Inexperienced investors should steer clear of ICOs (or at least follow these 8 tips)
By Pavel Cherkashin
Please note: this article originally appeared on VentureBeat.
When it seems that everybody around you has gotten rich by investing in cryptocurrency, the temptation to invest in initial coin offerings (ICOs) can be almost irresistible. After all, even though the major coins still have growth potential, they are already expensive, and alternative coins with solid applications in various industries will most likely hold the most value in the future.
It’s easy to buy into an ICO’s promise, whether explicit or implied, that investors who enter early and buy coins while they are still cheap will be able to sell them later with a tremendous return. The tension is reaching its limits, especially now, when, I believe, the cryptocurrency market is on the verge of the next boom. The rally has been intense, but be prepared for a more extreme ride. Everyone who missed the opportunity in the 2017 hype and was afraid to invest in the first quarter of 2018 as the market was going down is now ready and looking for good projects.
There’s just one problem: How do you determine which ICOs will actually become successful? In 2016, there were only 43 ICOs total vs. 902 in 2017. In 2018, dozens of ICOs emerge every day.
The plain truth is, while ICOs have democratized investments for the masses, they don’t offer automatic profits. In fact, news.Bitcoin.com recently reported that nearly half (46 percent) of the companies that launched ICOs in 2017 have failed already, and another 13 percent seem certain to fail soon.
There are several reasons for this. First, the ratio of quality projects that will bring good returns is extremely low in the ICO arena. Second, the ICO market is flooded with scams due to its immaturity and poor regulation. And third, these scams often succeed because of the large number of unqualified investors who act based on FOMO (fear of missing out) rather than knowledge about the market, technology, projects, and teams. Novice investors are very likely to fall for nonviable projects in which the sole intention of the ICO team is to fundraise and disappear.
Among all the pitches I get daily, there are still too many scams, weak teams, and projects that do not require blockchain technology. Though the market slowly matures, individual investors need to understand the risk and the amount of work they need to do to minimize it, which often comes as a surprise. If you are an inexperienced investor, I would not recommend investing in ICOs. In fact, a lot of experienced investors I know prefer not to do so due to the high risk of losing money.
However, if you still want to invest in ICOs, here are eight tips worth keeping in mind:
1. Build a portfolio; don’t bet on one horse
Be prepared to lose all of the money you put into at least 50–70 percent of your ICO investments. This is no different from other venture investments — the top 20 percent performing assets should bring 80 percent of the returns, while the lowest performing 50 percent of your portfolio will most likely return nothing at all.
2. Avoid projects with hired advisors
Since the team is the most critical factor in the success of the ICO, many projects hire celebrities from the crypto world or media as “advisors” to make the project look more legitimate. If you see the same advisor’s name on dozens of projects, that’s not a good sign — that advisor will probably provide no value to the project outside of the fundraising stage.
3. Evaluate regulatory risks for yourself
Many ICOs rely on their own interpretation of what’s a “utility” versus a “security” token. In many cases, regulatory authorities have a completely different view on that. So don’t simply accept what the ICO team writes in a white paper or posts online; use your own judgement to assess the risk. Keep in mind that unregulated “utility” tokens have higher liquidity but much higher risks than regulated tokens, which have lower risks but questionable liquidity because exchanges tend to avoid listing them.
4. Check signals from the community
Any blockchain is an open ecosystem with many supporters and developers. The information about it is publicly available on Telegram channels and Github communities, so investors can easily verify it. If a community is dead or closed or shows no code progress, it means the blockchain team will most likely fail to deliver on time and within the statement of work. On the other hand, it is a good sign if the project and innovation it offers is supported by older market players, for example, when a project for a platform that sells airline tickets is supported by major airlines. Another good sign to look for is media and public attention — all large and serious projects get a lot of it.
5. Check what other investors are doing
The best ICOs are extremely competitive. If large funds have taken significant allocations of tokens far ahead of public distribution, the ICO is probably worth investing in. The experienced investors most likely did their due diligence before they approved the investment. They may also have access to private information from the founders that is yet not available to the market. However, don’t forget about FOMO, which leads the herd into the chasm.
6. Only invest in what you understand
If you can’t follow what a technology or strategy is designed to do or you don’t believe that it is a valid business model, avoid investing, even if all the self-proclaimed and real experts around you recommend doing so. For example, I don’t believe paying users to provide information for targeting or viewing advertising will ever work: It didn’t work online, it didn’t work on mobile, and it won’t work on blockchain. Several large ICOs have raised hundreds of millions of dollars with the claim that it will work, but I avoided them due to my lack of long-term confidence in the projects.
7. Evaluate the team
Look at the background, experience, and reputation of the key team members. Was the team formed a few months ago, or has it been working on the project for a long time? How much relevant experience do the team members have for an ICO project?
8. Evaluate the technology and project
Understand the technology behind the project. Is it feasible? Is it innovative? Is blockchain necessary for the project? (There are plenty of ICO projects on the market aimed at solving a problem that doesn’t require blockchain at all; investing in such projects doesn’t make sense.) What stage has development of the product reached? Does the team already have a minimally viable product? Are the speed and quality of development satisfactory?
In short, investors in ICOs need to behave like professional investors in any other venture. Evaluating an ICO is a challenging task and investors need to be ready to do the fundamental analysis. I believe it is safer to wait and buy tokens on the secondary market at least 6–12 months after ICO, when the economic value of the project becomes clearer. The 2017 hype will repeat itself, but now is the time to think about the opportunities with a cool head and approach them wisely.
Pavel Cherkashin is a venture capital executive and entrepreneur. As a cofounder and managing partner at Mindrock Capital and GVA Capital, he invests in artificial intelligence, blockchain, and self-driving tech.
