With the stock market becoming ever more tightly regulated and ever less accessible to new enterprises, initial coin offerings (ICOs) provide a new frontier in investment. The usefulness of ICOs has, as yet, primarily been limited to investments in blockchain-based products.
The lack of a regulatory environment and the international nature of ICOs has turned them into an investment field akin to the wild west – unlimited opportunity laced with innumerable risks. While no investment of any kind is completely free from risk, following these 12 tips when selecting ICOs for investment can help safeguard against many of the hazards associated with this high-risk investment vehicle.
1. What is the product?
The product which the company is raising money to develop is the single most important factor in determining whether an ICO is a safe investment. What market will the product be offered in? Does the product have competition in its market? What unique features does the product bring to the table? Is there a demand for the product? Would you buy or use the product yourself? These are all key questions to ask yourself before investing in any product. If the token itself is the product (a cryptocurrency, for example) rather than a component of a service or fintech product, find out what real innovations the token brings in relation to other cryptocurrencies and blockchain tokens. The product’s whitepaper should explain the product and its functions clearly and in sufficient detail. If it does not, the product may not be worth investing in.
2. How many tokens will be issued in total?
Although the cryptocurrency coins or tokens which you purchase during an ICO are used to raise capital in the same way as shares, they generally do not give you legal ownership rights to any share of the company. You also do not normally receive dividends in the way that shareholders receive dividends from the companies which they own shares of, though you may benefit from special perks when you use the product. The value of tokens is determined entirely by supply and demand. Demand for tokens is determined by how many people use the product and how intensively the product makes use of tokens. The amount of tokens available at any one time also plays a role in determining their value. If the process by which new tokens are created is resource intensive, the chances of the market being glutted are lower. If the limit on the number of tokens which can be created is low in relation to potential demand (driven by solid products), the value of those tokens is likely to increase over time.
3. How is your investment secured?
From a legal standpoint, buying blockchain tokens is similar to buying hand-written lottery tickets from a schoolchild. It is a fully trust-based relationship which does not give your a legal claim to any compensation whatsoever. You simply own a handful of tokens which may gain in value or become completely worthless. There is little to stop unscrupulous players from closing up shop and appropriating investor’s money. Serious company’s will take very clear measures to secure investor’s capital and engender trust.
ICOs may or may not reach their investment targets. If they do not, investors should be able to choose between having their capital returned or reinvesting it in a subsequent coin offering. Assets should be held in an escrow account managed by a trusted third party (an established accounting firm, bank or law firm, for example) which is responsible to return them to investors if targets are not reached. Ideally, invested capital should continue to be managed by a trusted third party when goals are met. This party should ensure that assets are used for product development as intended.
4. Is the company transparent?
Reputable company’s looking to attract serious investment will not hide behind a veil of secrecy. Phone numbers and physical addresses should be clearly displayed on the company’s website and marketing communications in addition to electronic channels. You will want to check up on the authenticity of office addresses and phone numbers before investing. The names, photographs and biographies of key members of the team behind the product should all be displayed and you should attempt to verify these before investing. The company registration number should be provided and should match information included in government commercial registers.
5. Is the business plan sound?
No matter how innovative a product is, it will not likely become a financial success if its developers do not have a concrete plan and clearly defined goals. Request a copy of the company’s business plan if this is not available on their website. If after reading the plan you cannot clearly understand exactly how the company will convert invested capital into revenue, what the company’s goals are and how those goals will be reached, then that company probably is not worth investing in.
6. What is the company’s history?
Is the ICO being held by an existing company with a proven track record? This is not a must, particularly because many innovative products are offered by newly established startups. However, a link to an established service provider brings a certain amount of trust to the table. If the company behind the ICO is listed on a reputable stock exchange, you benefit from the knowledge that the company meets strict listing requirements.
7. Where is the company located?
Where is the company conducting the ICO headquartered? What legal rights does that country grant to foreign investors? Would you and other investors be able to hold the management of the company liable if it does not maintain its commitments to token holders? What is the regulatory environment of the country in which the company is domiciled? These are all key questions to ask yourself before investing. In the case of Swiss ICOs, reviewing regulations which apply in the canton which hosts the issuing company is recommended.
8. Is the product well marketed?
Is the product and the ICO well advertised? Is the product or token getting positive reviews and comments from blockchain experts and investment gurus which have a reputation to risk? Positive reviews from experts are in no wise a guarantee that a product is good. In many cases, investment gurus and cryptocurrency experts may already have a claim to tokens ahead of the ICO and are looking to drive up the value of their tokens by encouraging investors to pour money into the token so that they can sell at a profit down the line. However, the more publicity a token receives from trusted sources, the higher the demand for the token is likely to be. Strong demand generally creates greater liquidity, meaning you will likely be able to sell your token more easily and at a better price.
9. What services are available to token holders?
Does investing in the company by buying tokens entitle you to any special perks, benefits or dividends? Does buying tokens through an ICO entitle you to special rights over token holders who purchase tokens on blockchain exchanges? Does the company have a “token holder” relations department which services your ongoing investment or trading needs? Does the company provide clear information to token holders in relation to new token issues, legal developments and tax requirements? Ideally, you should be able to answer “yes” to these questions before becoming a token holder.
10. Can you pay via bank transfer?
Payments in U.S. dollars, Euros, Swiss francs or other fiat currencies via bank transfer can generally be traced to a bank account attached to a specific legal entity. Payments in bitcoin or other cryptocurrencies can be difficult or impossible to trace to a person or company, opening the door for scams and other forms of abuse. Having to make investments in bitcoin is also inconvenient because you must fists purchase bitcoin – often paying high commissions and spreads in the process which adds to your costs as an investor. Reputable company’s will normally give you the choice between buying tokens using money or trading them for bitcoin or other cryptocurrencies.
11. Is the token liquid?
Does the company have agreements with major cryptocurrency exchanges on which you will be able to sell tokens for real money or trade them for other, more liquid cryptocurrencies? Does the product itself provide ways for you to convert your tokens into money (as is the case with some fintech products) or barter them for goods or services? Blockchain tokens may increase or decrease in price, or even become worthless if the services which they are used for cease to exist (if the company goes bankrupt, for example). You will want to make sure that you can easily convert your tokens to cash if rates start to fall.
12. Where can tokens be stored?
Can the tokens you purchase be stored in a third-party wallet, in cold storage (offline) or on a hardware wallet? If the issuing company’s central wallet is the only wallet available for the storage of tokens and private keys, you risk losing your tokens to hacking attacks – particularly if the issuer only offers an online wallet. Ideally, tokens should be compatible with secure, open-source cryptocurrency wallets.
The above tips provide a general guideline for ICO investment. There are cases in which investments in tokens which do not meet these criteria can turn high profits, but these come with a much higher level of risk. Whether you invest in reputable companies or fully anonymous initiatives, investing all of your capital into a single token is not recommended because you risk losing everything if the token becomes worthless.
As a high-risk investment, blockchain tokens should make up a relatively small portion of your investment portfolio, with medium-risk products like stocks and high-yield bonds making up a larger portion, and low-risk investments in low-yield bonds, precious metals and savings accounts making up the bulk of your portfolio. Ultimately, your risk tolerance and risk capacity should be the defining factor in determining whether or not you should invest in blockchain tokens.