A whopping $12 billion have been raised from 4,000+ ICOs since January 2017, according to a Boston College research paper. Of these, less than half survived more than a few months after the initial offering.
According to a similar study by news.bitcoin.com, 46% of new crowd-sales listed on Tokendata in 2017 have since failed, either during the ICO stage or post-ICO.
In this article, we try to discover what is going wrong in this space, and how investors might avoid the ICOs that are doomed to failure.
Disclaimer: The information provided in this article is a personal opinion and does not constitute investment advice, financial advice, trading advice, or any other sort of advice, and you should not treat any of this story’s content as such.
Although the startup and high-tech sectors are known for being volatile, and often present a high-risk investment, ICOs are failing much faster than most other businesses – including ventures in other high-tech sectors. But why?
One of the main reasons for the popularity of the ICO is that anyone can raise money for any idea. An ICO can be launched without any proof of concept, financial modelling, seed capital or prototype product. On one hand, this is what makes ICO investing so exciting and inclusive. On the other hand, there are good reasons behind traditional investors looking for some basic business criteria. There is always a big gap between a concept and a product, which accounts for the 90–95% chance that a conceptual ICO will be a failure.
According to cryptocurrency data firm ICORating, idea stage investments in ICOs are the most risky:
“The highest percentage of unsuccessful ICOs in terms of product readiness arose from projects at the idea stage. 58% of such projects failed to raise more than half a million dollars.”
The logic behind this is simple; if a team cannot commit sufficient funds, time and experience to turn an idea into (even a basic) product or prototype, it is more difficult to trust them to do so with ICO funds. The result is not just less ICO investment, but also a higher likelihood that a product will never actually reach the market.
Even more alarming is that some crypto startups appear to be deliberately creating products aimed at the ICO investment market, with the sole aim of raising as much money as possible and with little or no commitment to using it for the development of an actual product. They rely on market hype to generate cash, and the lack of regulation in the space to allow them to do as they wish with the funds.
The Greater Fool Theory is an economic theory states that “the price of an object is determined not by its intrinsic value, but rather by irrational beliefs and expectations of market participants”. In other words, the price of an object is determined by the hype surrounding it, or the beliefs or feelings of a community. For example, a stock value could rise or fall based on a rumour or prediction by the financial community rather than the actual financials of the company. Similarly, a suspected Rembrandt painting could multiply in value once confirmed that it is genuine; the object itself is the same but the beliefs surrounding it affect its value.
In the ICO world, we see this regularly. New coins, Dapps or tokens are often subject to a great deal of “hype”, usually created by aggressive marketing efforts. The coins are subsequently purchased regardless of whether they present a solution to a problem or add anything of technological or business value, and this creates groundless inflation.
Often this inflation is unsustainable and eventually results in a crash, probably around the same time that investors realize the token is not actually useful. Rather than avoiding this phenomenon, it seems that some developers are actually creating coins with ICOs as their final goal, rather than to possess actual value.
According to Fortune Jack, the ten most high-profile ICO scams managed to defraud investors of $687.4 million. Deadcoins.com has revealed over 150 ICOs to be scams, and research from Satos Group has identified nearly 80% of ICOs in 2017 to be scams.
In a recent article, Bitcoinwarrior wrote:
“the decentralisation and lack of regulation for so many cryptocurrencies has paved the way for fraudsters to swindle thousands of unsuspecting investors.”
With technology often comes a certain level of psychological distancing; many ideas in the crypto space seem innovative, technologically groundbreaking and exciting, but do not actually have a real-world application. ICO investors often forget that even the crypto world is a part of a real business ecosystem. If a token is not valuable in real life, why should it be valuable in virtual life?
One of the most overlooked yet important coin properties investors should consider when evaluating an ICO is whether or not a token is likely to reach wide-scale adoption, whether it solves an actual problem and whether it has a useful application in the real world.
Perhaps as a result of the many stories of bitcoin millionaires and early adopters of other coins that have exploded, ICO investors often have the mindset that investing in ICOs is a get rich quick solution. Although this is possible and has been known to happen, most coins do not catapult in value for no good reason.
The parallels between ICOs and the dot-com bubble are quite shocking. ICOs have attracted a lot of investors who base their decisions on a fear of missing out on the gold rush. Similarly, investments in ICOs are commonly made on the basis of speculation and potential, with most ideas not even offering an alpha version of their end product.
According to Blockgeeks, there are three main principles, which they call “pillars” that must be upheld for an ICO to be successful in the long run. These are crypto-economics, utility and security. If any of these elements of the project appears to be lacking, the chances are the ICO may encounter problems down the road.
In a recent interview with Coin Telegraph, Brian Kelly, founder and CEO of BKCM LLC, said that ICOs proved to be an effective tool for funding projects using blockchain technology but that when choosing which digital currencies to invest in, there is a combination of positive indicators should be considered, such as activities that will increase the network or potential software updates.
According to Fortune Jack, there are 12 “flags” that one should look out for in order to avoid investing in an ICO scam. The indicators to avoid are:
Some of the properties to avoid, such as fake profiles and mistakes in materials, may seem obvious. Others are far less so. We aimed to avoid all the common pitfalls in our own token offering by adhering to regulation, providing financial audits, creating a forward-looking economic model, adopting established technology, and having a strong real-world use in an industry worth $217 trillion. Mark Lloyd, Managing Director of Dominium says,
“Dominium might be the first regulated property company to launch an ITO”
