The burgeoning Initial Coin Offering (ICO) market is expected to be worth more than $20 billion in 2018 alone.
In just a few years, thousands of high-tech investors have flooded the sector with cash, hoping to get in early on the next hot crypto token.
But, as in any market growing this fast, the number of scams and fraudsters preying on unsuspecting investors are also growing by the day.
Many tricksters are relying on very low-tech deceptions, like sharing fake ICO wallet addresses on social media in the hope that investors will simply send their funds to the wrong account, while others are going to far greater lengths of sophistication.
In the last year, we’ve seen examples like PlexCoin, set up by Canadian Dominic Lacroix, which raised $15 million before the SEC declared it a “full-fledged cyber scam,” or Benebit, which raised $2.7 million before its creators mysteriously vanished without a trace.
Unlike an Initial Public Offering (IPO)—where stock exchanges dictate strict rules around the disclosure and the auditing a company must go through—ICO scams run rampant as the fundraising method is largely unregulated.
But that doesn’t mean investors can’t still protect themselves with a little due diligence.
We asked two ICO experts for their top tips on how investors can avoid falling foul of scams and fraudsters.
Investing is risky. Following these steps still doesn’t guarantee an ICO isn’t a scam, nor does it guarantee a return from a legitimate ICO. Proceed with caution.
Stage 1. Basic due diligence
ICOs typically start with a glossy campaign homepage that sets out the startup’s plan and promises for what it’s raising money for, what its token does and how much money it’s already raised.
The first tip that all the experts we asked mentioned is to perform a “gut check” on this campaign page: Do the company’s claims and promises seem plausible?
– The gut check
“Like with any investment, if a company is promising the world with little evidence to back up their claims, tread with caution,” Leigh Travers, CEO of Perth and New York-headquartered ICO advisory service DigitalX, told Forbes.
“No serious business will claim they will surpass Bitcoin’s success unless they have already proved they can do it. Be wary if you come across an ICO making claims that are too good to be true.”
PlexCoin, for its part, promised to have built essentially a “better Bitcoin” that also came with eye-popping returns for early investors.
If it’s too good to be true, it probably is.
– The white paper
To justify raising millions of dollars of investment, the startup should also have come up with a feasible plan to break down exactly how it’s going to build what it’s promising.
This should all be laid out in a white paper, and your first port of call should be to read it inside and out.
“If they’re raising an exorbitant amount of money, I’d be looking at what are they actually trying to develop, and whether or not they need that much money to develop what they’re trying to do,” Corey Parkinson, founder and CEO of Bloc Advisory, a consultancy that advises companies on ICOs, told Forbes.
All these protocol projects don’t need $100m or $200m. You’d never spend that money on development, even if it’s business development.”
The white paper should go into detail about how the token will work, exactly what the funds being raised will be spent on.
“Often a lot of the tech is actually missing,” says Parkinson. “It’s literally just venting and talking about the industry for 30 or 40 pages, with two pages on the tech.”
It may also have crucial details of the ICO’s escrow wallet and advisors …
– The escrow wallet and advisors
Any ICO worth its weight in bitcoin won’t see the project creators given the funds you invest directly.
Instead, proper corporate governance when it comes to ICOs involves what’s known as an escrow wallet, or a multi-signature crypto wallet.
The system is designed to release funds to the project creators upon them hitting certain milestones or to return funds to investors should the project go pear-shaped.
The release of such funds is typically controlled by three parties, one from the company and two independent individuals or companies trusted by the wider community.
“Ensure the ICO has good escrow—think of it as a form of insurance in your investment. Escrow is essentially a bond which guarantees you won’t have to stump up money if the ICO doesn’t end up going ahead,” says DigitalX’s Travers.
These independent parties can also be contacted, as can the project’s advisors, who are typically also listed in the whitepaper.
“The big thing to check here is that the actual advisors, are actual advisors,” says Parkinson.
“I’ve seen this countless times where people go to conferences, meet somebody, realize they’re quite influential in the space, and add them to the project as an ‘advisor.’ ”
A lot of these people won’t even realize they’re listed on the project until it’s too late, because who does due diligence on themselves?”
– The team
At this stage, it’s probably a good time to figure out who exactly is running the company you’re investing in.
“Investigate who is behind the ICO and their work histories. What companies did they previously work for? What is their experience? Do they have a solid tech background? Make sure they are real-life people who exist and not a fake profile,” says Travers.
The team should also be responsive to your questions, either via email, social media, or through Telegram chat groups (although the rise of fake Telegram accounts has made these groups less useful, says Parkinson).
That said, with so much money up for grabs, the most sophisticated fraudsters will go to great lengths to build out their digital presence, often creating fake LinkedIn profiles, publishing elaborately detailed white papers, and even developing digital communities around their scam.
Which is why it’s always good to dig a little deeper …
Stage 2. Digging deeper
If an ICO passes all the checks above, but you still have concerns, it’s time to go full crypto-detective on the project.
So how do you take your due diligence to the next level?
– Real businesses?
Fake LinkedIn pages are one thing, but faking an actual business is both harder and more effort than many scammers will be bothered to take.
In the U.K. checking whether a company exists is often as simple as searching Companies House for its name—you can then check when it was incorporated, when directors were assigned, etc., and ensure this all stacks up against the details of their white paper.
In the U.S. it’s more difficult. Searches have to be done on a state level, but with a little perseverance, you should be able to stand up their claims.
That said, it’s not unusual for these company databases to take a while to update, so just because a company isn’t on Companies House yet, that doesn’t necessarily mean it must be a scam …
– Picking up the phone
Yes, in this digital age there are still times when you need to pick up the phone and talk to another actual human being.
John Laverty, the supposed CEO and cofounder of Benebit, had a fabricated LinkedIn page detailing past jobs at Goldman Sachs and a BA from Imperial College.
Calling the HR departments of large employers is a long shot, they’re often reluctant to give out details on former employees, but they may at least be able to confirm whether the person did actually work there.
On the other hand, universities, in the U.K. at least, will offer to verify academic qualifications, often with the graduate’s permission, as it’s fairly routine for employers to request these.
If you’re dealing with an entirely faked profile, the university should flag that the person isn’t in their system.
So there you have it, our top tips for vetting and verifying an ICO.
It’s not comprehensive, and scammers will always come up with clever ways to deceive, but hopefully, by being prudent and doing your due diligence, investors can avoid seeing their money simply disappear.
Got another way to verify an ICO, or been affected by a genuine scam? Get in touch.