Do you know enough about ICOs to get excited about the opportunity, and yet not fall prey to an ICO scam that wipes the excitement right out of your wallet? Find out how to detect not just an ICO scam, but also an ICO that stands little chance of success.
What are ICOs?
ICOs are token-generation events, in which a startup funds its project by selling a form of cryptocurrency to investors, using a smart contract on an existing blockchain. In an ICO, investors usually buy tokens which serve a twofold function: a proof of investment and a means of payment on the platform. This is a so-called “utility token”.
Most ICOs, over 77% of the total, use Ethereum’s platform. While this is only to be expected, as Ethereum first enabled the technology that allows for token creation with its ERC20 standard, it also led to a very crowded platform with slower response times and inflated Ether prices. Developers are still working on improving protocols, but it is taking longer than initially estimated.
Crypto valuation is not rational. At least, this can be inferred from several studies and reports published since the beginning of 2018. Crypto markets and ICO valuation are seldom moved by factors in the external economy, such as stocks, commodities or macroeconomics. Most often, ICO investors are simply driven by FOMO, the fear of missing out fueled by marketing hype.
Usually, under normal market conditions, certain equations could attempt to produce accurate valuations. The most common attempt is M*V=Q*P, where M (or sometimes T) is the number of tokens, V is the turnover or velocity of spending, P is the price and Q is the quantity of tokens or services being provisioned. However, momentum and investor attention turn out to be more credible price drivers.
Token sales can be capped (tokens are sold at a set price) or uncapped (tokens are sold as a proof of interest and the price is set at the end of the ICO. Both have advantages and disadvantages. With capped funding there is usually a very short span of time in which to invest, sometimes as short as minutes or half-minutes. With uncapped funding, many are not willing to commit until the very last minute, which creates technical problems for the platform.
Quite often, you will hear “ICO” mentioned in the phrase “ICO scam”. There are many ways in which naive investors could find themselves duped by savvy ICO scam masters, or simply by smart contract terms that were not apparent to the naked eye. Some risks are inherent to the nature of ICOs or the cryptocurrency markets, others could be prevented by careful examination of the white paper, code, team and other essentials that should be made available at the ICO launch. Just think: banks lose an estimated $1.2BN to hacking attacks, while the crypto market registers losses about 40% higher. Bank losses are insured, though; crypto exchanges are usually not, and transactions are irreversible.
- price volatility. This is an inherent risk in ICOs, as well as on the cryptocurrency market in general. Coins sometimes go wildly up or down depending on market movements and current events, but price volatility is sometimes caused by seedy founder and/or investor practices.
- bad coding practices. Untested code, bad coding on smart contract protocols, bad algorithms, unsafe external public libraries can affect the outcome of either the ICO or the ulterior product/service.
- hacking and phishing. 10% of ICO-acquired funds are lost to hackers. That figure is increasing, as hackers realize there are enormous profits to be made from successful crowdsales in an environment where reverse transactions are impossible. Private keys get stolen, exchange funds get drained into substitute wallet addresses, wallets are emptied and so on, all because of bugs or privacy issues within the ICO code. What starts out as far away from an ICO scam can turn out to be a terrible investment because of lax security. Even when money doesn’t necessarily change hands, so to speak, information can. Private data can be easily compromised in such an attack.
- regulations. In fact, the issue here is regulation as much as non-regulation. Some countries forbid ICOs altogether, like China (many of them invoking the high risk of ICO fraud). Others tax tokens depending on their function. European countries have recently come out with initial guidelines for tokens and cryptocurrency in general. Expect attempts of the ICO market to set better internal rules and safeguards, as well as much tighter national and international regulation.
- blockchain incompatibility. Not all projects and services offered through ICOs should actually use blockchain technology. Some are simply lured to it because of the apparent ease of getting money fast, but should not use a technology that encourages transparency for services that are meant to be anonymous, to give just one example. Also, with the rush of ERC20 projects built on Ethereum, the platform has been affected and is working hard to scale fast enough to keep up.
- project flaws. Many ICOs propose projects or services that are far from any meaningful development stage. 85% of them are in prototype stage, and their launches are expected in a year or more after the ICO. A large number of these projects or services will never reach implementation stages.
- corrupt ICOs. Since this is a fundamentally unregulated market and investors often have little experience, there are plenty of ICO scams, with founders who deliberately use deceitful tactics to quickly cash in and run. For instance, in certain cases, the project stakeholders can change the duration of the ICO, disable or destroy the token, or issue new tokens, all these behind the backs of investors. When you get wind of such practices, know it’s an ICO scam – and run.
Protect your investment from an ICO scam
A simple checklist will tell you most of what you need to know about a potential ICO investment: whether it’s an ICO scam or merely a flawed project that will result in an eventual ICO or project failure, whether you should even bother to take a second look etc.
- Legal / regulatory status: is the ICO legal in both its country of origin and your country? Is it likely to run into any legal difficulties? Are there legal advisers on the team?
- Tokens: what is the token current vs. total supply? What is the token distribution? Is the token trading? What will be the token distribution? Capped or uncapped ICO, and why?
- White paper: is it detailed enough? Does it use too many catchphrases or hype terms instead of actual product/service information? Fuzzy information is often the sign of an ICO scam.
- Team: are the product developers and managers prepared for their roles? Is the team large enough to be credible? Do they have any prior work that can be assessed? Any important advisers or backers? No social media profiles or stock photos of team members are another telltale sign of an ICO scam.
- Product/service: is there any market research to suggest market fit? Is there any market analysis?
- Roadmap: is there a plausible calendar/roadmap in place? Do you know what to expect at each stage?
- Security: has the product/service done, or will it do a security audit? Has it been tested at all? What are the security protocols? Is there two-factor authentication, are there security experts on the team?
- Marketing: too much or too little marketing? Where are they touting the product/service? Is there a specialized company? Will there be one once the product goes out?
- Post-ICO: is there any post-ICO strategy in place? Where will sustainable funding come from? If the project outline ends when the ICO ends, it’s either terrible business planning or just an ICO scam.
There is one caveat, though: if you are not tech-savvy enough, you won’t be able to examine the code for potential security flaws, hidden execution procedures or bad coding. If you are planning a major investment, you can try an ICO audit. If you are somewhat familiar with the field, you can hunt those ICOs whose team is the most credible and has the best market-fit profile. A major name in the field will not back an ICO scam; however, make sure the endorsement comes from someone who knows blockchain technology. Just look at the fallout of the ICO scam in which DJ Khaled and Floyd Mayweather played a major part.