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What is an Initial Coin Offering scam?

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  • An ICO is essentially a version of a stock exchange Initial public offering (IPO) that works with cryptocurrencies instead.
  • It launches a new crypto coin or token by making it available to investors for the first time.
  • The process can be potentially fraudulent, and some estimates point towards around 80% of all ICOs being a scam of some kind.

The basics of an ICO scam

A normal initial public offering (IPO) is when shares of a private company are made available to the public in a stock issue. This is how capital is raised by many operations as opposed to taking out loans or other forms of financial backing. An IPO will usually be underwritten by an investment bank and arrangements made to list the company’s shares on one or several stock exchanges.

This is often called ‘floating’ a company and sees what was previously a privately-held business to become a publicly owned one. The reasons for taking this action usually involve either raising equity capital for expansion or monetising the prior investments of the company founders or other backers.

An ICO is a similar process used to launch a new cryptocurrency. As such, it carries the same risk/reward possibilities as an IPO in as much as the focus of the process may go on to be a success or it may not live up to the plans and promises of those behind the launch. However, as IPOs follow an established pattern with a long history of public scrutiny and legal precedent, actual scams are few and far between. However, the still-developing sector of cryptocurrencies means that ICOs are not only at risk of failure, they are also often simply fraudulent.

The basic premise of an ICO scam is pretty much the same as any other financial fraud — to get gullible investors to think they are on to a good thing, take their money and leave them empty-handed when the truth eventually emerges, as it always does. Unfortunately, the ‘wild west’ nature of the crypto sector currently does little to discourage would-be scammers and often encourages reckless investors to make risky choices.

How to avoid an ICO scam

Thankfully there are many ways in which a savvy investor can recognise a potentially fraudulent ICO. The most obvious way is to undertake ‘due diligence’ and find out as much as possible about the digital coin in question. What are other people saying about it on specialist online forums? Is there a functioning website for the project that offers full disclosure on the launch and provides in-depth details about its development and the team behind it?

Even so, as web portals are now the first point of call for most people looking for more details on any given subject, some scammers will go to great lengths to ensure that the online presence for their fraud is well-produced and looks convincing. As such, other ways of delving deeper may be needed.

A legitimate project will be happy to reveal all about the team behind it and when it comes to crypto companies their pride in their developers will be the same as most other outfits working in the tech sector. Checking on backgrounds that are provided by looking at other sites such as LinkedIn and GitHub can give invaluable insights into whether or not the new coin is one to be trusted. An absence of history for the people involved in it can only be a very large red flag.

Being as clever as the scammers can you lead down a rabbit hole of detective work, as even fake social media pages can be set up to make it look like the ‘team’ involved has a professional history of employment. By ‘right-clicking’ on photos used in profiles and then clicking ‘search Google for image’ you will be able to see if the pictures used are likely to be authentic or are simply stock images used to trick the unwary.

Another way to look for a scam can be found in the whitepaper. The whitepaper details information about the company and the project in hand, and therefore, should be a document that is quite unique. Even in the world of crypto where new projects may seem quite similar to other existing ones, they should never be indistinguishable.

By copying some text and doing a search, you should be able to find out whether the white paper has been copied from somewhere else. Additionally, bad grammar, vague ideas and any obvious errors should set alarm bells ringing.

As with a standard share offering, IPO investment plans laid out by the ICO should be realistic and achievable. This is something any whitepaper should address in great detail, listing each stage of the development plan from day one of the project through to the eventual goals and targets.

Whether or not the developers themselves are holding onto amounts of the new currency tokens themselves over a period of time is also a key factor. Historically, when the originating teams sell their own coins the value usually falls very quickly.

Conclusion

Every ICO is conducted by a company so, therefore, doing more due diligence checks on the registration of that entity should be quite straightforward. Where it is registered can be another tell-tale sign as some of the best countries are Malta, Gibraltar and Switzerland. This usually offers some peace of mind, but even so, if registration details are sketchy or look like a series of dissolved or shell companies, it can be a bad sign.

Although much of this might sound like using common sense, sadly some investors who think they are onto a good thing will fall foul of their own confidence and not be thorough enough in their fact-checking. This is something that all scammers take advantage of and can easily be avoided.

Most fraudulent ICOs rely on their victims failing to conduct their own quality research into the project, which is why, in many cases, they can be quite easy to identify.