Scams involving cryptocurrencies and especially initial coin offerings (ICOs) are on the rise and the trend shows no signs of slowing.
This month, securities regulators across North America initiated an organized crackdown on fraudulent cryptocurrency investment products. According to the North American Securities Administrators Association, up to 70 investigations are already underway with additional cases pending.
The announcement comes on the heels of a parody Initial Coin Offering website that was actually designed by the SEC to warn enthusiastic investors about rampant ICO scams.
For every legitimate blockchain-based investment product, scores of fraudulent products exist. These efforts by the SEC and regulators are increasing investor awareness of the risks associated with the cryptocurrency ecosystem.
"Potential investors should understand that while the crypto space, including ICOs, is exciting and can hold some potentially profitable opportunities, they are not traditional investment-grade opportunities," says former CFTC Commissioner, Bart Chilton. "They hold, generally, greater risk and are a haven for bad actors. Investors should do deep due diligence to ensure their hard-earned money isn't lost to some sleazeball."
But in a relatively new landscape, many investors don't understand how to tell fraudulent cryptocurrency opportunities from legitimate ones. To help, TheStreet canvassed industry experts for their top tips.
1. Research the team
A theme among the seasoned cryptocurrency investors is the need to first ensure the teams backing an investment product are reputable.
"Do they have any experience in blockchain or cryptocurrency? It's a big red flag to me when they have no experience in the space," says Fred Schebesta, Co-founder and CEO of cryptocurrency broker OTC, HiveEx.com. "Also, if the people at the company are all anonymous... When a company won't tell you who's behind it, this to me shows a lack of credibility and trust of the brand."
Beyond researching team members listed on the site, it also makes sense to confirm that listed individuals are actually involved with the project as well.
"I look at the executives' backgrounds, and I sometimes ratify the quality of the advisory team if they are really advising in cases where it is borderline," says Stewart Rogers, analyst-at-large at VentureBeat.
2. Look for a viable product
"I look at the use case to determine the viability of the project, just as I do any startup," Rogers says. "I'm then looking for a solid white paper, an MVP [minimum viable product] at least, and things like community size and velocity of growth."
Many enthusiastic fraudsters see ICOs as a an easy way to raise money. Ieva Strupule, the head of marketing at European payment processor Paydoo explained that some companies have entered the cryptocurrency market as a way to bypass traditional funding through angel investors and venture capital. "There is no need to actually have a product or report to anyone. Crowdfunding through an ICO has no real liabilities like a kind of utopia," Strupule says.
Current expectations in the ICO market appear to diverge from expectations in traditional fundraising scenarios, where a saleable product or MVP is a requirement. Instead, as Strupule explains: "I've seen many blockchain that are just talking about their genius 'idea' but are light years away from actually executing anything or never have planned on executing, in fact."
In some cases, blockchain companies set to do an ICO will crowdsource not just funding but also technology development. "The worst thing I've seen at a decent event was a Nordic startup that actually did have a decent experienced team, good documentation and website and had raised $15 million through an ICO," says Strupule. "But when asked in what stage was the product, the CEO said 'well, we're still in R&D, but we will soon do a Hackathon in Eastern Europe with a bunch of computer science students in order to develop it.'"
3. Follow the money
"If there is no caveat or disclaimer as to where the money invested is going; when the sale is; or any links, news, or video/images to document what they've already done, all you have is a company or group of people who are just talking emptily and taking your money and you for fools," says Andrew Rossow, an attorney and expert on internet crime.
4. Look for traction
"Never invest in a project that talks about the potential future value or returns of their token. Ignore hype and look at actual progression on stated milestones," says Jared Psigoda, CEO at Bitguild, a decentralized gaming platform for gamers that offers ownership of in-game assets on blockchain.
5. Make sure you do your legal homework
"Look to see what measures were taken to prevent issues with the SEC," says David Garcia, SVP and partner at Ripio Credit Network, the peer-to-peer global credit network protocol based on cosigned smart contracts and blockchain technology.
"Even in the cases of a utility token [a cryptocurrency used to purchase goods or services on a blockchain-based platform], make sure to do your due diligence on the legal and regulatory aspects of the project. And check both soft and hard caps, as well as looking at token lock-up periods for founders and developers," Garcia continues.
"You'll also want to look at token distribution during the pre and public sales. Finally, you want to make sure the company is compliant and working towards improved KYC [know your customer] and AML [anti-money laundering] policies for their customers," Garcia says.
6. When in doubt, trust your personal connections
Addy Crezee, CEO of Blockshow, one of the biggest blockchain conferences in Europe, concludes that there is never a way to be 100% certain an ICO isn't fraudulent.
To that end, he suggests investors gear their highest support for teams and founders they personally know and believe in -- which, ironically, isn't much different from traditional investments.
Likewise, Crezee notes that he won't personally invest in a service or company that doesn't have any females on its executive team. "Three-fourths of the BlockShow team is comprised of active and successful women," he says. "Likewise, I believe the strongest companies in the ICO sector will be more successful when they include women as well."
Finally, consider the advice of Donna Redel, the managing director of New York Angels. "If you think an ICO is fraudulent, don't hesitate," she says. "Alert the SEC or state authorities to be sure."
The author holds stock in investment holding company, Leucadia, and remains a partner in an emerging technology fund. He holds no positions in cryptocurrencies or in any companies that invest in them.