Initial Coin Offerings (ICOs) were all the rage this summer raking in an ungodly amount of money that made entrepreneurs, advisors, and celebrity endorsers lots of money. The issue is that for every great opportunity, there are a dozen fake scams trying to take your money, and both good and bad are advertised on popular websites that list upcoming ICOs. However, that doesn’t mean there isn’t money to be made. With the SEC still slow to respond to this paradigm shift with clear guidance and rules, there is a small window to make outsized gains through investing “speculating” on ICOs. Below are the essential questions I believe every investor should ask before contributing to an ICO.

FUNDAMENTAL PROJECT QUESTIONS

What does it do?

The purpose of an ICO is to fund the development of a decentralized application (DAPP). The first thing you need to do is find out what exactly this DAPP does, which is also the first description you’ll see about any ICO. You can quickly and easily filter projects based on what their goal is and whether you not you believe there’s a market for what it proposes.

How does it work?

The next thing you want to do is actually read the white paper and try to understand how it works. This will probably take some work on your part in terms of looking up terms you do not understand if you are unfamiliar with computer science. If the white paper, or other documentation provided by the creators, does not explain how the project works and how the contract is implemented, you are better off avoiding the ICO.

Does this really need to be on a blockchain?

Once you understand what the creators are trying to do, and how they propose to implement your solution, ask yourself whether you think a blockchain is the best solution. Many (most) things are better off existing how they are in the real world. Modern blockchains are often slow, expensive, and inefficient to implement at scale. A blockchain is not a cure-all and should not be treated as some sort of business panacea.

Is the token necessary?

Lots of times, a DAPP can succeed without needing its own ERC20 token. If the project could easily work using Ethereum instead of requiring a brand new token, there is already a fundamental issue at hand.

Can the team execute?

This is a bit harder to judge, but you should try to assess the team and see if you think they are capable of bringing the project to fruition and carrying through. Do the founders have the technical acumen necessary to develop and maintain the DAPP? Do you think the team will stay on and keep developing the project after they raise the funds necessary to cash out? Do the advisors have a lot of industry experience?

What is the money being used for?

Make sure that there is a clear outline of what exactly the money is being used for. Usually there’s a large portion for legal fees, but make sure to watch out for money spent on marketing, and money spent paying off founders, influencers, and advisors.

How are tokens allotted

The most important thing of all is to see how the tokens are being allocated. At what price is each token being sold for? How many tokens will be in existence? How many tokens are being retained by the company? How many tokens are given to the advisors? How many tokens do the founders keep? How many tokens go to developers? How much was used on bounty? How big is the contribution limit? What you want to see is a majority of tokens going to the sale, with a small amount being given to the core team and a portion being retained by the company for giving to developers. Another important thing to look for is a lockup that prevents founders and advisors from dumping their tokens. They should slowly gain the ability to sell their tokens over several years. You also want to see contribution limits that prevents whales from gaining the power to manipulate the market, and also ensure there is unmet demand from those who want more than the limit, and will this drive up the price.

Is there a pre-sale?

Pre-sales are generally a bad thing. The pre-sale means that the company is selling the tokens at a discount (often a steep one) to the first people who put money in. What this means for later investors is that they are likely going to be screwed out of their money because a large part of the company was already sold at a much lower price. What this means for the pre-sale investors is that their money will likely be locked up for a very long time, and the company is not confident it can raise all the necessary funds in the public ICO (which is why they had the pre-sale). The stepper the pre-sale bonuses, the worse the ICO is.

Are there bounty programs?

Bounty programs are very very very bad news. Avoid bounties at all cost because it means that a large amount of tokens are being given out to those who post about the project on social media or write Steem and Medium posts about the project. This is your clue-in that this is really just a pyramid scheme where the company is indirectly paying bounty hunters to drive investments through artificial hype.

Is there a lot of advertising?

Many ICOs choose to advertise the sale very heavily. These ads can be on popular crypto websites, on websites that list lots of upcoming ICOs, and even on normal websites through Google or another ad partner. Avoid any project that advertises heavily because these projects are almost always just money grabs. Responsible teams do not spend heavily on advertising and let the project speak for itself.

What is the pricing model and what value is being assigned to the company?

Many ICOs just feature a hard cap that sets some amount of US dollars they want to raise and how many token they are offering. The actual contribution rate of N coins per ETH, BTC, NXT, etc. is determined at the start of the ICO based on the current USD price of the base coin. This model automatically gives the project a market capitalization that the founders choose, not the investors. This is not always the best model because it does not equate supply and demand. This can lead to overly high prices or overly low price. In this case, make sure that you agree with the price the project is being offered for and assess whether you think it is actually worth it’s implied market cap. Other formats such as that used by the Raiden Network ICO have more complex forms of auctions such as a Dutch Auction where the price goes down over time (others have the price go up over time). When the price is declining, contributors can enter at whatever price they think is reasonable and do not need to worry about whether they should have waited because everyone receives the cheapest price. I believe this is a better auction format because it finds a low price for investors, and the price is likely to go up since earlier contributors value the token higher than its sale price (meaning they valued it more than it sold for).

How much are you willing to lose?

The most important question you can ask yourself is how much money you are willing to lose. At the end of the day every time you invest in an ICO you are really just gambling and the action should be considered somewhere between throwing dice and buying pink slip OTC stocks. To hedge against large losses, look for a project that distributes the tokens right away and will go on an exchange sooner than later so your investment is still liquid. Ideally this will mean something like bittrex or finance, but if it hits etherdelta during the pre-sale, that’s a good sign. Regardless, never invest more than you’re willing to lose, and remember that the Wolf of Wall Street is the guy selling the pink slips, not the one buying them.

By Amit Gupta