Cryptocurrencies and ICOs are a highly talked-about and sought-after form of investment in today’s markets. As with any investment, though, there are risks. The explosion in number of crypto entrepreneurial ventures, which bring to the table a plethora of options, make it hard (and sometimes near impossible) to distinguish between real opportunities and scams. Before discussing risks such as those, let’s make a categorical distinction between investing in truly decentralised cryptocurrencies and ICO tokens.
Decentralised cryptocurrencies are the digital equivalent of commodities. They are mediated by their own peer-to-peer networks which are a form of digital commons, and, therefore, are not owned or controlled by anyone. The risk profile is best approximated as a form of faith in society and the crowd to behave rationally according to the rules and incentives laid out by the network. The software is open and fully analysable, so there are no unknowns in the system to worry about, if one is willing to perform that level of analysis. Investment risk in a cryptocurrency is therefore largely against the future adoption and development of the system: how society chooses to evolve, or devolve, projects like Bitcoin and Ethereum. In an already widely adopted network, however, making detrimental changes will be difficult, as users will have their incentives aligned through ownership of some of that currency.
ICOs, in contrast, are a type of crowd-sourced venture capital fund raising. Anyone buying into an ICO must put on their angel investor hat and appraise the proposition as any other centralised start-up firm, evaluating essentials such as team track record, team’s complementary set of skills, viability of the business plan, chance of falling foul of the law, uniqueness of the project, the current and future competitive environment and so on. An ICO typically uses a decentralised cryptocurrency network to host a dedicated token representing your investment in a centralised team with a business idea, which may or may not have something to do with decentralised systems or digital commons. Your ICO stake is represented by a token which you fully control and can typically trade in token marketplaces at will, unlike venture capital stakes, which are represented by legal paper work and are difficult to re-sell in the first few years. ICOs are currently rarely regarded as equity shares of the team, so their valuation should be based on other metrics specific to each given investment.
ICO valuations can, and frequently do, fall to zero. Cryptocurrency valuations, although highly volatile, are far less likely to fall to zero as this requires all participants to stop running the network, it only takes a handful to maintain a network and a (small) market.
If you feel ready to invest in ICOs and/or cryptocurrencies, consider that, given the nature of these technologies, there is both the power to have full control of one’s own digital assets, and the power to lose them completely with no effective means of recourse.
There are degrees of trust necessary to operate in the cryptocurrency space. In trade and commerce, you should question whether your counterparty will send the goods if you send the payment. Trading on a cryptocurrency exchange requires trusting the exchange with your money, so it might be wise to ponder whether you can trust them — decentralised exchanges are working on solving this problem, but there is room for significant progress still.
ICOs require further levels of trust. Just like any entrepreneurial initiative or investment proposition, they can go bad, either through bad intention and confidence tricks, as in a scam, or through incompetence from the team behind it, or even by theft from a hacker or robber.
So, if you still want to invest in an ICO after running your project due diligence and considering the risks, then the following practices will help to keep you safe:
- Generate your private keys yourself;
- Never give your private keys to anyone;
- Don’t keep your tokens on an exchange or a hosted wallet that you didn’t generate the keys for;
- Only invest an amount of money that you are willing to lose;
- Identify the official communication channels from the project team so you can stay abreast of any critical updates and warnings, and block out the imposters;
- Research the tax rules in your local jurisdiction to see how such an investment might affect your wider financial situation and plans.
If you follow the rules stated above, you are much more likely to be successful in your investment. However, even if you follow the advice in this blog, no one can guarantee your return on investment. Please do keep in mind that, as with any investment, there are always risks involved with investing in cryptocurrencies and ICOs.