Are ICOs Scams?

Token Sales

Are ICOs Scams?

Similar to a company’s IPO, an ICO is an attempt at crowdfunding to support a new blockchain project. Through the ICO process, a company has the ability to raise funds from a broad investor base to develop new technology, without having to guarantee its investors any financial stake in the project.  

However, unlike IPOs, ICOs, which have raised more than $20 billion from investors between the beginning of 2017 and October 2018, are unregulated. The SEC, and comparable entities worldwide, are still figuring out how to manage the risks around them. In the meantime, despite fundraising success in 2017 and 2018, ICOs have incurred severe reputational blows.

Scam coins, exits scams and hacks

In 2017, 78% of all ICOs were identified as scams, according to a study by the advisory firm Statis Group. Cybersecurity company Carbon Black also found that approximately $1.1 billion worth of digital currency was stolen in the first half of 2018.

Because the technology around cryptocurrency tends to be fairly complex and esoteric, it can be difficult to understand the nuances of what makes one coin or platform a more legitimate investment option than another, and investors can be subjected to scam coins, exit scams and more. And ICO scams have continued to plague the industry.

In April 2018, a company based in Vietnam launched two ICOs and raised over $658 million. When angry investors went to confront the company behind those ICOs,  Modern Tech, after realizing that the ICOs were actually a pyramid scheme, they discovered that the company had been liquidated. Later, in November 2018, Pure Bit, which launched an ICO from South Korea, raised over $2.4 million from investors and days later, rerouted all of the funds into personal wallets in what is frequently termed an “exit scam”.

While genuine bad actors have undermined the ICO space, even the most well-intentioned ICOs have their share of challenges. In July 2017, Israeli company CoinDash famously lost over $7 million when a hacker rerouted the funds raised to a fraudulent Ethereum address. Interestingly enough, by February 2018, the hacker reportedly returned a total of 30,000 ETH (worth $17 million at the time), though similar acts of conscience are rarely the norm.

Are ICOs scams?

Because of the difficulty in parsing out the qualities that make one ICO a more viable option than another, and because of the prevalence of exposed ICO frauds, it can be tempting to write off ICOs as scams altogether. Investor enthusiasm to get in on the ground floor of a lucrative cryptocurrency, combined with a lack of consistent regulatory authority and governing principles create conditions ripe for a scam artist .

In October 2018, the firm Ernst and Young published a report stating that 71% of the ICOs they had observed in 2017 had still not launched any tangible offering on the market. Again, whether or not the lack of delivery was a premeditated act from the founder is unknown, but this additional analysis certainly lands another blow against the reputation of ICOs as a whole.

On the other hand, at the time of writing, the market cap for cryptocurrency is estimated at more than $1.36 trillion. This includes quite a few with ICOs that have only launched since mid-2017,  like NEO, which had development support from the Chinese government (which has banned ICOs) to compete with Ethereum, or EOS which has raised over $4.1 billion between June 2017 and June 2018. Even now, after the roller coaster that major cryptocurrency prices experienced in the latter half of 2018, demand for more functionality still exists. As blockchain technology is better understood and adopted by more entities who value and are able to utilize practical applications like smart contract execution, proof of ownership, or even intellectual property rights, ICOs will likely continue to abound.

The question that will remain is how investors can protect themselves and better distinguish between bad apples and the next big thing.

Celebrities who got in trouble for promoting ICOs

To protect themselves, investors do traditionally conduct due diligence efforts on the founding team that proposes an ICO, reads carefully through the white paper and pitch and may even have a crack team who can analyze the viability and development path of a new cryptocurrency or project beyond just what is promised. However, sometimes it can be tempting to take a shortcut, and celebrity endorsements have proven to be a fairly controversial one.

One of the most recent, famous and dubious endorsements came from DJ Khaled and Floyd Mayweather, for a crypto debit card called Centra Tech. Claiming that they had a partnership with Visa, Centra Tech was able to raise over $32 million before Visa issued a public denial that any such relationship existed. The SEC investigated the founders for their unsubstantiated claims, eventually indicting the founders for fraud. As for Khaled and Mayweather, they were levied a total of $767,500 in fines and penalties, with Mayweather’s share being far greater due to his (non-disclosed) endorsement of Centra Tech and two additional cryptocurrencies called Hubii and Stox. Further, they are banned from promoting any securities for the next few years.

Other celebrities that have recently backed ICOs include Paris Hilton, Dennis Rodman and Steven Seagal (who famously backed “Bitcoiin,” not to be confused with “Bitcoin”). Seagal’s backing helped Bitcoiin raise over $75 million, though a cease and desist was filed in March 2018 by the Bureau of Securities of the State of New Jersey to help safeguard investors, as the developers apparently abandoned the project.

Celebrity endorsements have become so prevalent that the SEC issued a statement, noting that Celebrities and others are using social media networks to encourage the public to purchase stocks and other investments.” The Commission added that: “These endorsements may be unlawful if they do not disclose the nature, source, and amount of any compensation paid, directly or indirectly, by the company in exchange for the endorsement.”

More tellingly, and a great reminder to any investors looking for viable ICOs, the SEC reminds us that “Celebrities who endorse an investment often do not have sufficient expertise to ensure that the investment is appropriate and in compliance with federal securities laws.” There is truly no substitute for due diligence by a prospective crypto investor.

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