How to Identify Cryptocurrency and ICO Scams

Cryptocurrency initial coin offerings (ICOs) were very popular between 2017 and 2018. The majority of these ICOs were scams and quick attempts to grab investors’ funds before the “developers” disappeared. The practice of crowdfunding through cryptocurrency offerings fell out of favor in the U.S. after the Securities and Exchange Commission began filing charges against coin issuers for offering unregistered securities.

However, scammers are still attempting to steal money from unaware investors, so it pays to learn how to vet an ICO for legitimacy.

Key Takeaways

• Most ICOs will need to be registered with the Securities and Exchange Commission.
• Filing documents should be available on the SEC’s EDGAR system.
• Pitchbooks should outline how a project will use the funding it receives, and whitepapers should discuss the research behind blockchain and cryptocurrency.
• Team members should be experienced, reputable, and connected.
• Many legitimate projects will be backed by established cryptocurrency and blockchain businesses, but this doesn’t guarantee success or even make it possible.

Most ICOs Must Be Registered

In the U.S., The Securities and Exchange Commission monitors the markets for activity that does not comply with existing regulations. ICOs were initially crowdfunding attempts, where projects would sell cryptocurrencies to anyone interested for a certain amount of tokens. Token issuers bypassed regulation crowdfunding and securities issuance laws by using social media, web domains, and web pages to market their projects and hype their potential for returns.

The SEC began applying the Howey Test to cryptocurrencies and ICOs to see if they met the following conditions:

• Was an investment contract
• Was a common enterprise
• There was an expectation of profits
• Profits were expected through the efforts of a third-party

Their evaluations revealed that ICOs and related cryptocurrencies generally met the conditions for being considered securities. This meant they needed to be registered with the SEC as security or exempt offerings. Thus, valid ICOs should be in the SEC’s system.

Check the SEC’s EDGAR System

Because of the stance taken by the SEC on cryptocurrencies, the first step you should take to evaluate an ICO is to find out if it is registered. The company or project should have a Form 1-A, Offering Statement or Form D, Notice of Exempt Offering of Securities, available for viewing.

If you cannot find one of these documents on the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) System, the ICO has not been registered. In this case, it’s best to wait and see what happens because the issuer isn’t following the rules, and it might be a scam. There are circumstances where an ICO might not need to register, but they are very rare and will likely not gain much traction.

Analyze the Project’s Pitchbook

During the ICO frenzy of 2018, many projects published what they considered and called “whitepapers.” However, what they were really publishing was a pitchbook.

A pitchbook is a marketing document that outlines what a project or venture is setting out to accomplish and how it plans on doing it. It discusses the competitive environment it faces, its competitive advantages, its initial valuation, and more.

A pitchbook should also lay out how the business intends to use any funds raised and at what point, if at all, it intends to generate returns for investors. Pitchbooks should help you valuate a project and give you the confidence that the team can financially pull off what they are attempting to do.

Get to Know the Team

Perhaps the single most important success factor for any ICO or cryptocurrency is the developers and administrative team behind the project. The successful cryptocurrencies are dominated by well-known figures, with developers like Vitalik Buterin, Gavin Wood, Peter Wuille, Jed McCaleb, Peter Todd, and David Schwartz. Many ICOs invent fake founders and biographies for their projects to compete with the established names in the industry.

The best protection against this fraudulent tactic is to thoroughly research the individuals making up the team. If you’re unable to find any information about a particular developer or founder on LinkedIn or other social media outlets, be suspicious. Even if profiles exist, check to see if their activity matches up with the number of followers and likes they accrue. There are people who have developed the skills and abilities equal to the established names, but they would likely have published research papers or previously been involved in projects.

Pore Over the Whitepaper

Whitepapers can be incredibly revealing—you may not understand much of what is said due to industry jargon—this is a good thing. Whitepapers don’t outline how the project will use raised funds and generate returns for investors. A whitepaper is a research document that, in the case of a blockchain and cryptocurrency, outlines:

• The issues a blockchain and crypto will address
• The blockchain design
• The network protocols
• Consensus protocols, if needed
• Other blockchain-specific topics

For example, XRP’s 2014 whitepaper started with an introduction and then defined components, terms, consensus goals, the project’s own consensus algorithm, and much more about the blockchain the cryptocurrency was built on. There is no mention of financing.

Projects or companies that don’t offer whitepapers might claim to be protecting intellectual property (IP) or trade secrets. If that is the case, they should offer enough information to satisfy you that they are a legitimate blockchain and cryptocurrency project.

Analyze the Competition

While it may seem obvious, ICOs with the greatest chance for success are those with a strategic plan to bring something new to the market. If the project offers more of the same thing the market is already flooded with, it’s not likely to achieve anything. It must truly stand out from all other cryptocurrency projects to be worth funding. Otherwise, it will end up in the cryptocurrency graveyard alongside thousands of similar projects.

Look for Backers

Most new (and legitimate) blockchain and cryptocurrency-related projects are generally linked to, sponsored by, or affiliated with other successful projects or businesses.

Warning

Project backing and business funding are good signs, but they don’t always mean a project will be successful or profitable. It might have fooled the vetting process and been a scam, highlighting the importance of understanding that there might be no way to verify that a project and cryptocurrency are legitimate. The industry is just not regulated enough yet for investors who prefer low— to mid-risk investments.

For example, Babylon is sponsored and invested in by Binance Labs, Binance’s incubator for legitimate up-and-coming projects. Babylon is a project that allows Bitcoin owners to stake their idle bitcoins to earn yields. The project may or may not be successful, even with the backing of one of the largest cryptocurrency exchanges. However, the incubator claims to have vetted the project and invested in it, suggesting there might be potential in its rumored token launch.

Coinbase also has an incubator, Coinbase Ventures, with 0x, Alchemy, Consensys, and OpenSea in its portfolio.

Are 80% of ICOs Scams?

In the past, it is likely that more than 80% of ICOs were scams, and many are today. However, there are legitimate projects looking for funding.

Can You Make Money From an ICO?

It is possible to invest in an ICO that generates returns. The difficulty lies in identifying a legitimate offering with a high probability of success in a market full of similar offerings and projects.

What Are the Biggest Cryptocurrency Scams?

Romance and ransomware scams top the list of cryptocurrency scams, followed by fake exchange scams where the scammers lock trading accounts after they are funded.

The Bottom Line

The most successful ICOs and cryptocurrencies were fueled by early speculative investing. The lure of getting rich quickly is probably older than recorded history, and the outcomes were likely the same. A few early birds get rich, and many of the rest that try lose it all in the attempt.

Legitimate ICOs will do everything they can to assure you they are real, from registering with regulatory agencies to publishing pitchbooks and having verifiable backgrounds. Cryptocurrency will neither be airdropped into your wallet by legitimate companies nor hurry you into making a decision.

Do your research, reach out to like-minded investors, check with regulators, and, in the end, remember that cryptocurrencies are speculative investments, as are legitimate ICOs and projects with wealthy backers.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. Read our warranty and liability disclaimer for more info. As of the date this article was written, the author owns BTC and XRP.