Unless you've been hiding under a rock for the past years, you might have noticed that the crypto market is booming. As of June-2021, there are over ten thousand coins and tokens that comprise the crypto universe. Despite the recent market crashes, the current market cap stays at 1.6 trillion USD, and the potential upside is tremendous. New technologies emerge every day, and who knows what the future holds.
Not all that glitters is ̶g̶o̶l̶d̶ Bitcoin though, right? We're not lacking in new marketing proposals that have no clear purpose, that are plain copies of consolidated projects or that are downright scams!
With so many coins and tokens in existence, the first step should always be in quickly spotting a Shitcoin. Sure, it can go 1000x, but as Benjamin Graham put it a long time before Bitcoin was ever conceived, the intrinsic value and the market price tend to converge in the long run. If the intrinsic value is zero, don't waste a dime on it.
So let's take a look at some of the Red Flags of a Crypto project!
1) Where does the money come from?
Every coin is a software development project. And not only that, it's of a very specific technology and with a market that currently lacks in developers. Therefore... Coins will be expensive to develop and to maintain. Money has to come from somewhere, and among the most common alternatives we have:
- ICOs (Initial Coin Offering): this is where institutional money joins in. It isn't bad in itself, and one could argue that institutions must have had the time to analyze the project to check that it was solid. In theory, it makes sense, but in practice, institutions don't buy into numbers, but rather into people and ideas. A good salesman might be more often than not selling a terrible product to investors who are eager for more crypto that they barely understand. There is a lot of institutional money available right now, and don't count on institutions doing your research. Managers aren't even investing their own money, after all... These aren't a red flag per se, but be sure to check out the percentage of the coin that was sold and at what price. Does it make sense? Does it leave room for the developers to work and sell consecutive fundings?
There is a sweet spot here that usually stays at 15 and 30 percent of total coin supply being sold. Tread extra carefully outside of this range.
A common technique in which the developer team is allocated part of the coins before they are allowed to be obtained by the masses, as a means of funding, and usually combined with ICOs. Nobody likes someone who gets the larger slice of the cake before the cake is even baked though.
Crypto is decentralized, and pre-mining is perfect for pump and dump schemes. Create a wallet with 90% of your coin supply. Put a very high number, say 500 trillion coins in supply. Shill your coin on the internet for its very low price on a hidden exchange. As soon as you have some fans mooning your coin, sell as much as you possibly can before it drops. Your fanbois will even call it a dip and will be eager to buy more of it!
Be careful with pre-mining. Some of it is okay and sometimes necessary, but the project must have room to grow and with a plan for decentralization, or the incentives might be in the wrong place.
The sweet spot here would be < 20% of total supply. And that is already a lot.
- Private funding:
Usually a good sign. Private fundings usually conducted by VCs tend to require a lot more analysis and thorough processes for when to invest and how best to help the team into achieving its goals than the usual ICOs. You can expect a VC to make the due dilligence of the company to some degree, and they usually go for winners. It's a different game that's played here.
However, too much secrecy behind a project or the founders can mean a hidden agenda. Try to dig up as much as is publicly available, and when in doubt, it's better not to invest. Missing out on an opportunity is better than losing money.
- IEOs (Initial Exchange Offering)
a quick way for decentralizing coins and offering it to the masses via a large exchange. Some of the most reputable exchanges have better processes in place, but bear in mind that the crypto market is extremely new. This means that it hasn't been fully battle tested, and it is a market where people learn from mistakes - so they will happen! Personally I'd rate an IEO as neutral in terms of funding: not a red flag, but not necessarily a good indicator.
2) Too much burning?
The feature of burning coins is an interesting one, if well applied. It can be used to disencourage certain behaviours where market alone pushes the other way, as well as to ensure a deflationary measure, which can be beneficial to everyone in the environment. However, some recent projects have made sure to put in place a high burning percentage with every transaction that gets executed. Add to that a 'feature' where each coin HODLer automatically receives part of the fees for every transaction in a staking manner, and pronto: you got the recipe for a terrible coin with very little incentives for sellers (or to use it, but who's being rational here?). Never mind that the seller will lose 30% of his coins in burning fees altogether, that's a problem for the future!
The percentage of burning is your first hint here. Anything greater than 1% of the underlying value is shady for whatever purpose it's being used. Take as a comparison fund managers, who will *burn* your money at a usual rate of 1-2% yearly, or ETFs that will do so at 0.2-0.8%. Are you gonna use this feature more than once in a year? That might be more than your average fund investment would consume in fees in a year.
The second hint here is the purpose for the burn. Is it a default mechanism implemented into every transaction that gets sent into the blockchain? - the project might be compensating for something. Perhaps it is too inflationary, and this is a way to benefit HODLers (especially the team itself)? Remember that blockchains in essence are a communication tool, and that can only happen with sending and receiving information (lots of it!). Therefore, every blockchain should strive to be scalable, and transactions should be incentivized. And not the other way around!
Always take a look at some quick tokenomics questions:
- Is the supply curve too inflationary? Inflation in itself isn't necessarily bad. Some amazing coin projects use a moderate amount of inflation in tail emissions for example, in order to incentivize miners to stay in the network. At a constant rate of coin emission, this implies a decreasing inflation, which can be beneficial and barely noticeable in the long run. However, a high inflation curve means your coins will get diluted in value.
- What is the current market cap? Does the coin require half of the money supply in the world to migrate to it at its current stage just so you could make a 10% return? It might then be too late in the cycle (and/or too pumped!).
- What can happen to the supply under some stress scenarios? Is there some hidden scenario that can generate a lot of coins at a point in time? Or like the burning example before, can there be a huge deflation?
I can't emphasize this enough: always read the whitepaper. You don't have to be an expert in crypto to grasp its main points, and it's fine to not fully understand the technical bits. But always keep your BS meter turned on!
*Our coin was peer-reviewed by scientists*
*This coin is a frictionless, yield-generating contract that allows you to seek shelter amidst the chaos of the market*
*A community driven, fair launched DeFi Token*
I might get some hate here, but don't get me wrong. This lingo sells, but please tell me what your coin does that 100 others similar out there don't. That's what I want to know. Keep your buzzwords.
5) What does it do?
Last but definitely not least, it is uttermost important to understand what is the goal of the project! What problem does it intend to tackle, what's its roadmap and how is it relevant for the world?
Some common mistakes:
- Lack of purpose: the project is another Bitcoin or another Ethereum copy, with no clear or too weak a difference. Why would anyone want such coin when they could have the original? Sure, it's faster and cheaper, but will it stay as such should the network grow as both did? Also, both are already tackling these issues, and this coin can be irrelevant in the long run if that's all it has to offer.
- Scope is too broad: Failing to plan is planning to fail. IT workers can relate:
Projects with a clear and defined scope already generate a HUGE backlog on their own! Should it be too megalomaniacal and wish to solve every problem in the world, it'll end up not solving any.
Additionally, decentralization also stands for decentralization of projects. It's not healthy for a single project to take over the entire market anyway!
That's it! Hope you enjoyed this short list of ideas and I'd love to read your comments.
Tips are appreciated ;)