Synopsis: ICOs are initial offerings of cryptocurrencies / crypto assets, similar to initial public offerings. It is an exciting, innovative space – but also one where a lot can go wrong if investors are not careful. Read this ICO Investment guide now to learn what to spot the best opportunities, and filter out the duds.
How To Join The ICO Investment Club
In an earlier article, I explained what an initial coin offering is, and why they have become so popular. This follow-up article in the series is a high-level overview of what to look for in an ICO project, if you are considering investing.
Again, remember that ICO investment is highly speculative. Before doing any in-depth iCO investment analysis, the first question to ask is: are you allowed to participate? Some ICOs blacklist investors from certain countries. Don’t spend time on ICOs that prohibit you. For example, the Monaco Visa ICO excluded American citizens. An article on Bitcoin.com explains why:
“American financial policies have circled the world through tax and compliance treaties that are enforced to varying degrees by signatory nations. Americans are required to disclose income earned and wealth held abroad to the IRS… And so, [an ICO called] Monaco Visa asked every applicant a question: Are you a citizen of the United States? Those who checked the “yes” box were directed to a page that stated, “sorry, your citizenship excludes you from participation in this ICO due to excessive regulatory risk from your SEC [Securities and Exchange Commission]”.
The document laying out the ICO investment proposition is called the white paper. This should contain information about the history of the project, the founders and other key people involved, a market overview, competition analysis and so on – ostensibly, everything that a would-be investor needs to make a well-informed decision.
An ICO investment white paper is a bit like an IPO prospectus, but a lot shorter and less legalistic. The rest of the analysis involved before making an ICO investment comes down to two factors:
- Fundamental analysis
- Deal terms analysis
Studying the inherent quality of the ICO investment project is called fundamental analysis. It is similar to the job that equity analysts perform during an initial public offering. Fundamental analysis involves coming to a view of what a company is worth, and then comparing this to the actual price on offer, thus deciding whether it is undervalued or overvalued.
In the classic fundamental analysis book One Up On Wall Street, Peter Lynch argued that investors should stick to investing in things they understand. When it comes to ICOs, this means reading the white paper and getting to grips with the investment case before putting capital at risk. Below are some factors to consider in the course of your fundamental analysis.
1. Is The Project Novel & Useful?
Just as a company needs to sell something that customers actually want, an ICO project needs to solve a real problem if it is to be valuable in the long-term. Before making ICO investment, you should be convinced that the market will support what the project is proposing. Are competing projects already doing something similar? Even if not, could this project’s solution be easily copied? Unique tokens which build something very hard to replicate will do best in the rough and tumble of the free market.
2. Existing Traction
How far along the pathway has the project already come? If all they have is an idea and a white paper, it isn’t a good sign. Ideas are extremely common – what matters is ability to execute. Ideally, they should be able to get some of the way towards project realization before going asking for money from outside investors.
Information about the management and key developers is essential to know before making an ICO investment. By reading the team bios, investors can get a sense of the backgrounds of those involved in the project they are considering investing in.
Ask: What is their prior track record? Ideally, this will not be their first foray into crypto tokens. Perhaps members of the team have even conducted successful ICOs and built successful businesses in the past. Strong existing experience comes in especially useful when facing the inevitable roadblocks that come with any early-stage project.
Ravinder Deol of B21 Block Podcast says that ICO investors should follow the most talented developers. “What projects are these developers working on, what excites them the most? This is a good marker to filter out the pointless projects. Rather than assign the tangible assets as many would do with a traditional investment, look at the intangibles with ICOs. Are they strong enough?”
4. Professional & Easy To Contact?
These days it is straightforward to create a nice-looking website, but some projects even manage to screw this up. If they can’t even get their online presence right, it is a very bad sign. Are they active on social media? Are there typos and formatting errors in their white paper?
You may be able to get more confidence in the people behind an ICO investment if you can physically meet them, shake their hand, and ask them questions in-person.
At the very least, there should be an easy way to contact them online, and they ought to be responsive to questions. You can immediately disqualify ICOs if contact information is vague or non-existent.
5. Relative Valuation
ICO investment valuation is admittedly fraught with difficulty. In many cases, there is no revenue, no users, no blockchain, and no intellectual property to base a valuation on. In this case, the only value rests in the integrity of the founding team and their idea.
But one way to arrive at some form of valuation figure is by looking at past successful ICOs. If companies in a similar industry and at a similar stage of development valued themselves at under $5 million, but this one is asking for $30 million, it is an immediate red flag.
6. Who Are The Other Investors?
If an ICO investment is attractive, it will gain the attention and backing of those in the know. This is important information to seek out. Having existing reputable investors is strong validation for an ICO. If the project hasn’t been able to convince any well-known investors, there is probably a good reason why. Investing alongside other successful crypto investors allows an investor to effectively copy their investment strategy. All else being equal, following in the footsteps of those who know what they are doing is not a bad way to go.
7. Pathway To Project Realization
Look at what the project wants to do with the money they raise. There should be a detailed budget laid out, and a clear pathway to milestones they want to achieve. Again, it is about understanding what you are investing in: is this ICO being conducted in order to develop something that doesn’t exist yet, or is it about growing the marketing an existing solution that already has proven demand? The earlier that a project is, the more speculative it is.
Deal Terms Analysis
This category of analysis is all about how the deal has been structured, rather than the project itself. It recognizes the fact that even a terrific project can still be a poor investment if the tokens on offer are unattractive.
1. What Do Investors Get In Exchange For Their Capital?
Instead of shares of equity, ICO projects may offer a share of revenue to token holders, a share of profit, a share of the underlying asset value that the tokens represent, or something else entirely. ICOs are a lot less standardized than initial public offerings. Make sure you understand the detail of what you are actually getting for your investment.
2. Entry Point
As explained in Cryptoassets by Burniske & Tatar, “ICOs have a fixed start date and end date, and often there is a bonus structure involved with investing earlier. For instance, investing at an early stage may get an investor 10 to 20 percent more of a cryptoasset.”
Early investors drive momentum in an ICO, which is why these investors are rewarded with a lower valuation when they buy in. A lower valuation is preferable for investors, because it implies more tokens for the same amount of capital. It is similar to the way that a cheaper “early-bird” rate often applies to event tickets, to encourage early signups.
3. Funding Minimum & Funding Maximum
An ICO should set a minimum threshold, which if not reached will result in the ICO failing and all investors getting their funds returned. This is an important feature because a project will need a certain amount of funding to do what they are planning to do. If they cannot raise this minimum, then they won’t be able to attempt the plans under which investors were investing.
There should also be a funding maximum in place. ICOs without a funding maximum are signaling they will take all the funds they are offered, which is a bad thing for post-ICO demand for the tokens. ICOs with 2x the demand for tokens compared to the number of tokens actually available can expect to have good price performance post-ICO because some of the investors who missed out on the ICO may try and fill their demand by buying after the ICO is over. But if the ICO project will issue all the tokens that there is demand for, it removes this wall of unsatisfied demand and the price tension that goes with it.
4. Founder & Key Person Token Allocation
It is suspicious if the founders allocate themselves too many of the new tokens. When Satoshi Nakamoto first launched Bitcoin, he didn’t give himself a huge payload of Bitcoin to reward himself for having invented it. Every Bitcoin that Nakamoto ever received was mined, the same as everyone else’s was.
ICO founders are not as altruistic as Nakamoto. People who work hard to create a valuable project usually want to profit from it, but it’s a matter of degree. Picolo Research uses 10% of tokens to management as a reasonable benchmark for the amount of tokens to be held by them as a bonus for launching and commercializing an ICO project. The same report says “In the event that you see the token allocation to management of 15%, you should flag this and ask why such a high proportion is kept by management.”
5. Founder & Key Person Lock-Up Period
ICO investors should make sure that the founders and key people have skin in the game. That is, they cannot just jump ship from the project as soon as it is over, sell their newly-valuable tokens and sail off into the sunset – leaving the ICO investors holding the bag.
The mechanism to ensure founders and key people have a strong reason to stick around and drive long-term project value is to have their tokens subject to a lock-up period. As in, they cannot sell their tokens for a certain period post-ICO. Commonly, their tokens will be unlocked on a set schedule – for instance 1/3rd after 12 months, 1/3rd after 24 months, and 1/3rd after 36 months.
Jose Mota is the host of Daily Crypto podcast. His view is: “We have definitely been seeing an emerging trend of locking up tokens to incentivize not just founders, but also team member’s, user’s, and investor’s tokens to combat turnover after an ICO is complete.”
6. Investor Lock-Up Period
Equity crowdfunding investing and venture capital investing usually require years of waiting before shares can be sold. But ICO investors can often achieve an “exit” fairly soon after the tokens begin trading on an exchange. This way, investors can cash out and recycle their capital into new ICOs, if they desire. However, some ICOs restrict this by locking up investor tokens. Such restrictions make an ICO less attractive to invest in, all else equal.
7. Scaling Mechanism
Most ICOs work on a first-come, first-served basis to encourage people to invest as quickly as possible. More desirable ICOs can afford to scale with a maximum allocation policy – as in, they won’t allow any single investor to get more than a set amount of the tokens.
Maximum allocation ICOs should end up with the tokens held by more investors, rather than concentrated in the hands of fewer large investors. It is a strong signal for an ICO to run their offer this way – albeit a risky one, if the kind of widespread demand they are expecting fails to materialize.
Make sure the approach you take is in line with your own risk tolerance. Great opportunities can go hand-in-hand with great risk – but you need to decide for yourself whether those are risks worth taking. By applying a rigorous screening criteria to ICO investment, you may miss out on some profitable projects, but you should also be able to protect yourself against the real duds as well.