Many initial coin offerings (ICOs) were tickets to quick riches in 2017. Take a token called Status—it was issued in June, raised about $100 million and soared 1,200% within six months. It’s easy to get excited by crypto’s surging prices. But now that the market has corrected somewhat and it’s clear that tokens both rise and fall, it’s prudent to determine whether the virtual asset you’re buying has merit and utility in the real world.1. Who’s the team behind the coin?
Much like the venture capital world, the founding can make or break a crypto asset. When evaluating a coin’s developers, look beyond education to find out what projects they’ve built, says bitcoin investor and researcher Tuur Demeester. He likes to see that developers are “respected in the fields of cryptography, memory compression, peer-to-peer networks and large open-source projects.” The more knowledge and experience they have, the less likely they’ll be to repeat past mistakes that have plagued other crypto coins
And try to evaluate the team’s integrity. Chris Burniske, a co-author of the book “Cryptoassets” and a partner at crypto investment firm Placeholder Ventures, tells Forbes it’s important to “get to know the developers. If not in person, through podcasts, videos or talks.” Do they explain their project clearly, or do they seem evasive when answering questions? Do their motivations seem sound?2. Read the white paper and ask what problem the coin is trying to solve
Developers typically publish a white paper that explains the software and economics behind a coin, and investors should read it with a critical eye. Cryptocurrencies’ main reason for existence is decentralization—they’re controlled by many people instead of a single, central authority. In crypto-theory, that’s good because central authorities are more susceptible to incompetence and corruption. The white paper should clearly explain why the digital asset benefits from decentralization, Chris Burniske and Jack Tartar write in “Cryptoassets.”
Swarm City, a crypto platform that aims to power services like a decentralized Uber, isn’t owned by a company that needs to turn a profit, so it might be able to operate more cheaply. That could attract more drivers to the platform and result in lower prices for consumers. “Are these factors enough to gain traction over […] Uber over the long term?” write Burniske and Tartar. “The innovative investor should perform similar thought experiments with any crypto asset under consideration.”
Keep in mind that decentralization comes with real costs: blockchains are slower, more expensive and less private than traditional databases because they have to coordinate with many entities in their basic operation. And they often require transaction fees to transfer information.3. When was the token launched?
Investors should ask when in the history of a crypto project the token launched. Some projects start solely as platforms where information and currencies can be transferred, and they use pre-existing cryptocurrencies like Ethereum’s ether for transactions. But they decide to bolt on an ICO later. Sometimes, such a change is warranted, but investors must understand why the developers are veering off from the original vision and why they didn’t create their own token at the outset.
Alex Sunnarborg, founding partner at Tetras Capital—a New York-based crypto hedge fund with about $20 million in assets under management—cites the Raiden Network as an example. Its software runs on top of Ethereum to speed up blockchain transactions. “When I first heard about it, there was no concept of a token,” Sunnarborg says. The project’s creators said development was underway in February 2017. But the ICO wasn’t announced until September, around the time ICOs were popping up like weeds. “The fact that it was introduced down the road—I thought maybe it’s just a fundraising tool,” Sunnarborg says.
According to Raiden’s creators, the ICO intended to “improve the quality and innovation of the system.” Investors came running, buying up about $33 million in tokens. Today, “No one is using the Raiden token for the Raiden Network,” Sunnarborg says. Yet the total market value of all Raiden Network tokens is nearly $200 million, according to CoinMarketCap.
“In a lot of these cases, is a token required?” Sunnarborg asks. “Maybe not.”4. Could the crypto platform run on ether, instead of its own token?
When evaluating a token’s merit, Sunnarborg suggests asking an even a simpler question: “Is it technically or philosophically possible for the system to exist without this token?” Arianna Simpson, founder of the crypto investment fund Autonomous Partners, recommends a similar question: “Could this token be replaced by ether?”
One that couldn’t easily be replaced is Augur’s REP token, according to Sunnarborg. Augur is a gambling-markets platform where users can bet on questions posed by the community, such as, “Who will win the 2020 presidential election?” You don’t need REP tokens to bet, but if you hold them, you’re asked to weigh in on the outcome of bets. And if you provide the correct answer, you’re rewarded with REP tokens. “If you do your job and report on these markets, you’re entitled to a future cash flow stream,” Sunnarborg says. With this architecture, there’s an incentive to hold REP, because it entitles you to income. But if a token’s main function is to give you access to a system, and you’re incentivized to sell the token immediately after using that system, the token might not be necessary.5. Look at the Github repository
Crypto coins typically publish the code behind their software on Github, a programming repository website. Github also shows how often a crypto project’s software has been changed. Frequent updates show developer engagement, but that’s not always a positive indicator since it could mean a platform has problems that need to be fixed.
One metric that can be helpful, according to Burniske and Tartar, is the “Code Repository Points” shown on CryptoCompare.com. A crypto coin earns points when a Github user “stars” its code to bookmark it or show appreciation. Points are also earned when developers “fork” the code, or copy it and use it as the foundation for their own crypto network. The more points a coin has, the better. Just keep in mind that older coins will have an unfair advantage over newer coins on this metric because they’ve had more time to accumulate points.
And if you’re not a coder, ask a programmer friend for help.