CONDUCTING ICO DUE DILIGENCE
In the absence of clear guidelines, following these simple steps can help investors avoid falling into an ICO trap.
The dramatic acceleration in Initial Coin Offering (ICO) fundraising over the past six months means that the amount raised as of June 2018 had surpassed the entire amount raised in 2017. The sudden wave of momentum within the ICO space presents unique challenges and opportunities for prospective investors, who have to conduct their thorough due diligence when considering their next investment. This nascent industry has created extraordinary wealth for some participants, while others have been ripped off by seemingly legitimate projects to the tune of US$9 million a day.
This begs the question; how can an investor tell the difference between a legitimate ICO and a scam?
Currently, a recognized standard of due diligence has yet to be established for ICOs, making a due diligence review of an ICO daunting, but not insurmountable. There is a wide variety of regulatory frameworks emerging across various jurisdictions, which poses challenges for investors trying to understand the intricacies of an ever-evolving industry. However, prospective investors can take some simple steps to guide their investment decisions.
Firstly, investors in a new ICO should be in tune with the mission of the project. An ICO project usually represents an idea, with teams building their reputation and credibility from the ground up. This is a challenge for investors as there is often no track record to assess. Thorough evaluation of project white papers, development roadmaps and website material can go a long way towards gauging an ICO’s credibility and potential.
Prospective investors should start with the bedrock of an ICO: The White Paper. This encapsulates the vision of a project, outlining the problem, solutions and a thorough description of the token. The White Paper must also showcase the governance structure of the project, introducing potential investors to the team and familiarizing them with the project’s roadmap. The best performing ICOs have, at the very least, a Minimum Viable Product (MVP) prepared when they are launched. While ’White Paper ICOs’ have been successful, an investor will have more faith in a project if it already has a working product or an established customer base.
The Public Face
As unorthodox as it may seem, reviewing the LinkedIn profiles of a project’s team and advisory board is a core element of any due diligence effort. However, investors should be wary of fake profiles and unsubstantiated claims. It is also advisable for prospective investors to examine communications platforms like Slack and Telegram as well as online messaging boards such as Reddit to gain insights into the views of community members, and to check the engagement levels of project team members. Check to see if the project is gaining traction in reputable media outlets, engaging in Ask Me Anything (AMA) sessions and taking part in top-tier podcasts.
Governance And Regulation
The true litmus test for any ICO has to be the strength of its governance. The project should demonstrate a firm commitment to transparency at all stages of development and beyond. Assess whether the project is committed to any recognized governance initiatives, such as the European Union (EU) ICO Charter or the ICO Governance Foundation philosophies. Prospective investors should also thoroughly examine how resources will be allocated and managed. The project should clearly indicate the arrangements that are in place to safeguard project funds and ensure funds are exclusively used for the purposes outlined in the White Paper.
Checking the regulatory status of a project is a simple task and is verifiable through the relevant regulator’s website. Regulatory status should provide investors with a significant degree of comfort because it requires high standards and stringent adherence to regulatory and legislative structures.
Consideration should also be given to the ICO projects ‘hard cap’, bearing in mind that the vesting and lock-up period for founders is usually one year. Most ICOs will have an auditable smart contract to prove that the lock-ups are in place. If founders are able to immediately sell their tokens, this is a red flag and should be queried with the project team.
As blockchain technology continues its rapid ascent into mainstream society, it is crucial that investors have a measured approach to investing and to carry out robust assessments of a project’s governance structure, as well as dedicating time to reviewing project White Papers and social media channels. But primarily, prospective investors should firmly believe in the vision of a project, and the principles of decentralization and transparency.
About The Writer
Shane Brett is the co-founder and CEO of GECKO Governance, the world’s first RegTech regulatory solution for bank and fund financial compliance that will now ensure an ICO is regulatory compliant from start to finish. Shane has over 20 years of experience in the finance and technology fields. He has held a variety of roles in hedge fund and asset management operations including programme and product management at top fund managers and administrators worldwide such as BNP Paribas, HSBC, UBS and RBS.
This article was first printed in MillionaireAsia Issue 49 - Sep 2018