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One of the most significant changes to the investing world to coincide with the growth of digital assets is the rise of Initial Coin Offerings (ICOs). An ICO enables an entity or individual to raise capital for a project or contract by selling underlying cryptocurrency tokens.
However, before investing in an ICO, consider asking the below questions about the offering.
- Is the offering a securities offering? If you are purchasing an investment, you may be buying a security. If an ICO is a securities offering, it will fall under the Securities and Exchange Commission’s (SEC’s) jurisdiction and enforcement. Is the offering in compliance with applicable securities laws?
- Who are the key players in the ICO? Identify the key stakeholders’ experience and track records with investing, particularly as they relate to digital assets and ICOs. Do those associated with the investment have the background necessary to make it a success? Can they see the ICO through to completion? Ensure you conduct as much due diligence on the key players as you do the investment itself.
- Are the materials well-written and professional? Are the offering materials thorough and polished? Or do they appear rushed, full of grammatical and other errors, and poorly conceived? The materials should present a balanced description of potential risks and rewards—and not omit the former to further enhance the latter. While professional, fair and balanced materials in no way legitimize an investment, they could help legitimize the party(ies) behind it.
- Does the offering include a celebrity endorsement? This is really nothing new in the investing world. However, celebrities and others are now beginning to promote ICOs as well. Such an endorsement may appear unbiased but is, in fact, part of a paid promotion. The SEC has even warned of this in a recent public statement.
- Do you understand the investment? This one’s problematic for many, as the allure of substantial gains and new technology supersedes basic common sense. Ensure you know as much as you can about the investment: its commercial use/need, utility function, etc. Do you understand why this is better as an ICO and not another investment type?
- Does this even need to be on a blockchain or use a new token? Once you understand the investment, you can determine whether a blockchain is the best solution for the project or contract the ICO is funding. Why does a new token have to be created? If an existing token or coin like Ethereum can be used just as easily, this may present a red flag.
- Does the risk match what you’re comfortable with? As with any type of investment, is the risk too much or is it acceptable? How does investing in an ICO fit your risk profile?
- How are the digital assets held? Understand the security of the wallet holding the tokens or coins. Find out who has access to the wallet and who will have underlying custody of the assets.
- How are the tokens or coins allotted? If new tokens or coins are created, identify their selling price and the total number in existence (including how many are being retained or given to others involved in the offering). Is a significant amount retained or given to others instead of going to the sale? Also, are contribution limits in place to prevent market manipulation? Are the key players prevented from dumping their tokens?
- Does it sound too good to be true? Remember that very, very few investments can offer a guaranteed rate of return. Investing is inherently risky. The promise of unreasonably high returns in a relatively short amount of time is oftentimes a major red flag for investors.
Several of these questions are the same, or at least similar to, questions to ask when considering any investment. While cryptocurrency and ICOs exist in a relatively new investment space, you must consider many of the same safeguards before moving forward.
For more information on understanding Initial Coin Offerings, visit the SEC’s page spotlighting ICOs and digital assets.