Penn Law: Biggest ICOs not reflecting white paper promises in smart contracts

ICOs are failing to keep their promises, says a new ICO study from the University of Pennsylvania Law School. The report was helmed by Penn Law professor David A. Hoffman with contributions from faculty and PHD students from Penn’s School of Engineering & Applied Science and the Law School’s center for Technology, Innovation & Competition.

The study surveyed the top 50 highest-grossing ICOs of 2017 and revealed numerous discrepancies between the promises of the white paper and the underlying code.

Many of the project white papers were no longer available from the original source, but the authors were able locate most of them from community archives — including from Brave New Coin’s repository of first draft white papers.

From the fifty ICOs examined, 25 percent of those with a supply limit failed to write that restriction into the contract, 35 percent failed to encode scheduled coin burns, and 40 percent of those with modifiable tokens didn’t disclose the detail (at least in English). Finally, a whopping 80 percent of those that promised token vesting neglected to put it into the protocol.

"Our main finding is, in a financial ecosystem built around the proposition that regulation is unnecessary because code is the final guarantee of performance, often ICOs are not embedding the governance promises they make—which protect investors against exploitation—in software code." — Penn Law professor David A. Hoffman

Broken protocols

In an exercise that spanned several weeks, the team collected the white papers from the fifty most popular ICOs, and held the code against the light to see if it reflected the contractual promises. But, despite "transparent code-based investment contracts" being central to the appeal of ICOs, many of these promises were not enshrined in code.

The first project called into question is Kin, ICO of instant messaging platform Kik. In its marketing documents, Kik pledged that 30 percent of the ten trillion tokens created would be allocated to the team, subject to a schedule that automatically released ten percent every quarter, for ten quarters. Code for this vesting mechanism, however, couldn’t be located by the study team:

"There’s nothing about the token code that enforces separate ownership of Kik’s stake and the Foundation’s. Instead, it depends entirely on the offline governance features of the project, enforced using traditional tools like corporate charters and bylaws (or not at all)."

Another example is provided by Polybius, whose whitepaper promised a "fully digital bank accessible everywhere at any time", and one that would yield "higher returns" than investing in a traditional bank.

This vision requires several features to be encoded in project tokens, but the investigation found that the protocol had gone beyond this functionality, and included "modifiability functions in the smart contract code that extended well beyond contractual promises."

"We also show that at least some popular ICOs have retained the power to modify their currency’s rights, but have failed to disclose that ability to investors in plain language."

Who buys these promises?

To negotiate "the uneasy relationships between law and technology" that are developing, the study suggests increased regulation. But to be successful this must be based on market participants—an aspect explored in the third part of the paper.

If ICO investment is driven by "dumb money" pumping a speculative bubble, then the study claims "informational requirements" could be enough to pop it. If on the other hand demand is driven by the black market, then further imposition of KYC policies could be the best option.

Perhaps more likely, is the idea that ICO demand is driven by crypto market cycles, providing an outlet for investors "playing with house money" from recent bitcoin wins—much like gamblers "playing the roulette wheel after winning at blackjack at the Casino." Finally, the possibility is explored of ICO demand being driven by "smart money", a thesis supported by anecdotal reports that VC firms have experimented with the investments.

Raising ICO Standards

With more data on investors, policy makers will be better equipped to look beneath the "froth of the market" and recognise the potential in what is still a very experimental form of raising funds.

In a final note, the study suggests that it is not just regulation that is needed, but that the entire ICO model might be best served by the addition of trusted, technically fluent third parties:

"Our results strongly suggest that an increased presence of gatekeepers and regulators might help that process […]. Other regulators, along with courts, will also contribute to increasing formalization of ICO code standards. The rise of trusted intermediaries appears to be the next necessary step in the maturation of this revolutionary financial form"_