“But all those who used their knowledge in a bid to enact social change saw cryptography as a tool to enhance individual privacy and to shift power from big, central institutions to the human beings who live in their orbit.” — Paul Vigna
When we talk about due diligence for ICOs, we must look at things from two angles. First, we must consider what due diligence means for businesses and promoters who are looking to launch their ICO.
Recently, the US government has sought to impose tougher regulations on ICOs. The IRS and SEC have particularly laid out guidelines and asked for information from new and existing ICOs.
The policies have also been imposed on virtual currency exchanges. All these moves are considered part of the government policy to require due diligence for ICOs.
We must also look at things from the investor point-of-view. Before making the decision to invest in an ICO, investors must carefully review the business plan, expected profits and long-term goals of the ICO.
The adage ‘let the buyer beware’ holds true in the Fintech industry just as it holds anywhere else. There have been a number of scams where companies raised millions of dollars in ICO, only to run away with investor money.
Whether you are a business looking to raise money through an ICO or an investor hoping to earn a good return from your investment, proper research and adherence to guidelines could help you save from potential losses in the future.
Due Diligence For ICOs
Jay Clayton, the chairman of the SEC, has advised investors to be cautious when making investment decisions. Just like any other investment opportunity, if an ICO offer seems too good to be true then it probably is.
The chairman also advised investors to be careful when an ICO pressurizes them to act quickly or offers guaranteed returns. Investors should do their due diligence of ICOs when making a decision.
Some of the steps they can take are listed here.
Identify the Founders
A project’s leadership plays an important role in its success or failure. When making an investment decision, investors should find out as much as possible about the founders and promoters behind the venture.
Fintech is an emerging technology and the number of true experts in the field is limited. According to some estimates, the number of genuine experts in blockchain can be as low as 5000 worldwide.
Identify the Demand for the Project
Right now, there is an overflow of blockchain projects and ICOs in the market. It is an extremely easy way to fund new businesses. The great successes of projects like Ethereum, Stellar, Ripple and NEO have made it the technology to rally behind.
However, just because a project is built on blockchain does not necessarily means that it would be a success. Investors should carefully examine what the company is hoping to achieve and what improvements the company offers over dozens of other projects that are already present in the market.
Blockchain networks are expensive to operate and require real resources like time, money and expertise. If the project doesn’t offer a competitive advantage over existing options, it would be difficult to get it off the ground.
Evaluate How the Tokens Will Be Distributed
The amount of money being raised through ICOs is impressive. Consider the money raised for Filecoin which reached $257 million during its ICO.
It is important to know how the total coins are distributed for the platform. A transparent ICO should offer more than 50% of its coins to the general public.
If the majority of the tokens remain under the control of the company’s directors and founders, that cannot be considered a fair distribution.
The majority of coins being held by one entity would give it too much power. We should also consider the fact that most new crypto tokens are now developed with proof of stake mining.
Over 50% coins being held by the company would give it the power to manipulate the transactions which is never a good sign.
Consider How the Funds Will Be Used
Just like an IPO, an ICO should clearly identify and communicate to the investors how it intends to use the raised funding. Most projects use the funds to develop the infrastructure that runs its blockchain network and improve the technology through research.
An ICO without a financial business plan or operating cycle for its expected expenses is more likely to fail than an ICO which has well documented goals and financial expectations.
Identify the Support and Sentiment around the Project
Investors should consider the existing support for the project before getting involved. A coin that is listed at reliable crypto exchanges with a reasonable volume of daily trade is much better than a coin that hasn’t been listed.
A project with a large number of supporters and an active community behind it is likely to do well.
Crypto projects are built on trust and every token needs its community support for growth and doing well in the market.
Strong and thorough due diligence for ICOs is definitely called for