Investing In Cryptocurrency And Blockchain: How To Differentiate Legitimate ICOs From Scams

Not every venture needs a blockchain, and not everything needs to be decentralized. This might seem obvious, but with all the hype around blockchain technology and its disruptive potential, it can be easy to latch on to an idea the moment its White Paper mentions a large industry that the project is purportedly tackling.

When evaluating an ICO, a good first question to ask is: "Do we need a blockchain or a native token for this project?" If the answer is no to both, chances are the ICO project is an example of solutionism — crypto for crypto’s sake — or a scam.

Understanding who is behind a blockchain project is perhaps the most important step in your due diligence process. Even if the premise of the venture and the addressable market seem attractive, one of the biggest determinants of a venture’s success is the makeup of the team behind it.

Anonymous Teams

As with all Initial Coin Offerings (ICOs), the team is important. Trusted people with long verifiable track records will be less likely to perpetrate such a fraud. It is often a red flag if the team behind an ICO does not have any named full-time developers. Additional caution should be taken if none of the leadership team has any domain knowledge in the specific industry.

When looking at a team and verifying their experience, platforms like LinkedIn and Twitter are useful. However, it is important to note that they are not infallible, as profiles can be faked and resumes embellished. If members of the team claim prior association with universities or companies, double-checking with reputable third-party sources (e.g. a university newspaper or the company website) can provide the facts. ICOs often list their advisors on their websites. You should also verify whether the advisors are legitimate and bring relevant knowledge and experience to the table.

Insufficient Information on Websites and White Paper

When you are unsure whether a project is a scam or not, it is better to err on the side of caution. While it is possible that the lack of well-designed websites and detailed information for a crypto project is because the project is still in its infancy, it can be hard to determine whether a project is underdeveloped or a scam.

In many cases, they can be both. In those cases, interested investors can either wait for more information — such as in the case of Asia-based ICOs, where information is only translated into English later on in the project — or simply avoid ICOs they do not fully understand. Nothing can compete with quality due diligence. When Venture Capital firms investigate companies and their projects, there is a heavy emphasis on thorough due diligence — investors should do the same.

Another crucial source of information for all ICOs is the White Paper, or the key document that outlines the mission, technical details, team and other central details behind the venture. While the amateur investor may not have the technical or business background to fully understand every aspect of a White Paper, a general understanding of blockchain concepts is a must when evaluating whitepapers.

Pyramid or Ponzi Schemes

Perhaps the most common types of scams are projects categorized as pyramid or Ponzi schemes. These types of frauds can be ICOs that offer incentives to be first in and suggest that outsized returns can be earned by these early participants — often in the form of a daily payout of several percentage points of the initial investment. If something sounds too good to be true, it generally is.

Schemes sometimes involve paying off investors not with returns from the venture, but with new money coming in from later participants. This generally works as long as new money is coming in. But as soon cash flow diminishes, the scam collapses, with latecomers losing most or all of their investment. This is what happened with the collapse of Bernie Madoff’s fund. Note from this example that incredibly sophisticated investors were fooled and the fraud continued for decades until the financial crisis.

Promises of High Returns

The incredible returns that Bitcoin and other cryptocurrencies have experienced over the last year have generated enthusiasm and interest in the broader public. This type of environment often causes people to be less cautious or blinded by the potential for outsized returns. Scammers take advantage of this by promising or inferring that huge gains will accrue for people who participate in their ICO. No legitimate ICO will ever guarantee any level of return. All investing carries risk and legitimate ventures will outline those risk prominently and be realistic about the type of gains that investors can expect.

Things to look out for here include guarantees of certain return levels or suggestions of huge returns. Additionally, legitimate ICOs will back up claims with clear reasoning and research to support their claims. Finally, any ICO’s White Paper should have a section that outlines the risks associated with the venture. Steer clear of those that do not check all of these boxes.

Internet Trolling

Even if an ICO is legitimate, you still have to watch out for trolls who want to scam newbies to the crypto community. These trolls have various methods of manipulation, such as creating phishing traps, copycat websites that trick people into giving them crypto and other hacking methods.

Moreover, trolls often operate in sophisticated groups and attack an entire project with the objective of extorting funds or blackmailing the management team with internet ransoms. Crypto projects are inherently susceptible to such attacks due to the fact that the attackers are difficult to trace, and stolen or extorted funds are often converted through various exchanges and cryptocurrencies.

Another thing to look out for is a company that actually has real goals and plans to help change an industry but somehow gets slaughtered by trolls that label them a scam. Trolls have a habit of calling anything they see doing well a scam. Even worse, they may actually like the project and just want to scare everyone into selling their coins at a low price so they can buy the crypto at an even lower price, only to dump it at a profit later. At the end of the day, this level of “trolling” is becoming a significant underground market with high-level scammers.

“Scam” a serious word to throw around — fraud is a crime that’s punishable by jail time — but on Twitter and in some crypto forums, the word gets thrown around so easily. However, outside of the Crypto Wild West, calling something a “scam” implies an intent to deceive. Accusing a company of running a scam can seriously damage its reputation. Without solid evidence, that label is potentially defamatory. It is possible to raise doubts about a project or a team's ability to execute on it without jumping straight to accusations of fraud. But that four-letter word is the easiest way to make oneself heard in the shouting match of online conversations, which is most likely the reason why it gets used so casually.

Keep in mind that trolls are extremely well-versed in manipulating the truth. As a result, investigate any accusations of a company’s wrongdoing, and don’t let yourself be swayed by the opinion of an organized group on social media channels.

Jessica VerSteeg is the CEO of blockchain platform PARAGON.