How to Do Due Diligence in Cryptocurrency Investments

In the cryptocurrency market, due diligence is important. Investors must understand what due diligence means and why it is important. This process can greatly reduce risks and improve chances of success. This guide will explain how to do due diligence, and necessary procedures, and provide a detailed checklist.

What is the Meaning of Due Diligence?

Due diligence is a detailed check or audit of a potential investment to verify all related facts and financial information. This is especially important in the unstable and scam-prone cryptocurrency space. Due diligence includes checking all parts of a project, from its team and technology to its market size and following rules.

Why Due Diligence is Important

Proper due diligence can show red flags that are not obvious right away. For example, during the 2017 ICO boom, many projects raised millions with a whitepaper and a promise. Due diligence helps distinguish between real projects and scams.

How to Do Due Diligence

Due diligence in progress.

1. Examine the Whitepaper

The whitepaper explains the technology, purpose, and plan of the project. Key points to check:

• Clarity and Detail: Is the whitepaper clear and thorough?
• Problem and Solution: Does the project address a real problem?
• Tokenomics: How are tokens distributed and used within the system?

2. Research the Team

A capable and clear team is vital. Investigate team members’ backgrounds:

• Experience and Expertise: Do they have related experience in blockchain and similar fields? Look for team members who have worked on successful projects before.
• Public Profiles: Are their professional profiles verifiable on platforms like LinkedIn? Check their education, work history, and support from other professionals.
• Past Projects: What were their previous projects and were they successful? A track record of successful projects can show a team’s abilities and reliability.

3. Analyze the Technology

The project’s technology is essential. Key points include:

• Blockchain Technology: Is the technology strong and scalable? The whitepaper should explain the technical structure, system, and scalability solutions.
• Security Measures: What security rules protect against hacks? The project should have strong security measures, such as smart contract checks, to protect against weak spots.
• Development Activity: Is there ongoing development? Check platforms like GitHub for active updates. Ongoing development activity shows a committed team.

4. Evaluate the Tokenomics

Understanding tokenomics is key to judging financial parts and sustainability. Consider:

• Vesting Schedule: How are tokens vested? Look for details on the vesting period, which shows when team and investor tokens can be sold. This affects the token supply and price stability.
• Token Generation Event (TGE): When is the TGE scheduled and how will tokens be distributed? The TGE affects token liquidity. Projects like Polkadot used staggered TGEs to manage token distribution effectively.
• Cliff Period: Is there a period during which tokens cannot be sold? This helps understand when large amounts of tokens might enter the market, affecting price stability.
• Circulating Supply: How many tokens will be in circulation initially and over time? This affects market dynamics; a low initial supply can lead to higher demand and price increases.
• Initial Market Cap: What is the initial market cap at launch? This shows the project's valuation at the start. Compare this with similar projects to see if it’s overvalued.
• Fully Diluted Valuation (FDV): What is the project’s total value if all tokens were in circulation? This helps judge long-term value and possible market cap. An FDV that is too high compared to the current market cap can show inflationary pressure.

5. Market Potential and Competition

Checking market size and competition helps judge the project’s workability:

• Market Size: What is the possible market size? Determine if the market is large enough to support the project’s growth. For instance, DeFi projects target the financial industry, which is a multi-trillion-dollar market.
• Competitors: Who are the main competitors and how does the project stand out? Assess the project's uniqueness. Projects with unique features or superior technology, like Ethereum's smart contracts, have an edge.

6. Community and Partnerships

A strong community and trusted partnerships show a healthy project:

• Community Engagement: How active and involved is the project’s community on platforms like Twitter, Telegram, and Reddit? Active community involvement can show strong support and possible growth. Projects with large, active communities, like Chainlink, tend to perform better.
• Partnerships: What partnerships exist and how trusted are they? Check partnerships and their value to the project. Partnerships with established companies or other trusted projects can add credibility and potential for growth.

7. Regulatory Compliance

Following regulatory standards is critical:

• Legal Jurisdiction: Where is the project based and what are the legal results? Understand the regulatory environment and possible legal risks. Projects based in countries with clear crypto rules, like Switzerland, tend to have fewer legal issues.
• Regulatory Status: Is the project following relevant rules? Make sure the project follows AML (Anti-Money Laundering) and KYC (Know Your Customer) rules. Non-compliance can lead to legal issues and affect the project’s viability.

Due Diligence Checklist

Did you erase the checklist from the board?

Here is a complete due diligence checklist:

1. Whitepaper Analysis

• Clarity and detail
• Problem and solution
• Tokenomics

2. Team Research

• Experience and expertise
• Public profiles
• Past projects

3. Technology Assessment

• Blockchain technology
• Security measures
• Development activity

4. Tokenomics Evaluation

• Vesting schedule
• Token Generation Event (TGE)
• Cliff period
• Circulating supply
• Initial market cap
• Fully Diluted Valuation (FDV)

5. Market and Competition Analysis

• Market size
• Competitors

6. Community and Partnerships

• Community engagement
• Partnerships

7. Regulatory Compliance

• Legal jurisdiction
• Regulatory status

Conclusion

Conducting due diligence is crucial in cryptocurrency investments. By following these steps and using the checklist, investors can make informed decisions and minimize risks. Always thoroughly research any cryptocurrency project before investing to maximize chances for a successful outcome.