The fear of missing out runs rampant through the crypto universe. Thanks to what seems like an endless emergence of new coins and a 24/7 investment cycle, crypto slows down for no one.
This FOMO effect is highly prevalent in the work of ICOs, or Initial Coin Offerings. In fact, these businesses are counting on it.
ICOs are to the cryptocurrency market what an Initial Public Offering, or IPO, is to Wall Street. Investors familiar with IPOs and who are well aware of the potential returns may rush at the chance to “cash in” by getting in on the ground floor of a new ICO.
But are ICOs smart investments?
It depends. Unfortunately, where there’s big opportunity, there’s also big risk. And for investors, that big risk comes in the form of ICO scams.
To safely decipher a legitimate ICO from an ICO scam, investors need a solid understanding of the basics, starting with how ICOs work.
How Do ICOs Work?
Companies use ICOs to raise money in much the same way companies issue shares of stock through an IPO. When you invest in an ICO, you’ll receive the new cryptocurrency that the company is offering. This currency might be related to what the company does — be used as “in-game currency,” for example — or simply represent an ownership stake in the company.
How are ICOs Structured, and How Do You Invest?
ICOs generally fall into one of three types — a static pool and two types of dynamic pools.
— A Static Pool with a pre-set token price and a limited number of tokens available. This structure is used if the issuing company has a specific dollar amount it wants to raise.
— A Dynamic Pool with a dynamic price and a limited number of tokens available. Seeing an ICO with this structure means that the token’s price correlates with the amount of money being raised.
— A Dynamic Pool with a pre-set token price and a dynamic number of tokens available. Under this structure, the price of the token doesn’t change, but the amount of money raised will determine how many tokens are available.
You should also expect to find a whitepaper, or pitch book, that essentially lays out the reasoning behind the ICO. This is used to attract investors.
With most ICOs, you’re able to use traditional fiat currency or another digital currency to buy the new tokens.
What to Look for in an ICO
The risk of fraud is much higher with an ICO than with an IPO, primarily because they’re largely unregulated. Quite literally anyone can develop and launch an ICO. That means the level of due diligence potential investors must perform is exponentially greater.
We’ll give our overall take on ICOs down below, but if you’re considering investing your money, here are some things to keep in mind.
What’s the Team’s Track Record?
Having a great team behind an ICO doesn’t guarantee success. But having a bad one almost guarantees its failure. In a space that’s almost entirely unrestricted and unregulated, development teams behind an ICO can play fast and loose with the truth. It’s not even unheard of for scammers to completely invent fake teams and fake credentials of key team members.
If you’re considering a particular ICO, verify everything. And if you can’t find legitimate interaction with team members on sites like LinkedIn, for example, that’s a pretty serious red flag.
Where is the ICO Listed?
Again, it’s no guarantee that an ICO has promise, but if the ICO is listed on an American exchange, it’s had at least some minimal due diligence applied to it.
If it’s NOT listed on a major American exchange, that’s another red flag.
How Thorough is the Whitepaper?
A whitepaper should answer every question you have about the ICO. It should cover topics such as the concept behind the currency, what success for the currency looks like, the financial model it follows, what sets it apart from other currencies (i.e., what is the need?), which strategy it’s following to reach its goals, and more.
Pay attention to little things — poor grammar, for example, or spelling errors. Sloppiness is never a good sign.
It should go without saying that if a company doesn’t have a whitepaper, that’s an enormous red flag. However, a great whitepaper isn’t enough to indicate that a currency is a solid investment. For instance, a fraudulent company called PlexCoin, which was eventually shut down by the U.S. Securities and Exchange Commission, raised over $15 million largely on the back of a brilliant whitepaper.
Has it Been “Vetted” by the Marketplace?
Think about the trials a company that issues an IPO has been through. It has proven its business model, demonstrated demand for its products and services, has most likely been through multiple rounds of funding and valuations and has proven its legitimacy each and every time.
An ICO hasn’t had to endure any of that scrutiny. Many of the “tests” we describe above — a solid whitepaper, a listing on an American exchange, a team with a proven track record — can be thought of as substitutes for this scrutiny, but they’re really no match for it. There should still always be a much higher level of skepticism with ICOs when compared to their IPO counterparts.
Bottom Line: Are ICOs a Solid Investment?
It’s easy to understand the appeal of ICOs. Who among us doesn’t wish we got in on Bitcoin when it was $100? But that in no way means throwing money at any of the dozens of new coins that launch each month is a smart investment.
While it’s true that ICOs are finding favor among large institutional investors, you have to remember that these firms can afford to “hit it big” on one ICO while losing on dozens of others.
In other words, if you throw enough darts at a board, you might eventually hit a bullseye.
At Gumbo, we don’t believe luck is a smart strategy for winning the game, which is why we’re enormously skeptical of ICOs as wise investments. We would rather pursue consistent and reliable returns for our investors than roll the dice on unproven ICOs and their enormous downside potential.
Gumbo is a cryptocurrency hedge fund dedicated to increasing investor Bitcoin holdings, paying dividends monthly, and only profiting when their investors do. All investments are managed 24/7 by crypto experts. To learn more about Gumbo and investing in Bitcoin, contact our team.