Babbitt Column | Deng Jianpeng: Rethinking the Risk Prevention of IEO/ICO Investment

(For more details, see Deng Jianpeng, Sun Penglei: “Intermediary Chain Supervision and Compliance Response”, Mechanical Industry Press, 2019)

I. The basic mode of IEO ∕ ICO

Since the beginning of 2019, more than a year of the currency circle bear market has suddenly set off a wave of IEO mode. The so-called IEO is similar to ICO, both of which are issued. The difference is that IEO is a virtual token issued at the core of the exchange, which is directly issued on the exchange. In the past, before the ICO project was put on the exchange, private financing was first carried out, or public financing was carried out on a third-party website. Usually, after the item paid a large amount of the foreign currency fee, the token could be traded on the exchange. Different from IEO, because there is no strict audit mechanism, ICO has a large number of frauds or running roads when it is publicly financed on private or third-party websites. After more than a year, it has caused huge losses to investors.

In the past two months, IEO projects have been carried out on some well-known overseas trading platforms. In this process, the exchange undertakes specific work such as prior promotion of the project, substantive review of the project content, and then sponsors the trader. This may reduce scams and suspicious items that raise funds through the trading platform, and IEO makes fraud more difficult.

Therefore, IEO is essentially a transaction so its own credit promotes the transaction to the public. The IEO has a series of features, such as platform coins for the transaction of the base currency, the reduction of intermediate links, the review of well-known trading platforms for endorsement, etc., which has become the current confidence model for the bear market reconstruction market.

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But IEO is also a double-edged sword. Trading so your own credit is endorsed by the IEO project. If the project corresponding to IEO is optimistic in the future, it will achieve a win-win situation. Otherwise, if the IEO project fails, the exchange is likely to be discredited.

Second, the high risk of IEO ∕ ICO

To this end, this paper further analyzes the investment risk of IEO and its model source ICO, and hopes to raise investors' risk awareness.

To deal with risks, investors should be aware that the blockchain is still at a very early stage. In the long run, investment in the blockchain sector is not a means of wealth. Some project parties claim that the so-called "ten or a hundred times", there is still suspected fraud. The blockchain industry has become bigger and stronger and has become an important part of the real economy. It may take another ten years or more. This means that any success at the moment may be phased.

First of all, when we surveyed some industry veterans in early 2017, they thought that at that time, only 15 to 20 companies that really started blockchain business in China, and the blockchain projects that have really entered the commercial application field, do not exceed 5, projects that have already been profitable are rare in the world. The high-risk situation of ICO has no essential changes in the next two to three years. At present, some IEO project tokens have soared ten or even twenty times in the short term, which is still only the result of speculation, and will be at the expense of other investors losing money.

Secondly, most of them directly raise funds from the public through the overseas ICO crowdfunding platform. The characteristics of investors' individualization are very obvious. Even some ICO projects clearly stipulate that the minimum amount of a single direct investment is 0.01 ETH, and the maximum amount is 30 ETH. In the IEO model, whether it is an appointment or a platform-based purchase restriction mode, there are retail characteristics. There are many birth defects in this type of retail investment:

(1) Investors are highly dispersed, involving a large number of public, and there will be disputes in the future, which may easily lead to mass incidents and easily affect social stability;

(2) The retail investors are mostly irrational, often tempted by the soaring of some so-called star-rated ICO projects in the previous period, using the blind and extreme investment methods of “ALL IN” (investing all personal funds), the consequences can be Imagine

(3) Retail investors' ability to resist risks is extremely limited, and often they do not have good investment strategies and psychological responses.

Third, IEO∕ICO is involved in huge policy risks in addition to various fraud risks. Looking at the history of changes in international and domestic virtual currency prices, the skyrocketing virtual currency has a great relationship with a country's regulatory policy. Once such a situation occurs, it is easy to cause the market value of all kinds of encrypted digital tokens to drop, and even the possibility of zeroing is not ruled out, which ultimately makes investors lose their money. At a time when the IEO model is booming, the China Development and Reform Commission’s draft for comment has appeared to require the elimination of the “mining” industry. It cannot be said that the government’s deep concern in this field has once again been expressed.

Finally, the market risks of the various digital tokens involved in IEO∕ICO are enormous. Digital tokens are extremely vulnerable to manipulation by some institutions. ICO was popular around 2017-2018, when some institutions invited some famous people to stand on the platform to endorse a certain token and corresponding projects. Control the rise and fall of token prices through inductive remarks by celebrities. In order to raise the price of the token market, some project sponsors often pay a high fee for the famous person who invites the coin or chain of the platform. Fees are often paid in the initial issuance of tokens. Some famous people charge even 10% to 20% of the shares of the publicly issued tokens. All these costs will be borne by ordinary investors who do not know the truth. In the recent IEO model, the aforementioned features are hard to say and have disappeared.

In order to enable digital tokens to go online soon to virtual currency trading institutions, increase the liquidity of tokens, and raise prices, some token makers with no real meaning or value often pay huge sums of money (or equivalent virtual tokens) or cooperation. In the form of bribery in disguise to certain trading institution executives. In the absence of effective regulation, certain trading institutions may participate in some illegal activities. For example, some project sponsors' joint exchanges raise or suppress the price of tokens, artificially modify the transaction price of tokens, the number of transactions or the total amount of transactions, etc., to induce ordinary investors who do not know the truth to make wrong decisions.

Recently, when the IEO was hot, some long-term and rarely-received tokens (known as “zombie coins” in the industry) suddenly rose twenty or thirty times in a week or two. The consequences of this kind of speculation can be imagined.

Third, IEO ∕ ICO risk prevention

First of all, for ordinary investors, they should enhance their risk awareness and must have considerable risk tolerance to consider entering this field. As mentioned earlier, most IEO∕ICO projects are similar to angel investments and VC investments, with a very high failure rate. If investors do not have high risk tolerance and good mental state, they should withdraw in time, or should try to avoid contact with any IEO, ICO project and other virtual currency investments.

Second, investors should form reasonable expectations for the project, and under the premise of controlling risks, formulate a reasonable investment strategy, diversify investment, and control risks. During the investment period, investors initially formed a reasonable expectation of the increase in the token. When the token rises to the appropriate price, investors are advised to cash out in time. Those who are too expensive in the issue of the project tokens and whose valuations are too high will be avoided. Investors should strictly implement the psychological expectations and investment strategies established in advance so as not to be dominated by market changes and unstable emotions that are overheated or too cold afterwards.

Again, if investors want to invest in a reliable project, they must carefully evaluate the project and form a reasonable valuation judgment. These assessments include: Whether the project itself is reliable and whether it solves the actual problem. In particular, the blockchain project is mainly in the scene of lack of credit, which can best show its value; the technical strength of the team, whether there is technology Team, whether these team members have previous experience in the blockchain industry; previous cases of investors; whether the project sponsors' technology and creativity are original, whether they hit social pain points, and whether they are consistent with national policies and regulations.

Horizontal comparison, when the project is in the same life cycle, the market value of the project is relatively higher than the average or below average. If it is lower than the average, it is obviously undervalued, and the return on investment is relatively higher; Does the project have too much financing and the team lock-up period is too short? The long lock-up period of the team (usually more than half a year) usually indicates that the team is more confident. Some teams hope that the tokens can't be unlocked in the planning. For example, the tokens will be released in a short time, often there are problems; whether the startups will get financing The mainstream virtual currency is used for the project; whether the digital tokens of its initial issuance will be competitive in the future of the virtual currency market; whether the future participating users of the project are active, whether the project has a supporting community, and whether an ecosystem can be formed ( Community) and so on.

Author: Deng Jianpeng, Central University of Finance and Law Professor

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