Crypto due diligence is similar to the traditional forms of due diligence, since it comprises a number of tactics with the end goal of identifying existing issues in order to reduce the likelihood of falling victim to fraud. By way of thorough investigative research and the meticulous review of relevant financial information, crypto due diligence provides the framework to determine the true value of a business transaction or investment. This, in turn, establishes a complete picture for a potential investor to consider and to therefore make an informed decision regarding the legitimacy of crypto assets.

There are currently more than 1,500 (and counting) crypto assets in the public sphere. While many of the designers of crypto assets and projects have altruistic intentions and remain focused on innovation and problem solving, others are clearly motivated by deceit and greed. Thus, proper due diligence is in the best interests of investors, and to take into account every conceivable scenario when navigating the murky waters of crypto currency.

Three of the most pertinent and effective forms of crypto due diligence are:

  • Financial Crypto Due Diligence
  • Crypto Team / Developers Due Diligence
  • Crypto ICOs, Profits and Partnerships Due Diligence
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Financial Crypto Due Diligence

Since the crypto currency industry is still in its nascent stage, and as a result, an overall lack of understanding for its intricacies is common among those who are contemplating crypto as an investment. The majority of crypto assets are of no practical use (other than as a speculative investment) and as such, non-traditional methods must be utilized when conducting financial due diligence for these assets. Instead of assessing the performance, worth and potential for growth of a business by focusing on the financial information that has been provided and reported, nagel + associates prioritize unconventional metrics, such as scalability, the crypto assets white paper and technical due diligence.

There are several measures and potential indicators that technical due diligence of a specific crypto asset could divulge about a potential investment in that cryptocurrency, including:

    • Does the business model allow for scalability?
    • Is the business model unique to the industry?
    • Do the whitepapers hold up to scrutiny and analysis?
    • What is the quantity of the circulating supply, commonly referred to as the ‘float’?
    • How have they raised equity, and managed debt in the past?
    • Is the volume of the crypto asset organic or synthetic (who controls the supply and at what %)?
    • Are the current and projected liquidity levels sustainable and acceptable?
    • What are the Key Performance Indicators?
    • Is the underlying source code easy to duplicate?
    • What are the projected revenues of the crypto asset
    • How has the crypto asset been classified?
    • What is viability of the adoption plan (on-boarding customers)?

Crypto Team and Developers

Crypto Team and Developers Due Diligence

Behind each cryptocurrency project lies a designer who is sets out to achieve a pre-determined goal. It is vitally important to resolve if the attainability, scope and content is a realistic proposition, or if an outright fraud needs to be considered. Performing an in-depth analysis into both the designer and the support staff involved them is critical to anticipating the overall success of the project. This is achieved by conducting extensive research into the skill set and relevant experience of each person involved with this venture, his or her background in the crypto space, prior employment and conducting personal interviews with them. Understanding these key factors about the people involved will play a pivotal role in determining whether the project will ultimately be a success. Alternatively, ‘red flags’ could discourage and deter a potential investor from becoming involved with a particular crypto project. There are several ways to acquire this information, including:

  • The history, successes and failures of the project and company
  • A thorough review of the history, reputation and track record of the designer and his or her associates
  • Have the team members previously been involved in projects that have raised funds before? If so, what was the total amount raised?
  • Has a specific timeline for the development of each phase of the project been established? If so, what are they?
  • Is there a history of fraud and litigation against the designer and others involved in this group?
  • What are the benefits that this project will inject into the crypto community?
  • Do the team members listed on the project exist, and if so, do they have suitable and substantial experience in the role for which they were hired?

Crypto ICOs, Profits

Crypto ICOs, Profits and Partnerships Due Diligence

Another effective method for performing due diligence on cryptocurrencies is to review and analyze the Initial Coin Offering (“ICO”). These are the profits that are generated when the cryptocurrency is issued. It is also useful to comprehend the strategic partnerships between venture capitalists, members of the crypto community and the individuals that are involved in the development of the cryptocurrency in question.

Vladimir Volkov graduated with a computer engineering degree in his home country of the Ukraine. Upon graduation, Vladimir moved to Canada to live closer to his father who had moved his family to Canada while Vladimir was attending university. After several months of job hunting without success, Vladimir was able to secure employment as a custodian at a local hospital. One month after his hire, the hospital was attacked by a malware scam which resulted in the perpetrators profiting $250,000. Angered by the fact that he could not find a new job which he felt that he was qualified for, Vladimir was left with no choice other than to accept a position that paid minimum wage. This – as well as the fact that the fraudsters managed to execute a successful fraud of such significant proportions – forced Vladimir to consider alternative options in order to secure financial stability. He decided to hatch a plan that would defraud unsuspecting investors in the new world of Cryptocurrency.

Vladimir launched his own cryptocurrency through an ICO named VCoin. He deceived investors by reassuring them that his VCoin would revolutionize the way in which the world looks at construction projects. VCoin would allow anyone to invest as little or as much as they wished in any construction project across the world through the use of a tokenized coin. Vladimir promised investors 75% guaranteed returns within the first year of their investment, under the provision that they invested in advance of the ‘countdown clock’ on his website struck ‘0’. Vladimir was able to raise $5,000,000 from unsuspecting investors until he became careless and made his one fatal flaw. Vladimir attempted to defraud Jace Pyroth, a forensic investigator who possessed extensive knowledge of the cryptocurrency landscape.

After Jace reviewed the ICO white papers and performed in-depth research into the tokenized coins, the VCoin development team and the underlying source code, it was not long before he came to the realization that this project this was a scam. He subsequently reported it to the proper authorities.

Relevant Evidence:

  • Lack of presence in crypto discord groups
  • Whitepapers
  • Investigation into the track record and employment experience of the Designer and his or her colleagues
  • Review of the Underlying Source Code

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