Evaluating Initial Coin Offering (ICOs) & Crypto Token Investments
What is an ICO
Initial Coin Offerings (ICO), Initial Token Offerings (ITO), Token Generation Events (TGE) or Token Crowdsales are fundraising mechanisms for crypto projects which are poised to be disruptive innovation tools in the digital era. More specifically, they are events where cryptocurrency projects sell their tokens to early adopters in exchange for money. The project usually creates a white paper and a technical paper which states what the project is about, what the technology is and in most cases how blockchain is used in their business model and how their business model is being tokenized. Early supporters of the project are usually motivated to buy the tokens in the hope that the project team will deliver on their promise and create value to the ecosystem.
Emergence of New Asset Class
Cryptocurrencies have been a hot topic over the last few years, with Bitcoin and Ether taking pole position whilst hundreds of alternative coins also attract attention from investors. The total cryptocurrency market capitalisation stands at $182bn to date according to https://coinmarketcap.com/charts/. In order for investors to evaluate long-term investment potential, they need to understand the following:
- The function cryptocurrencies serve within the ecosystem
- The underlying blockchain technology
- Governance structure
With the rise of ICOs we can clearly see that crypto tokens are emerging as a new digital asset class. Crypto tokens are digital assets that use a decentralised peer-to-peer network called blockchain. Blockchain has the capability to cryptographically represent, record, store and exchange any kind of assets. Such assets can be; real estate, financial securities (bonds, derivatives, equity), voting right or right to access goods & services.
Tokenization – The “New Economy”
Tokenization is an essential part of the technology that serves the purpose of platform identification and accessibility. Blockchain platforms are powered by tokens and sometimes they are referred to as “coins”. In essence the “Tokenization” concept occurs when the legal entity decides to move away from an old economy (centralised) model into the new economy (decentralised) model by transforming their back-end operations into a blockchain powered platform, while creating network effects and building their community.
Crypto Token Valuation Challenges
Trying to value digital currencies is a difficult task due to the complexity and various dynamics that a potential investor needs to consider. Bitcoin for example is part currency, part commodity and part technology; using traditional valuation models to value this currency does not work. Bitcoin is too recent to reliably use back-test models and does not have cash flows or earning data that can predict its future value.
Utilising macro-financial indicators and cost-of-production models to try and value Bitcoin have not been reliable tools to predict its future market value. However, there are other cryptocurrencies or tokens that can be much easier to model. Treating crypto tokens as stock only for valuation purposes will allow investors to use existing economics and cash flow models to predicts their future value.
How do you value crypto tokens if the traditional methods do not work?
If traditional methods do not work, you can value crypto tokens using the framework below and additionally, measuring community engagement. The majority of ICOs are open source projects which means that most of the community can be involved.. The community is an investor, a stakeholder, a consumer, PR, sales and marketing team, a critic, the governance and control team.
Evaluating Framework of Crypto Tokens
1. Team – Look at the team composition and research everything about the team. The core team, project development team, advisors and their partners. Research their social media accounts i.e. LinkedIn, Twitter… Do they have any crypto experience and prior ICO involvement? Does the team have experience of running a business?
2. Idea – evaluate the idea itself, sector and industry, market potential, market segmentation. What problem is the project trying to solve and what is their solution?
3. Tokenization vs Old business model – Remember not every business would necessarily need blockchain, What is the use of blockchain technology and how does the token fit within the ecosystem? What is the token’s main purpose?
4. Project stage – evaluate the projects progress, is it still a concept, does the whitepaper and technical paper exist,.
5. Prior investments – Do they have prior investments? If so are any tier 1 VCs or well known crypto investors already involved in the project?
6. Community & Partnerships – It is important to have an open and engaged community which supports your project. Try to understand the size and the atmosphere within the community. Try to understand if the project has already had any partnerships locked in to trial the token; this is important and shows that the project will have traction once the technology gets deployed.
7. Media – Most of ICO community is active on social media. Some of the social channels to look at are: LinkedIn, Twitter, Facebook, Telegram, Slack, WhatsApp, BitcoinTalk, Reddit, Medium, Blogs, other crypto related channels. Evaluate their bounty scheme impact which can create hype around the project.
8. Evaluating the White Paper – The project usually creates a white paper and a technical paper which states what the project is about, what the technology is and in most cases how the blockchain is used in their business model and how their business model is being tokenized, in addition to an indication of their deployment timelines and roadmap. Make sure that you read and understand the whitepaper and technical paper too.
9. Tokenomics & Distribution – Tokenomics is an important part of the whitepaper as it explains how value is created and distributed within the ecosystem. The distribution of the token in a good project will be linked with the roadmap, as each phase or milestone of the project requires a certain amount of funding. Most common token distributions will be as follows; token sale, team and advisors, reserve.
10. Auditing the code quality – Most ICOs use GitHub as their open source to allow their community to review and audit the code. An understanding of programming languages will make reviewing the audit code straight forward. Otherwise utilise third parties to do the audits on your behalf or rely on comments from the more technologically advanced members within the community.