollars, it’s important to look for an asset that will lead to long-term gains and adoption by a certain market. The two things you should look for in an investment are for them to be both under-priced and under-capitalized. This means you can get these investments for the best possible return. If the market capitalization is well above what an asset is actually worth, this can lead to a significant price drop to stabilize its intrinsic value.
For example, imagine that company X plans to sell a product of 100 units per year and has a limited market to sell to. And the maximum amount of profits that the company could make is 1 million dollars.
If this company were to run an IPO and it made 50 million dollars within its first day, no matter how well the production or the products of the company the, the assets in the company will remain heavily overpriced. In the majority of cases, this is what leads to an aggressive price correction.
The key here is to try to find the coins that have a decent market capitalization without being oversaturated. You don’t want to invest in coins that are either too popular, or not popular enough. This is why most people consider the planning the research stage of finding an ICO the most important of all.
Go For Disruptive Ideas
You should look for ideas that are original, feasible, and disruptive. Far too many ICOs have made the mistake of being another “me too” of an existing project. ThIs results in only a marginal amount of value created for the business, as it can only be cheaper, faster, or better in some way. Unless an ICO provides something truly unique, the chances are that these startups will compete with what’s already on the market, as opposed to offering something truly innovative.
In short, the product or service of the project must address a real need and offer real solutions. Look for ideas that truly change how things are being done today through the strengths of the blockchain.
Understand The Target Market
It’s critical to place the company, its technology, and the product or service in the view of their target market. It’s inevitable that they will be subjected to the pressures of the market and regulation for their given industries, so it’s important to know the environment, as this will give you an idea of the challenges and opportunities for these ventures.
As an example, a healthcare company that is using blockchain technology may be a great concept to invest in, especially since there are a now laws that require drug manufacturers to have tracking and record keeping systems in place. However, the largest and most established players are also eying this space carefully, which means that small startups will face severe competition.
Bonus: Discern Your Appetite For Risk
Like with any other investment, it is critical for investors to honestly evaluate their own appetite for risk. Unlike IPOs where companies have typically been around for years, if not decades, many startups are in their early stages, with some not even operational. This means there is a lot of risk for potential investors. And there is always a chance for investors to lose money if the venture is unsuccessful.
The figures posted by ICOs also are not reliable indicators for a venture’s viability in the market. Some ICOs have raised significant amount of money, only to be scrutinized later for their lack of progress in getting the ICO off the ground. Therefore, ICOs will always be high-risk, high-reward investments that have no guarantee of success. So you should know how much you are willing to invest and lose before participating in one.