Scam sign
Scammers are using social media platforms to launch finanical scams. geralt/Pixabay

The U.S. Securities and Exchange Commission is cracking down on shady token sales, often referred to by cryptocurrency insiders as initial coin offerings (ICOs). The Munchee ICO, set to launch MUN coin for restaurant reviews, received a cease and desist letter from SEC on Monday citing potential securities law violations. Meanwhile, SEC is cooperating with Canadian authorities to shut down the cross-border PlexCoin project. CoinDesk reported a Canadian court sentenced PlexCoin creator Dominic Lacroix to two months in jail after his ICO disregarded regulations to raise $15 million.

SEC chairman Jay Clayton released a statement Monday clarifying that “calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.” Most experts agree investing in ICOs is incredibly risky. Although token sales raised around $3 billion in 2017, many token sales are not based on practical business models. On the other hand, some of the most widely respected projects in the cryptocurrency community also launched unique tokens this year, including FileCoin and Blockstack. Here’s how cryptocurrency experts discern the red flags of a sketchy token sale.

The commonly held belief among serial ICO investors is the best qualities to look for are: teams with multiple cryptocurrency veterans who have years of experience working with this type of technology, thoughtful approaches to compliance and a secure cryptocurrency with unique features beyond what other tokens or high-tech tools already offer. Infrastructure projects generally garner more favor from blockchain veterans than niche startup tokens. Only a few token sales, out of hundreds, satisfy these requirements. What about token sales by less experienced teams?

Scalar Capital co-founder and Coinbase alum Linda Xie told International Business Times a few rare token sales caught her eye despite being run by amateur cryptocurrency fans with a niche focus. “I try to see what their motivations are for coming to the space,” Xie said. “I’ve spoken to some teams that are joining this space specifically because they knew it was easy to fundraise, that it’s hot right now. That’s an immediate red flag if that’s why they are coming in.”

Sometimes, Xie is less concerned with a startup's niche than the team launching it. “Do they actually have a history of shipping products and building successful companies? That can be a great sign of what they are capable of,” she said. However, the token’s unique function and ecosystem mechanics can still present challenges for seasoned entrepreneurs.

The London-based startup Tigereum, for example, is led by experienced fintech expert Darren Olney-Fraser. “I realized the excitement is actually over there, over in crypto,” Olney-Fraser told IBT why he pivoted to the cryptocurrency industry more than a year ago. Tigereum’s ICO, which is collecting funds until Dec. 18, aims to raise $15 million for a peer-to-peer cryptocurrency transfer service via text message.

Olney-Frasner told IBT the mechanics of its back end infrastructure were still undecided, including security and storage solutions. One of the most prominent warnings in Clayton’s statement was: “Are there substantial risks of theft or loss, including from hacking?”

“The answers to some of these questions, and how it would work will depend on how the project actually develops out,” Olney-Frasner said. “The purpose of the token swap is to find the objective of the project and to, you know, provide for a roadmap for something to be developed.” He estimated the development team would spend up to 8 months before they launch a beta version in 2018.

Regardless of what security solutions the team finds, most of the cryptocurrency transfers will probably filter through a centralized, manual service where the startup itself accepts funds, converts them (sometimes into fiat), then sends them on to the recipient. Assuming Tigereum receives all the proper licensing for such financial services in all the relevant jurisdictions, as Clayton’s statement clarified is crucial for any lawful project, there is still the issue of how a multi-currency transfer service would actually work. Working across multiple blockchains is no simple task.

Serial ICO investor Ian Balina, who has participated in 45 token sales, told IBT the first thing he looks for in an ICO is a prototype. “How far are they in development with the product itself?” Balina said. “I don’t invest in companies that are mainly ideas because that’s a huge red flag.” Balina said Tigereum’s website showed it has a starting point for a prototype. Another ongoing token sale at the moment, which Balina had greater concerns about, is Gaze Coin. This token sale has an ambitious cap of $35 million.

The blockchain media startup behind Gaze Coin sent IBT a press release touting the upcoming release of “Kim Kardashian West’s KCoin” in 2018. It was supposed to be an example of the types of cryptocurrency the company can offer. So far, West is not involved with this project in any way. This raises questions about using another person’s name or likeness without permission.

Kim Kardashian
It’s been estimated that Kim Kardashian makes hundreds of thousands of dollars for a coveted promotion on her social media. Instagram/Kim Kardashian

Legal questions aside, paid celebrity endorsements are a red flag in Balina’s opinion. “I would prefer they be a member of the core team,” Balina said. “$35 million is quite high for something that isn’t an infrastructure far, I probably would not invest in this.”

None of this is to suggest most startup token sales for non-infrastructure projects are scams. One example of an ICO aimed at people who aren’t already involved in decentralized technology is the cooperative banking platform called Moeda, which raised around $19 million in August.

Moeda aims to help entrepreneurs with sustainable startups in developing countries, businesses such as organic farming and clean water projects, connect directly with international investors through a P2P platform. Loans will range in value from around $5,000 to $100,000, with up to 15 percent interest depending on the circumstances.

“We’re building a transparent investment platform for investors to see where their funds go to, who they are helping,” Modea co-founder Isa Yu told IBT. “We want to be the token for the whole impact investing ecosystem.”

Somewhat similar to Tigereum, Moeda plans to launch a limited beta in 2018 and help users convert cryptocurrency into fiat as needed. The latter has partnerships with local banks in Brazil. Unlike Tigereum, Moeda already has a clear plan for how decentralization plays into their technology.

“There are definitely cases where centralized systems makes sense. But generally I prefer decentralized systems,” Xie said. “If it can be replaced by a more liquid coin, then we don’t need a token... For me, it's pretty rare [to need a unique token]. If the token is just acting like ether, I generally stay away from it.”

Moeda’s token isn’t simply a way for users to transfer value. Moeda’s cryptocurrency system will help entrepreneurs without any official ID or banking history build credit by establishing a blockchain-based identity. This digital identity aspect gives their token added value as a cryptocurrency. “For the transfers, we are going to build our own private chain,” Yu said. “For the longer term, we want to be a leader in impact investing. We don’t only want to offer entrepreneurs access to loans. We also provide education.”

Moeda Founders
Moeda's founding team from left to right: CTO Brad Chun, Director of Crypto Market Isa Yu, CEO Taynaah Reis, Product Lead Athena Diaconis, Chief Design Officer Alex Todaro. Moeda

All things considered, the top questions Xie asks herself about less experienced token sale teams with niche business strategies include:

  1. Are they excited about decentralized technology itself or just its potential for fundraising or profits?

  2. How involved are they with the broader cryptocurrency community?

  3. Does the startup have a strong development team bolstered by thorough research into similar projects, plus clear examples of how this startup will improve on the pitfalls of predecessors?

Moeda is addressing some of these concerns by engaging with leaders in the monero community for technical guidance. Yu has herself been involved with the cryptocurrency community for four years, even if she is still an amateur blockchain professional. That’s why Moeda immediately established partnerships with several cryptocurrency exchanges before the beta mobile app launches, to ensure the new token’s liquidity.

If a token sale matches all the experts’ criteria, the odds are still stacked against any new cryptocurrency. There are already hundreds of dead cryptocurrencies. Ethereum creator Vitalik Buterin reportedly estimated 90 percent of cryptocurrency startups will fail.

“As with any other type of potential investment,” Clayton’s statement on token sales warned. “If a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost.”

Editor’s note: This is not investment advice. Any following statements are not legal pronouncements or endorsements regarding any specific project. This article is merely an illustrative reflection of the opinions expressed by interviewed experts.