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Are Initial Coin Offerings (ICOs) Scams?

It never ceases to amaze us how many scams there are in the world of penny stocks and yet the SEC does very little to shut them down. We have been exposing these scams for years and will continue to do so because it’s people like the elderly who most often are preyed upon by these criminals. There are some extremely intelligent individuals out there who make their living fleecing people and they’re quick to identify new platforms to run scams on. Take crowdfunding as an example.

We’ve warned our readers before about just how easy it is to run scams on Kickstarter and there have been plenty. The people who run Kickstarter should be held accountable for these scams but they’re not, so all the muppets out there who continue to throw their money at that platform can expect to continue losing it. Now we have another platform to run scams on – initial coin offerings.

What is an Initial Coin Offering?

We’re going to assume that you already know a bit about cryptocurrencies. If you’re a complete newbie, then read our “Basic Intro to Cryptocurrencies for Dummies“. Now that you know what bitcoins are, just think about anyone creating their own currency using the same blockchain technology platform and then selling that currency to other people in exchange for bitcoins. The “seller” in this case is a “startup” and the “buyer” in this case is an “accredited investor” located anywhere in the world. The whole thing can take place under the nose of regulators under the pretext of “pre-selling access to a platform” as opposed to “selling equity“. Additionally, the people from around the globe who invest have an incentive to provide services and help the ICO succeed as a “decentralized technology project”. Here’s what the typical timeline looks like from a company that makes these things happen, TokenMart:

Arranging an ICO takes approximately 3-4 months. ICO sales stay open 30-60 days. After an ICO it takes 1-2 months to distribute tokens to crowdsale participants and convert raised funds to a project funding.

The same type of people who (understandably) love the idea of open-source software are drawn to the concept of an ICO for many of the same reasons. It allows a startup to stick it to the man and access capital without having to go through the traditional venture funding route. With an ICO, you raise funds directly from any investor that wants to participate. Now all those Silicon Valley VCs who have been funding the startups that gave us all the great innovations we see around us every day won’t miss all that talent that’s said to be slipping under their radar. Everyone has equal access to capital and we can all sing songs around a campfire and celebrate how great the world is with all the new found wealth we’ve accumulated – together.

What an Initial Coin Offering Actually Looks Like

Imagine a scenario where a bunch of software developers have an idea and ask you up front for money to invest in their idea. No software has been built, but rather the developers put together a “white paper” that describes their idea. It’s just like a Kickstarter campaign except about 10X riskier because you’re dealing with software that hasn’t been built yet. Experienced software professionals understand just how incredibly difficult it is to develop good software, even in the best of cases. These guys don’t just have to build software though, they have to build an entire business. Even if they have software in beta form, they still need people to sell that software, people to support the software, and product developers who help decide what needs to be built next. Just because you have a set of requirements and you build to those requirements exactly doesn’t mean they were right in the first place. This means that even if you complete the project, you could have built the wrong thing.

While that scenario sounds like a horrible value proposition, people can’t seem to get enough of it. Take the recent example of Tezos, a new crowdfunded blockchain that’s taken in over $200 million so far – for this white paper. It’s simply described as a “new decentralized blockchain that governs itself by establishing a true digital commonwealth”. These people are the ones that are hopefully going to make that happen, whatever “that” turns out to be. Then there’s a fintech in Thailand that raised $25 million recently through an ICO. That sounds a lot shadier than it actually is, since according to this article by TechCrunch they already had VC funding. Still, good luck battling that out in the Thai courts if isht goes south. Incredibly, the amount of money pouring into ICOs is now greater than the amount doled out by VCs according to Coindesk:

As of this week, it’s said that over half a billion has been doled out to these ICOs. The first time one of these things blows up and gets splattered all over the news you’re going to see buyers dry up. People who panic will be forced to dump that stuff for pennies on the dollar. Even then you’d question whether or not to buy it based on some of the risks we’ve talked about.

Where Can You Find a List of Initial Coin Offerings?

The startup we mentioned earlier, TokenMarket, is a marketplace for tokens, digital assets and blockchain based investing and they seem to be handling quite a few of these transactions. In fact, Tokenmarket has 254 of these “blockchain assets” that you can trade and there are new ones popping up all the time like the ones seen below:

ICOs - Are Any Scams?

Any time someone describes a potential investment using the word “hot”, you should probably hide your wallet and run for the exits. The CTO of TokenMarket said in an interview that “many of the teams that approach us don’t have a CTO, or the team members may have some technical background but can’t write code“. Are you kidding? So does this means that TokenMarket is evaluating the development skills of each and every person who wants to raise money on the platform before they take their 1.75% fee for the equity sale future platform access? They can’t, so the solution they are proposing is “smart contracts” that only trigger the release of funds once certain milestones are complete. You mean like all those milestones we see people hitting for Kickstarter campaigns that turn out to be scams? Who is actually policing this?

Are Initial Coin Offerings (ICOs) Scams?

While the platform seems surprisingly easy to run scams on, let’s pretend for a moment that there are absolutely no scams on the platform, EVER. Even if the people who are asking you to give them money have the best intentions in the world, 99% of them will still fail to deliver on their promises and you will lose all your money. Does it really matter if it was a scam or not when your investment disappears? You still lost your money. Here’s why we believe that number is 99%.

Venture capitalists are the best people on the entire planet to assess the suitability of a given venture to succeed or fail and still incorrectly choose 9 out of 10 startups that eventually fail. That’s a horrible track record, and you think you’re better than they are at sniffing out an opportunity? Good luck with that. Aside from the dollars, a key role of venture capitalists is to provide advice to entrepreneurs who have raw talent, ambition, and a great idea. Forget about that sort of advice with ICOs. So in the absolutely best case with venture capitalists vetting opportunities and no scams to contend with, failure rate is 90%. It seems pretty fair to ascribe a 99% failure rate to ICOs for people who invest in them.

At some point in time you’re going to see or hear something that will tempt you. It could be used by a car salesman like this guy or this guy on Youtube blubbering on about how you can become a millionaire with initial coin offerings. Do not fall for this garbage. Even Travis Scher who came up with the first “bitcoin stock” and is recognized as somewhat of an expert in the field said that he thinks ICOs are “very unappealing compared to traditional VC investing” and states the following reasons:

  1. Regulatory uncertainty
  2. High valuations/over-capitalization
  3. Lack of controls
  4. Lack of business use cases

That last reason refers to the fact that the ICO has to be a blockchain project which means it has to use the blockchain platform we discussed before. There just aren’t that many viable use cases according to an expert in the field. Just one of those reasons alone is enough reason to avoid ICOs. Even if you think you’re the smartest person on the planet when it comes to evaluating the potential of these things, do you really want to take on the regulatory risk here? Not to mention the whole thing is priced in Bitcoin (typically) which as we pointed out is very risky in itself for reasons we pointed out. If you really feel like getting some exposure to cryptocurrencies, buy yourself some bitcoin, but think twice before getting involved in ICOs until the dust settles and some of these huge risks are resolved.

Bitcoin keeps hitting new highs. While we don't have any meaningful amounts of money in bitcoin at the moment, we'd be more likely to invest speculate by holding the actual bitcoin. As we said before, we are slowly accumulating bitcoins on Coinbase and logging in to a one-stop-shop couldn't be easier. If you click this link and put $100 in Coinbase, they'll give you $10 in free bitcoins (immediate +10% return) and we'll get $10 in free bitcoins to help feed our MBAs.

 

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