Initial Coin Offerings: Red Flags and Warning Signs
Initial Coin Offerings
The finance world has been shaken up over the last few years by the invention of "Initial Coin Offerings" or commonly referred to as ICOs. ICOs allow startups to fundraise directly from a wide range of investors, similar to crowdsourcing. And unlike typical venture capital fundraising, investors are not limited to those deemed accredited investors, thereby allowing the layman to participate in new projects. This form of fund raising is also likened to a pre-sale of a product that is not fully developed or even partially developed yet. As such, investors are buying these tokens in the hopes that the project may one day produce cashflows or have utility that does not yet exist. So there is a substantial amount of risk involved from the investors' perspective. In addition, this area of cryptocurrency markets is currently unregulated, and exposes any investors to potential fraud and other scams.
There has been research done that compiles a list of specific red flags and warning signs for "Zombie" ICOs; in other words: those doomed for failure. This is not a complete and exhaustive list of all red flags that may be present in any given ICO. We also recommend you view the entire research paper per the citation below. In no particular order or ranking ...
Specific areas of failure that are big warning signs
-- Core questions from their projects' whitepaper cannot be succinctly answered
-- Inability from project developers to respond to legitimate questions about core business or infrastructure, allotment of ICO proceeds/funds toward the underlying product, or the availability of underlying assets
-- Often cannot clearly articulate and explain how the product works
-- Often cannot explain use case for product, what problem it solves, or "why anyone should care"
-- Underlying team behind ICO lacks sufficient experience in starting and running a business
-- ICOs that propose an uncapped fundraise without an underlying product
-- ICO landing pages that focus exclusively on ICO project timeline, and not product, technology or team
-- ICOs that lack disclosures on vesting and lock-up periods
-- ICOs where the fund raising rules have changed mid-course of the raise period
-- Lack of information concerning the cryptocurrency conversion plans into actual company reserves
-- ICOs where tokens are traded before underlying network or product is live
Kaal, Wulf A. and Dell'Erba, Marco, Initial Coin Offerings: Emerging Practices, Risk Factors, and Red Flags (November 8, 2017). Forthcoming, Fintech Handbook, Florian Möslein & Sebastian Omlor eds., Verlag C.H. Beck (2018) , U of St. Thomas (Minnesota) Legal Studies Research Paper No. 17-18, Available at SSRN: https://ssrn.com/abstract=3067615 or http://dx.doi.org/10.2139/ssrn.3067615
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