With the help of blockchain technology, the first coin offerings have become an alternative means of obtaining funding for business projects with the help of the new, developing digital financial market for tokens. Unlike initial public offerings, which are subject to strict legal regulations, ICOs only need a white paper and a few interesting features like no barriers to entry, room for exponential growth, no geographic barriers, and easy validation.
It is therefore not surprising that the ICO market has seen exceptional growth recently. Research shows that ICOs raised nearly $13 billion worldwide from January 2016 to August 2019.
Despite the attractive advantages of ICOs, investors interested in them as an alternative investment face some dramatic risks. In this context, around 1,500 ICOs were examined in a report by the Satis Research Group from 2018. From the sample, 78% of the projects were identified as fraud with a total value of $1.3 billion.
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Together with my colleagues Niranjan Sapkota and Josephine Dufitinema, I conducted a study that aimed to examine and answer the following question: what are the different types of fraud in the ICO market and what is the expected financial loss of an average one ICO scams? To investigate this issue, we used web scraping and created an intensive data library that covers all ICOs launched from August 2014 to December 2019. Our unique, hand-collected dataset comprised 5,036 ICOs.
We found data on funds raised for 1,014 ICOs, 576 of which were found to be fraudulent, showing cumulative losses of $10.12 billion. The biggest fraud loss is what is known as the “petro fraud,” which resulted in a total loss of $735 million for investors.
ICO scam categories
Dead, wrong, or both
We pulled ICOs that were “listed” by Dead Project aggregators DeadCoins and Coinopsy and analyzed them to identify 13 different ways investors can be fooled by scammers. If a member of the Bitcointalk forum identified the ICO as having a fake team, fake project, fake wallet, fake social media, or fake trade, we have classified the ICO as “fake”.
The classic exit fraud
If an ICO has not paid out promoters who have been promised financial rewards (mostly in the form of tokens) for PR activities such as promoting the project in forums, telegram channels, messengers, translating and localizing documents, posting on social media or blogs, we classified it as “bounty fraud”. If the developers and promoters who raised money for an ICO suddenly disappeared and the investors ran out of information, we classified these ICOs as an “exit scam”.”
Compound scams and exploding drops of air
We have observed many ICO fraud allegations where the same group of developers have actively cheated on other projects. This type of fraud is categorized as “past scammers” in our study. Next, we defined “Airdrop Scam” for incidents where the scammers stole private keys from users. This can happen when scammers set a booby trap and users expecting to get free tokens click the links to reveal their private information and ultimately lose their coins.
Exchange fraud and copy-paster
In addition, developers who wanted to fool investors seemed to prefer starting their ICO on a fraudulent exchange. This type of fraud is classified as an “exchange fraud”. We have also found that copying the white paper of a promising ICO and launching it using a similar or different name is another deceptive tactic used by scammers. This type of scam is classified as a “white paper plagiarism” scam. In this regard, we have found that fortunately users are getting familiar with this type of scam and are now reporting it on the Bitcointalk forum.
The pump and the dump
“Pump and Dump” is another strategy used by fraudsters, but which is not always immediately apparent at the beginning of an ICO. In this type of scam, investors and traders rush to buy the token at an early stage when the price is still low, and some even buy at a high price for fear of missing out on the opportunity to make an easy profit . Once the scammers complete the sale, the price drops abruptly and dramatically.
Crypto Ponzi Schemes
A “Ponzi scam” is another category of scam that has been observed. This type of scam usually requires the victims to invest in some products or services associated with the ICO and to be promised returns at a later date.
URL scams and phishing trips
We have also observed a new investor scam tactic that involves launching websites with a name and design similar to the existing projects. Naive investors who are not familiar with the original websites can be fooled by these websites and lose their coins. This fraud category is identified as “website fraud” in our study.
We know what you did last night
We have also observed what we refer to as “porn scams” which seem to be growing in popularity with scammers, with an ICO pretending to offer premium access to their porn site (and / or products). Scammers may use this type of scam as users are less likely to report it as pornography is banned or looked down upon in many countries.
Market manipulation and pre-mining
Next, we defined another form of fraudulent ICO as “pre-mine scam” which refers to tokens that are shared between developers and / or promoters after the final token sale, rather than burning the unsold tokens, as is appropriate in such cases. This is simply cheating investors because a higher token supply in circulation implies a lower token price. In addition, the token market can be manipulated if developers keep a large portion of the tokens from the pre-mining phase. Interestingly, another recent study also found that pre-mining activities are associated with default settings for cryptocurrencies.
What’s the Biggest ICO Scam?
Our review found that the most common types of scams are “phishing and scam”. As a result, users receive spam emails, suspicious links and popups, questions about personal and financial details, withdrawal errors, pending withdrawals, funds disappearing from wallets, and other dysfunctional operations.
Finally, using our plug-in estimator, we determined that if an ICO business project turns out to be fraudulent, we can expect an estimated loss of $54.1 million, which is three times the general sample average of 17, Equivalent to $58 million.
In conclusion, due to a lack of regulation, developers and / or promoters can employ more than a dozen tactics to deceive investors. The money in this new, emerging market is overwhelming. We argue that our results have significant implications, including the need for ICO market regulations by governments and regulators to protect investors from heavy losses.
This article does not contain any investment advice or recommendations. Every step of investing and trading involves risk and readers should conduct their own research in making their decision.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Klaus Grobys is Lecturer in Financial Economics at the University of Jyväskyla and Assistant Professor in Finance at the University of Vaasa. Grobys is also a member of the InnoLab research platform at the University of Vaasa. His most recent studies examine the opportunities and risks of new innovative digital financial markets. His most recent research results have been covered by the US business magazine Forbes, among others.