Once seen as fringe by mainstream investors, initial coin offerings are now the talk of Silicon Valley as well as Wall Street. They’ve raised over $3.2 billion this year which is about 3,000 percent more than they raised in 2016. The rise has been dramatic, to put it mildly.
To be fair, they offer a new model for crowdsourced fundraising, allow people to raise more money than they’d be able to from venture capitalists, from a larger base, all while being able to do so with minimal oversight and bureaucracy. For example, Filecoin raised twice as much in its initial offering, without a working product, than a comparable company after it’s top round of VC funding, after five years of existence.
But there lies both the promise and the peril of ICOs. Many ICOs promise their investors that they will be able to have preferred access to the product the ICO is offering—eventually. They don’t promise an ownership stake, as one might expect with an IPO, because if they did so they’d be classified as a security and have to abide by SEC regulations within the US, which many ICOs seek to avoid.
The key here is the idea that, eventually, an ICO would deliver on the product it is promising. But if it doesn’t, investors have little to no method of recourse. This is just one reason that countries such as China and South Korea have outlawed ICOs in their entirety.
A few months ago, Chamath Palihapitiya, a venture capitalist and BitCoin enthusiast, tweeted that “99% of ICOs are a scam”, expressing a need to filter the crooks out. “Next phase of ICOs will be real.”
ICOs such as Authorship, Opair, and Bitcad have given weight to such claims. At the most charitable they could be considered failures, which raised millions of dollars and failed to deliver; but they were also plagued by issues such as founders with fake LinkedIn profiles, inability to launch products (or well anything else) at the agreed upon dates, and long stretches of radio silence to their investors, all of which alludes to more nefarious intentions.
The rise of due diligence communities
Due diligence practices exists for a variety of reasons, and when they works well, help protect investments from fraudulent or unscrupulous companies. While it’s easy to find a variety of resources online for traditional IPO or investment due diligence, including an easy to follow 10 step process from Investopedia, few comparable resources exist for ICOs.
More recently, the ICO community has begun to look inward to develop such practices. The Reddit community Ico Crypto is working to build out such practices, and offer a quick checklist of ways to suss out a fraudulent ICO, as well as lay bare what you’re actually dealing with when it comes to ICOs. Some key points include:
- Invest only what you can afford to lose.
- Invest in something you do understand. You have to deep dive into the product: who, what, when, how? What about technology, team, market, viability, roadmap, token, supply, market cap, distribution, incentives, etc.
- Ask if the product really need to be based on blockchain technology
- Ask for information. Ask again. And again. (Example).
- What about the token? Necessary? Useful? What’s the use? What about the incentives to use, hold or sell it? Is there a way to sell it?
- Do you have access to ICO smart contract code before the ICO? Audited? Terms of ICO / Presale? Website audited?
- Check accounts on Reddit (history, karma, redditor since, write to who and in which subreddits).
- A lot of ICO rating/due diligence services, forums and websites are in a potential conflict of interests. If the service accept donation: caution. If a company has to pay to be rated or is encouraged to make a donation to expedite the procedure: caution. If the rating service is also acting as an exchange, intermediary, consultant: caution.
The ICO community is worried that a coming SEC crackdown is in the works, and while that may change the tenor of ICOs and just how quickly they’ve proliferated, it may also help separate which ones actually have the ability to deliver on the potential of the model. As Palihapitiya said, the next phase of ICOs will be real. It’s time the tools to get us there were embraced, and that includes common and robust due diligence practices.