Along with driving a Tesla and hacking your diet with Soylent, the latest signifier of being part of the Silicon Valley early adopters club is owning bitcoins. When the price for one bitcoin--the digital currency created in 2009 that bypasses both the U.S. government and the banking system--topped $10,000 this week, tech entrepreneurs who have not yet personally jumped in might be feeling bitcoin FOMO.
But, says Peter Van Valkenburgh, the director of research at Coin Center, if you missed the boat on bitcoin, don't let the dramatic price increase lead you to jump in blindly. As Goldman Sachs warned yesterday, the world of cryptocurrency is filled with fraudsters. "Scams on the internet are not new, but ICOs [initial coin offerings] have become the hottest new way to make people part with their money," says Van Valkenburgh, the director of research at the bitcoin and cryptocurrency nonprofit, referring to the new unregulated tool startups are using to raise money.
Companies have raised $3.6 billion through ICOs this year, according to CoinSchedule.com. The way it works: Startups create their own digital coin and sell it to anyone on the Internet who wants to invest. To participate, investors have to buy a company's coins by using bitcoin, or ether, another popular digital currency. Whereas buying stock in a public company gives a buyer equity and voting rights, the majority of companies raising money through an ICO offer little for investors besides the distant promise of explosive profits.
Similar to other speculative bubbles, says Van Valkenburgh, a certain percentage of companies in the space are dubious. Before you invest, here are red flags to watch out for.
Beware of Empty Buzzwords
Scammers are creating their own digital coins and marketing their ICOs by hyping bitcoin buzzwords like "decentralized network," "cryptography," and "blockchain"--the underlying decentralized technology network that distributes bitcoin.
"It's comparable to the dot-com bubble when every other company added '.com' to their name to catch onto the hype," says Van Valkenburgh.
A startup named Confido did just that, promising investors it would build a cryptocurrency payment platform for online shoppers. Then in November, after raising $375,000 through an ICO, it scrubbed the internet of its website and social media accounts.
To avoid the next Confido, Van Valkenburgh says to carefully read their white papers explaining the technology before you participate in an ICO. He says most scammers are good at writing white papers (or hiring others to write technical papers for them) that appear legitimate. Make sure to vet these and other marketing materials, particularly those saturated with exciting buzzwords.
Avoid Celebrity Endorsements
If Paris Hilton is marketing a new digital coin (which she did in September), you probably want to stay as far away from it as possible. Earlier this year, the New York Times reported that cryptocurrency debit card startup Centra marketed its ICO by paying Floyd Mayweather promote the company on social media. Soon after, the Security and Exchange Commission warned investors that companies are using celebrities to endorse dodgy-sounding ICOs. Good rule of thumb: the harder a celebrity is pushing it, the dodgier the company probably is.
Does the ICO Company Actually Have a Product?
The most telling red flag, says Van Valkenburgh: Does the startup have a product or service that is already being used?
If not, and the company is raising money through ICO, you should be skeptical. "You need to ask yourself: Is there [working] code," says Van Valkenburgh. "If not, the project could be raising money on promises."