Before the Berkshire Hathaway annual meeting last month, CEO Warren Buffett told CNBC that bitcoin was "probably rat poison squared." Berkshire’s long time Vice Chairman, Charlie Munger was even more blunt when he stated "[t]o me, it's just dementia. It's like somebody else is trading turds and you decide you can't be left out."

Despite the criticism from these leading investors, the number of initial coin offerings (ICOs) has exploded over the last couple of years as well as the total amount invested. For those unfamiliar with the term, an ICO is defined as a round of public funding in which a tech startup sells in-house cryptocurrency tokens to prospective investors. These cryptocurrencies rely on blockchain and are touted as being a more secure way to buy and sell goods. (See our Firm’s blockchain service area page for an overview of blockchain technology). Tokens could represent digital currency or may be used for a specific product or service. The process is somewhat like the established practice of an initial public offering of stock issued by a company to the public.

ICOs offered in 2018 have already raised more money than all of 2017, with ICO funding for the first quarter of 2018 totaling $6.3 billion. They are attractive to investors because of the often extremely high promised return on investment. Ernst & Young research on ICOs noted the valuation is often based on a “fear of missing out” instead of based on the nature of the token and project development forecasts. Investors who are approached by a company launching its own form of cryptocurrency and offering an ICO need to proceed with caution. There have been numerous scams involving ICOs in the last few years and often little way to recoup the lost investment.

For example, this year, the company Modern Tech offered two ICOs that allegedly stole a combined $660 million from 32,000 investors. The company closed down its Vietnam office in April and took off with investors’ money. Investors in Bitconnect, based in the United States, have filed a class action lawsuit seeking to recoup lost funds after the company closed in January. The six investors who filed the lawsuit on their behalf and on behalf of other investors who lost money investing in Bitconnect say The Wall Street Journal recently analyzed 1,450 cryptocurrency offerings and found hundreds of firms raising money using deceptive or fraudulent tactics to entice investors. they lost $771,000. Bitconnect allegedly told investors to expect a guaranteed 40 percent monthly return.

It does this mean for investors? Buyer be very beware.

Ernst & Young research in December 2017 found more than 10 percent of ICO proceeds are lost or stolen in hacking attacks. Moreover, Forbes reports that almost half of all ICOs in 2017 were valueless by the end of the year. The SEC’s head of the Division of Corporate Finance at the SEC, William Hinman, recently said at a crypto conference that cryptocurrencies Bitcoin and Ethereum are not securities. However, he went on to clarify, some ICOs are securities that would be regulated by securities laws. In determining whether a security is being sold, regulators will look at how it is being sold and the reasonable expectations of purchasers, he said. Hinman said at the event that if there is a centralized third party, purchasers, and an expectation of a return, then the asset is likely a security. Indeed, in April the SEC filed a suit for securities fraud against founders and officers of an organization named Centra (backed by Floyd Mayweather and rapper DJ Khaled) which launched an ICO, and allegedly stole $32 million of investor’s money.

Given the rise in the number of cryptocurrencies and ICOs happening around the world, the Justice Department is increasingly watching out for scams and other criminal activity. The government has also launched a criminal probe looking for illegal practices by traders that affect prices, such as spoofing. The Justice Department is now working with the Commodity Futures Trading Commission on the investigation.

Investors can be victimized when funding an ICO in the cryptocurrency world. Research by a University of Texas professor found Bitcoin’s price may have been manipulated using Tether, another cryptocurrency. The professor found that Tether was used to stabilize and manipulate Bitcoin prices. In early 2017, one bitcoin was worth less than $1,000. By the end of 2017, that one bitcoin was worth $19,000. Coindesk reported on June 15, 2018 that one Bitcoin was worth $6,494.

Investors need to do their due diligence before investing in a cryptocurrency. Sometimes the project you invest in will cease to exist or take longer than expected to launch. Make sure to vet the project before investing, especially one that promises astronomical returns on the investment. These promised returns may come from Ponzi or pyramid schemes, meaning investors will likely not see anywhere near the promised return or may even lose their investment entirely. New blockchain entities customarily release whitepapers which are good starting points for understanding what they are attempting to bring to market. Work with your legal team to investigate the company offering the ICO, its terms and conditions, and who else, such as a large venture capital fund, may have invested in the ICO. Doing some homework before investing may save your dollars from disappearing to a failed ICO.