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How to do Due Diligence

Due Diligence is part of the decision support system when someone invests. It assesses the target business and reveals risks involved.

Dario Cesaro avatar
Written by Dario Cesaro
Updated over a week ago

1.0 Definition of due diligence

As defined in Wikipedia “Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care.

2.0 Why due diligence is indispensable in the crypto industry?

Crypto assets are deployed using decentralized computer network, unlike traditional assets which are based on centralized system. Crypto assets have characteristics such as Irreversibility, immutability, permissionlessness and trustlessness, due to which crypto industry is heaven for both good players and bad players. Decentralized financial systems are increasingly accepted in transactions by businesses around world. Again, scams in various forms have been reported since the launch of the first crypto currency, Bitcoin in the year 2009.

Common forms of crypto currency scams are:

  • Rug pull scams

  • Network hacks

  • Phishing scams

  • Man-in-the-middle attacks

  • Ponzi schemes

  • Giveaway scams

  • Fake exchanges and

  • Investment scams

Therefore, due diligence is the best tool to protect your investment in the crypto market from the hands of scammers.

3.0 Due diligence in crypto industry

Before investing in any crypto currency, it is necessary to visit their official website and do your own research. Carefully go through white paper, check the token allocation model, governance mechanism, roadmap, scalability, team composition, ownership and investors if not more.

If a crypto currency does not have a website and white paper or similar document attached to it, try to refrain from investing in that business.

Well designed tokenomics and token distribution methods have a positive influence on the activities of users in a blockchain system. It is prudent to check the equity cap table and token cap table before making investment.

Many types (Proof of Work, Proof of Stake, Delegated Proof of Stake) of consensus algorithms have come into existence. Each of them has advantages and disadvantages over others. Robust governance mechanisms may throttle a blockchain to the mass as it opens the door for scalability.

Roadmap of smart contract development should have SMART (Specific, Measurable, Achievable, Realistic and Time bound) goals. If the timeline has any unrealistic targets, don’t believe in them.

A scalable blockchain not only improves transaction per second but also successfully adds new nodes within the network which enables it to be fit for mass adoption. If the underline blockchain of a crypto currency is not scalable, it won’t establish an enduring relationship with crypto adopters.

Initial Coin Offering (ICO) is a common platform for raising funds to launch crypto currency. Many coins disappeared just after ICO. Make sure ICO is not running for a long time. Check whether the ICO process is transparent enough.

Some of the trustworthy ICOs are:

  • NXT in the year 2013

  • Ethereum (ETH) in the year 2014

  • NEO in the year 2014

  • ARK in the year 2016

  • Lisk (LSK) in the year 2016

  • Cardano (ADA) in the year 2016

  • EOS ICO in the year 2018

Some of the failed ICOs are:

  • OneCoin (ONE) in the year 2014

  • SpaceBit in the year 2015

  • BitConnect (BCC) in the year 2016

  • TEZOS in the year 2016

  • BoringCoin (ZZZ) in the year 2017

  • ENIGMA in the year 2017

  • GetGems (GEMZ) in the year 2017

  • Nano HealthCare Token (NHCT) in the year 2018

  • PayCoin in the year 2019

A blockchain project team consits of professionals from many disciplines such as engineering, finance, design, marketing, legal and HR. Speaking to founding team members and inquiring about their daily activities are important while investing in a project at the initial stage. Meeting the whole team together is important to know the dynamics, chemistry and internal disagreement of key strategies of the team. Personal and professional references of the team members will let you know a lot about the team members. Previous organization of a serial founder may give you the information you want to get about him.

Investigations on the adopted Business model, final product, distribution processes and pricing model are part of the due diligence process. If the pricing model can not show profit, investment in that business may not be advisable.

Auditing of crypto currency is a daunting task due to non-existence of any universal method or guidance. Still, quite a few organizations (Hacken, Certik, Halborn, PackShield and ConsenSys) have launched their crypto currency auditing operation. Crypto currency may be bug free and future proof if it is audited by a scrupulous auditor.

Most of the transactions in the crypto industry take place between anonymous or pseudonymous accounts where it is difficult to detect suspicious accounts. But, there are dApps (Example where users are KYC verified and scammers have no place.

4.0 Conclusion

Whatever the stage of the crypto project, due diligence is a must have tool before investing in it and should not be skipped. For some reason, if due diligence is omitted, some drawbacks in the project may come out later which good due diligence would have uncovered.

Author: Sukanta Manna

Editor: Markus Hinrichs

Sources & References

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