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20 questions to ask before taking part in an ICO
By Gary McFarlane | Fri, 25th August 2017 - 12:10
Here's everything you need to know about an initial coin offering (ICO) before considering taking part in a token sale.
What is the legal status of the corporate entity behind the ICO?
An unclear corporate identity should ring alarm bells.
Who are the lead individuals running the project and do they have verifiable publicly available profiles?
Look for someone who has been involved in running a real business in addition to the team members with the computer science degrees.
Is there a White Paper, including a breakdown of how the token sale is structured and the total number of tokens that will ultimately be in circulation?
Every ICO comes with a White Paper explaining the business model and laying out the project's roadmap. Some of it might be very technical but if it is a popular ICO chances are that someone that does understand it all has looked at it and flagged up any concerns.
Having said that, if the project's backers are not able to explain in plain English what problem they are trying to solve and how they intend to do that, then avoid. The old rule of investing in industries you understand still holds.
Is there a breakdown of how the token will be distributed?
Ascertain what the token is being used for in the project's ecosystem and how the tokens are being distributed. There should be a breakdown of the proportion of tokens being sold of the total created.
Is there a vesting schedule for the project's team?
Determine the proportion of tokens that are being given to team members. Anything above 25% should be treated with caution.
Also look for a vesting schedule. If the team members are able to trade all of their allocation immediately it could be a sign of a lack of long-term commitment to the project.
Is the blockchain open and public and is the code published, for example on popular source code repository Github?
Don't worry if you don't fully understand all the technical ins and outs of how the code behind the project works - the fact that they have made it public means that someone else probably does and has found any potential issues.
There can be good reasons why a project is not making its code available for scrutiny, but those that do are showing they have built something they have confidence in. Also find out if a cybersecurity audit has been carried out by an independent company.
Does the project have a website, social media and other media assets?
Establish whether the project has a website, blog and a presence on bitcointalk.org (see the announcement - ANN - message board) or a presence on other popular forums. See if the project has a history of posting on Twitter or Facebook.
How are funds held?
Ideally, you want to be seeing something like offline wallet or cold storage. ICOs can hold funds in a smart contract which should be OK, assuming the smart contract doesn't turn out to be dumb.
Other parts of the issuer's infrastructure may be vulnerable but this is hard to ascertain. Again, ask if an independent cybersecurity audit has been conducted? Custody issues are probably less likely to arise with those ICO companies that are working with established industry players.
Is there a prototype, minimum viable product or trial underway?
A live beta trial is ideally what you want to see. At a minimum, there should be a prototype.
What are the funds raised going to be used for?
If it's mostly for marketing, move along. There should be a breakdown in the White Paper of how the funds raised will be used. If there is no breakdown, move along.
Each project is different, but typically approximately half the funds should be allocated for product/business development and technical infrastructure.
When will the tokens be tradeable?
If a token is to become tradeable immediately or soon after the ICO has closed it means you could forgo buying at the ICO stage and instead buy the tokens when trading begins. This means you avoid taking the risk associated with letting the ICO company hold your cash during the ICO sale period.
Some tokens may not become tradeable or will have very limited liquidity, which means you will have to wait until the project is up and running and generating revenue before you see any returns.
Some exchanges pre-announce their intention to offer a market in a particular token if interest is considered to be high.
How will the tokens be distributed after the sale ends?
You want to see the words immediately after sale ends or something similar.
Does anyone else (the loudmouth at the bar doesn't count) think it's a good idea?
If you think a particular project is a good idea and has a team that looks like they know what they are doing, it's likely that someone else does too. What do crypto experts think? Google is your friend. Has there been coverage in the mainstream press?
But bear in mind that good ideas are ten-a-penny - the key is always in the execution. Remember Friends Reunited? ITV bought it for £175 million in 2005 only to sell it at a loss four years later for £25 million. It could have been a Facebook but poor execution crippled growth.
Does the project have partnerships or backing from VCs and/or established tech or other companies?
Backing from venture capital firms is an indication that professional investors have done some due diligence, although this is not an excuse to skip doing your own in-depth research.
Some recent ICOs that with backing from investment professionals and/or partnerships with established companies are listed below.
Launch partner - invest.com, an online investment house with three million registered users and $50 million (£39 million) in revenues and $12 billion annual transaction volume.
Holding company block.one is backed by VC Blockchain Capital.
NEO - formerly Antshares
Blockchain smart token platform Bancor is a technical partner. As yet unconfirmed rumours of connections with Chinese financial companies saw the price of the NEO token rocket in August.
Pantera Capital, Blockchain Capital, Digital Currency Group, Social Leverage.
Backed by billionaire investor Tim Draper.
Venture capital firms Andreessen Horowitz, Union Square Ventures, Digital Currency Group and Sequoia Capital back the project.
Spin-off from LakeBTC cryptocurrency exchange with 10 million user accounts in 162 countries. This ICO closes in October.
What competition does the project face in its chosen marketplace?
By way of an example, at this juncture a company pushing an ICO for entry into the peer-to-peer file storage space would be up against some very stiff competition from the likes of Filecoin (mentioned above), MaidSafe, Storj and others, including existing non-blockchain players such as Dropbox which could create its own blockchain product at some point in the future.
Are you up-to-date on the latest intelligence?
In addition to articles on Interactive Investor, cryptocurrency news sites such as coindesk.com, cointelegraph.com, bitcoinmagazine.com and cryptocoinnews.com are essential reading, in addition to ICO information and analysis site smithandcrown.com.
Coinmarketcap.com is a good place to keep up-to-date on the price movements and market caps of all the different coins and tokens.
Are contact details available?
It's a good sign if the company has transparent contact details. There's no harm in trying to get in touch with one of the members of the team.
Try LinkedIn or emailing the company direct. Most projects will have accounts on Slack and/or the Telegram messaging app, so you can engage there - but watch out for scammers.
Ask about anything you don't understand or that you think is omitted from the White Paper.
Where is the ICO company based?
If you are comfortable backing a company based in, say, Kazakhstan that's cool, but not everyone would be. Find out where the ICO company is located.
Sounds too good to be true?
Most ICOs have bounty schemes where you can earn tokens by sharing links about the token on social media but be suspicious of overly generous schemes.
If the company ICO has, for example, a bounty scheme where investors are given thousands of tokens for free for providing an email address, be suspicious. As always, companies offering guaranteed returns or pressuring you to buy now are red flags.
Have you read the US Securities and Exchange Commission Investor Bulletin?
There may be good reasons why a project fails on one of the tests above but if they fail on several of them then don't take the risk entailed in giving an ICO your money.
Also, be aware that most startups fail and that's even more likely to be the case in the ICO world where the vast majority of the companies have no revenues and often no up-and-running product either.
Given that, it is incumbent on investors to take a sceptical view and assume that 90% of ICOs are junk. As in the early days of the internet and the dotcom boom - and then bust - of the late 1990s, there is value in blockchain technology. But in the search for that value a lot of money will be lost.
Not putting all your eggs in one basket is even more relevant in an area this new and speculative. If you have decided you want to take the risk of dabbling in token sales, make sure you build a diversified holding of tokens - and to repeat, do your own research, and in that regard the best place to start is the project White Paper.
The author tweets about cryptocurrencies at @gary_mcfarlane.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.