ICOs: Avoid The Lemons

ICOs (Initial Coin Offerings [Crypto 101: What’s an ICO]) can be amazing fundraising tools. They can, just as readily, be amazingly bad investments.

As I’ve mentioned before, the same lack of regulation and ease of funding that makes ICOs popular among legitimate startups – also makes ICOs popular among scammers. Personal due diligence is essential in this space – as of right now, no government entity is vetting ICOs… and there are no refunds or assurances after the fact.

The crypto community is growing rapidly and many people are only focused on the unparalleled returns of crypto investments. The media has been adding fuel to the speculative fire, expounding on every positive price movement and ignoring the extreme losses many ICO investors have, or likely will, incur.

Governments have been slowly responding, as they realize the severe risk of fraud. ICOs have come under varying degrees of regulation in several jurisdictions already. It’s important to point out: regulation is not the only possible (nor likely the most effective) response to the fraud risks.

Deliberate investment decisions don’t require government intervention. The crypto communities are strong and active. Legitimate projects provide detailed information about their teams, goals, partners, and capabilities. The individual investor already has access to enough information to make intelligent decisions in most cases – they just need to actively consider it all before they commit to an ICO investment.

The single most important consideration when investing in an ICO shouldn’t be its website, its whitepaper, or even its team. It should be the structure of the ICO itself. Like everything in the crypto space – economic incentives should be aligned with everyone’s interests before anyone puts up money.

If a small project raises hundreds of millions of dollars before having produced anything useful, then investors have actually undermined the team’s incentive to work on the project. Funding should be tied to milestones or project development – and even then, over-funding can be a severe disincentive.

Funding should motivate progress, not simply be dumped on teams as an economic distraction. After all, why would anyone develop tirelessly when they suddenly have more money than they had ever hoped for? Altruism is rare – and motivation can be fickle… investors should demand ICO structures that keep the project’s team incentivized to make the project a timely success.

What’s more, is that the success of the project should be directly correlated with the value of the token the investors received. Issuance of additional tokens should be in the hands of token holders. Investing is only half of the equation – returns on that investment should accrue based on value creation by the project (ie not solely token resales to other speculators).

By paying attention to the proposed structure of an ICO, and only investing when that structure maintains positive incentives for all parties – investors are not only protecting themselves from undue risks. They are also making the ICO market as a whole safer for all participants. If poor ICO structures are exposed and continually rejected by investors, then the ICO market will have no choice but to respond with better ICO structures. This is a win-win for everyone involved.

Poor ICO structures are easy to spot – as long as investors are on the lookout.

The good news is that more people are on the lookout and spreading awareness.

Protip: if an ICO does volume bonuses (“buy at least $50000 of coins, get 20% more”) then they do not understand the first thing about the egalitarian spirit of crypto (or at least, the egalitarian spirit that I believe crypto *should* have). Skip them.


@VitalikButerin, Twitter