Reports indicates that a third of investments raised by startups in the first quarter of 2017 came from initial coin offerings (ICOs). The trend will only grow, as evidenced by the network congestion experienced with ICOs held since the report’s publication.
Startups that sell tokens on the Ethereum blockchain offer a new investment option. Benefits to token buyers include the ability to sell at a higher price after the launch of a project, using the tokens to pay for services, or earning dividends from a project’s profits.
Token issuance is not regulated, however. It is therefore upon you to ensure the ICOs you invest in are viable, genuine and safe. Taking the following five actions is a good starting point.
1. Read the white paper
Most startups running ICOs publish white papers to explain their underlying technologies. It is worth it to spend an hour or so reading this document. After all, your money is at stake.
Seek help to understand the technical parts if you are not a developer. Talk to a family member, colleague or a friend who understands how code works. Consider hiring an expert to explain it to you, if you are investing a lot of money.
2. Research the founders and developers
It is a norm in the blockchain space for developers to maintain anonymity and let the code they produce speak for itself. It all started with the founder of bitcoin, Satoshi Nakamoto, choosing to be anonymous.
Researching the reputation of the founders might not be necessary if a project is open source and the tokens are out of their hands. In this case, understanding how the core software works is more important.
On the other hand, if the project is not open source and the funds raised are centrally controlled, it is important you find out who the founders are before committing your money. The viability of a centralized project depends on the credibility of its founders as shown by previous projects they’ve worked on.
3. Read reviews and expert analysis
Websites and blogs that analyse ICOs are becoming common. We offer resources to help you make good investment decisions. On our site, we engage experienced developers and investors to analyse both technical and economic aspects of projects seeking ICO funding.
Also follow discussions about ICOs on blockchain social media channels and online forums such as Bitcointalk and the Bitcoin subreddit. The more opinions you get, the better decisions you’ll make.
The Business Blockchain author William Mougayar has created a list of 18 web resources for researching, tracking and launching ICOs.
4. Invest only what you are willing to lose
When you decide an ICO is viable, reputable and secure, invest only what you are able to lose without jeopardising your financial situation. Even ICOs run by reputable and experienced developers and entrepreneurs come with risk.
You may want to invest in several ICOs to spread your risks. Still, you should not exceed what you can afford to lose. Most ICOs use the Ethereum blockchain, which means their stability depends on the stability of Ethereum.
5. Prefer ICOs using reputable escrow services
Most ICOs use escrow services to hold investor funds until coin or token distribution. It is a positive indication if a project is using an escrow service. It is an even better sign if the escrow service is reputable.
Decentralized and open-source projects may use smart contract escrows. The Ethereum decentralized anonymous organisation (DAO) is an example of an ICO that used such an escrow. Following that example, which ultimately contained a vulnerability in the code, don’t forget to consider the soundness of the software design.