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Fraudulent ICOs Motivate Industry to Try Self Regulation

With promises that blockchain technology will revolutionize the world, many retail investors are looking for a way to get in on the action. And for good reason. A recent research report by venture capital firm Mangrove Capital Partners found that the average initial coin offering (ICO) returned an astounding 1,320%. But the industry needs self regulation to help protect investors.

While investors should remain excited about upcoming altcoins, it’s still a good idea to exercise caution. Vietnam-based Modern Tech recently stole $660 million in ICO earnings through their iFan token. This was a painful reminder of the need for regulatory oversight in the cryptocurrency space. The team of 7 duped 32,000 people by promising a 48% monthly return. They handily constructed a fancy website that fooled many. Then, they made off with the funds they had raised.

Regulators Respond to ICO Scams

Regulators are trying their best to keep up with such flagrant violations of security laws. The Securities and Exchange Commission (SEC) recently developed their own mock website which outlines what a fake ICO would look like at Howeycoins.com.

The SEC’s caution about investing in ICO’s without proper due diligence is prudent. But it would be naive for the them to suggest avoiding ICOs all together. Like the Mangrove report outlined earlier, many legitimate teams are launching coins. Many of these projects have the potential to positively impact the world while delivering outsized returns to investors. But until governments develop clear regulations and policies for the industry, some form of self regulation is needed.

Community Responds with Self Regulation

So, how is the community responding to fraudulent ICOs and regulators’ inability to effectively protect investors? Members of the cryptocurrency community have devised several ways to protect investors from becoming the victim of fraud. These include escrow mechanisms, vesting, and delayed liquidity.

Escrow

One of the most promising solutions that some ICOs have already begun implementing are escrow mechanisms. In such a fundraising structure, a trusted 3rd party stores the ICO funds, as opposed to making all the funds available to the developers in one lump sum. At certain developmental stages, the funds are released to the developmental team. In this way, investors can ensure that the developers are working diligently toward the production of the coin. If they are not, the funds can be returned to the investors.

self regulation

Vesting

The crypto community has also borrowed from the corporate world when looking for solutions to incentivize developers. Both industries want developers to work on projects for the long term. Companies often give their employee stock options. This allows them to purchase shares at a certain price, often below the current market price of the stock. The catch, and one that is meant to retain top talent, is that these options ‘vest’ over a certain amount of time – usually a few years. For this reason, employees have incentives to stick with the company lest they forfeit their stock options.

Delayed Liquidity

In the crypto universe, we see the same logic through delayed liquidity. In some forms of fraudulent ICOs, developers dump their coins right after their ICO funding round is over. They profit off the demise of unprotected investors. To prevent this, delayed liquidity fundraising structures force the founders’ coins to ‘vest’ before they are tradable. The vesting period varies, but is often for a year or longer. in this way, their own financial interests are aligned with the success of the coin. So developers have an appropriate incentive mechanism to continue the development of the coin.

How TruDex Supports Self Regulation

If you’re like me, you probably don’t want to spend all your time reading white papers and researching coins. That’s why TruDex has created a verifiable scoring system.  Our experts use this system to rank ICOs on an array of metrics. One of these is the types of investor protection mechanisms the development team has implemented. This information helps to determine whether or not they are in this for the long-haul. It also diminishes the chances that team members will make off with investors’ hard earned money. Indeed, the usefulness of TruDex’s rankings are  apparent when see the data.

Of the top 10 highest rated coins, 90% had either an escrow mechanism or delayed liquidity in place, and 20% had both. Of the lowest 10 rated coins, only 20% had one of these, and 0% had both.

Heard of any other ideas for making ICOs safer for investors? Drop them down in the comment section below. And if you’re looking to make prudent crypto investing choices, take a look at our ICO ranking system which reveals the top ICOs for you to research further.

 

Sources:

https://news.bitcoin.com/chinese-investors-use-wechat-brokers-bypass-ico-ban/
https://hackernoon.com/10-world-countries-with-the-most-vibrant-ico-scene-44273900701a?gi=208808f70f74 
https://venturebeat.com/2017/12/01/how-to-protect-ico-investors-auto-refunds-if-milestones-arent-met/
http://www.mangrove.vc/ico-report2017
https://techcrunch.com/2018/04/13/exit-scammers-run-off-with-660-million-in-ico-earnings/
https://cointelegraph.com/news/sec-launches-mock-ico-to-show-investors-warning-signs-of-fraud
https://cointelegraph.com/explained/what-is-a-daico-explained
https://www.forbes.com/sites/jonathanchester/2017/06/12/a-new-way-to-raise-money-the-initial-coin-offering/#726e9bdf5fb5