Few industries have ever experienced the kind of global investment boom that is currently taking place in cryptocurrency and blockchain. It’s a tremendously promising new technology, with developers all over the world experimenting with crypto-based solutions for everything from international cargo shipment tracking to decentralized wireless networks. To raise money for their ideas, developers can even sell off a portion of their tokens in advance to investors. These initial coin offerings (ICOs) have helped to launch some of the most exciting and successful cryptocurrency projects out there — Ethereum’s ETH coin was launched via ICO, for example — but not every token launch is a good investment.
Because the potential for profit is huge with ICOs, there are also plenty of scammers who are more than happy to take advantage of a hapless investor. Other ICO projects might be entirely sincere in their aims, but lack the resources and experience needed to launch a successful token. Because of these risks, anyone thinking of investing their money in an ICO should be extremely cautious and skeptical. A little common sense and a willingness to do basic due diligence research can go a long way in avoiding a bad ICO.
In this post, we’ll examine the five biggest red flags for cryptocurrency and blockchain investors.
1. The token uses a centralized, private, or closed-source blockchain. One of the absolute essentials for any blockchain-driven project is transparency. While there are a few successful, closed-source cryptocurrency projects, the vast majority of successful cryptocurrencies and blockchains are decentralized, public, and open-source. The more secretive the project is about what its code actually does, the more skeptical you should be about their claims.
2. The development team is anonymous, has no track record, or has a history that can’t be verified. Creating a website is easy. Making up fake names, bios, and credentials for a scam ICO is just as easy. Thankfully, we live in the age of the social media, and a simple LinkedIn search can go a long way towards verifying the backgrounds and professional histories of any self-proclaimed blockchain or cryptocurrency developer. If those search results come up empty, it’s probably time to look for another ICO to invest in.
3. The majority of the tokens are pre-mined, and almost entirely held by the development team. It’s common practice for an ICO project to create a stock of their own tokens before opening up the blockchain to the public. Some of those tokens may be used to compensate their development team at before launch, allowing them to earn crypto for their hard work. If the vast majority of all tokens are held in reserve by the development team from the start, however, it can be a sign that something fishy is happening. Many fraudulent ICOs have used this technique in “pump and dump” schemes, driving up demand (sometimes even offering free tokens to generate excitement), and then cashing out before the token price crashes.
4. The project’s investor documentation has few concrete details on their funding, development timeline, and their plans for meeting regulatory requirements. Before investing in any project, a smart investor will insist on seeing a viable business plan. Does the ICO already have funding? Do they have a realistic plan for development, complete with clearly defined and achievable milestones? Have they communicated with their country’s regulatory agencies about the ICO launch? Do they have a legally recognized entity (typically an LLC or C Corp) to do business through? These are all essential parts of running any legitimate business, and a project that doesn’t have them in place is in no position to be seeking outside investment.
5. The project’s whitepaper is vague, light on technical details, or is plagiarized from another project. It’s one thing to have an interesting idea for a cryptocurrency or blockchain project. It’s another thing entirely to understand the technical challenges that need to be overcome to make that project a reality. While ICO whitepapers tend to be somewhat broad in scope and language, they still need to contain specifics about why the token is needed, how it will work, and how their approach differs from other tokens. In extreme cases, some ICOs have launched with whitepapers that are plagiarized from other projects, only changing a few minor details like the name of the token. The cryptocurrency community has become pretty good at recognizing this kind of fraud over the years, and it often pays to spend some time researching what other people say about any new ICO.