Crypto due diligence is the process of verifying facts and details about something being considered to find out which are true and which are not. When applied to investing, it involves studying the intricacies of a project, internal or related external factors, to make sure the decisions being taken are well-founded. In cryptocurrency specifically, however, there are specific quirks that only apply to this market and its peculiar community, such as understanding the technology underlying this field.
It may seem that performing due diligence in crypto is harder than in TradFi, but it comes with proportional rewards. When a well-rounded investor recognizes a great project that’s not yet in its deserved place, considerable gains ensue: just take a look at Chainlink and Solana’s returns in 2021, the former appreciated by almost 400% and the latter experienced a 50 times price increase in the same period.
But how exactly does one conduct due diligence in blockchain?
A great start is to look for red flags that keep you away from scams and rug pulls, which besides making your money disappear, can seriously harm institutional reputation. One Coin, which raised millions in 2014 without providing verifiable information on its technology, instead of relying on buzzwords and promising returns, and Paycoin, which claimed $100 million in non-existent reserves and consequently landed its lead developer in prison, were two well-known crypto scams. To avoid falling victim to such scams, due diligence is indispensable.
Another aspect that has a large impact on a blockchain project’s success is its jurisdiction, which should offer flexible rules and be blockchain-friendly. Regulatory scrutiny has the capability to severely cripple any crypto initiative, as the folks at Ripple can attest. Another case was The DAO, a decentralized investment fund that suffered a hack that drained 3.6m ETH of its funds, attracting the attention of the authorities.
Due diligence for whom?
The average cryptocurrency investor has to perform due diligence if they want to succeed, but this applies to much more than just them. Investment funds and professional investors are increasingly dealing with cryptocurrencies to take advantage of the relative volatility of this market, carefully assessing risks and looking for opportunities. Governments have been recently starting to invest in blockchain technology (Ethiopia and Cardano’s partnership is a good example), and the public scrutiny democracies are subject to mandates meticulous analysis before committing to work with a specific blockchain initiative.
Exchanges and launchpad platforms, prior to listing a token, need to assess and audit the project to safeguard themselves from facilitating fraudulent conduct. Even cryptocurrency projects themselves can benefit from conducting due diligence by identifying their strengths and weaknesses and investigating their potential strategic partners and competitors.
Some partnerships that are worthy to note are:
Reddit and the Ethereum Foundation working together to convert Reddit’s Karma points into cryptocurrency tokens.
Visa, Circle and Crypto.com allowing USDC payments using a Visa credit card.
Paypal’s unexpected inclusion of Bitcoin, Ethereum, Litecoin and Bitcoin Cash balances for US customers.