What Investors Should Look for in an Initial Coin Offering (ICO)
An Initial Coin Offering (ICO) is a fundraising mechanism where new projects trade their virtual tokens for digital currencies that have an immediate value.
Investors hope to achieve similar economic gains from digital currency trading to their ICO investments. ICOs are, however, loosely regulated, resulting in many Ponzi schemes or fraudulent illegal activity.
Investors should be cautious about ICOs. They should be critical of the team, their current progress, and the contents of their white paper. All these components, among others, impact project completion, viability, and any potential for fraud.
Investing in ICOs are similar to investing in early-stage startups. Where there are significant gains, there’s the potential for substantial losses.
A vast majority of companies launching ICOs are early stage startups. Therefore, the team’s experience, talent, and skills will determine their project carry through and completion. The founding team is a crucial factor. Angel investors believe that a business’ success is dependent on the founding team’s capabilities.
Ideally, this team should consist of traditional startup members, specialists in the digital currency industry and executives that have exhibited past successes.
Companies who are serious about their ICO will have no problems publishing information about their team. Thorough research should be conducted on all team members to assess their capabilities and whether these members can collectively carry through with the vision.
Stage of the project
It’s important to know how far the team has progressed in relation to their project. Some startups have a white paper and marketing material while others are later in their Series A and B rounds.
For newer investors, it’s better to invest in projects that are more developed and have an MVP, beta version or at least some lines of working code. The technical progress of the project is often in online repositories like GitHub.
Why they are raising through an ICO
Although ICOs started with blockchain-based businesses, the ease of funding and loose regulations attracted many startups outside the blockchain space. Some startups now create a token simply so they can ICO and raise money quickly. This is a big red flag to watch for.
It’s important to understand the problem they want to solve, how they are solving it, and why fiat, bitcoin, or ether aren’t enough to serve the project’s needs. While the marketing and copy may be enticing, it’s important to be critical of the actual impact and solution the startup offers to the blockchain space.
Unlimited Open/Hard Cap
An unlimited open cap allows an unlimited amount of investors to fund the project. The largest ICOs, like Tezos, were uncapped. This approach provides the team with more funding. However, the more tokens that are in circulation, the less demand there will be for these coins.
A hard cap, on the other hand, is the absolute upper limit of funding.
If the project receives funds that exceed the hard cap, the funds return to the investor immediately. There’s also a soft cap, which is more speculative, as it reflects what the team’s fundraising goals are. There is a delicate balance between these options as projects that raise very little have tokens that are hard to sell after its release.
The white paper is arguably the most significant part of an ICO. It should detail every part of the project. The ICO should include the problem, solution, product, token implementation.
Further, it should detail how the token works with the product and the economic and technical component, the team, and a token deployment plan. If technical specifications are more conceptual and there are claims that their team will expand post-ICO, this is big red flag.
An example of a well-structured whitepaper is the Civic Token sale.
— Vinny Lingham (@VinnyLingham) May 25, 2017
Civic’s white paper explains concepts in plain English. Although it is relatively technical, white papers should be understandable. Civic even goes beyond the white paper and set up a telegram room to host discussions while engaging with their community via Twitter.
What to look for
There are tons of opportunities, but also many risks, with ICOs. Therefore, it’s important to be critical and cautious when considering an investment.
ICOs have democratized the fundraising process for startups. On the other hand, they are an extremely risky investment. An investor can mitigate risk through team analysis, checking the startup’s progress, and reading their documentation or white paper.
Even for beginner investors, this information will help you make a more informed choice. Of course, always complete your own analysis, including your risk tolerance levels, before making any investment.
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