This blank white paper still has more detail than most because it has the name of an actual person on it (via Shutterstock)

What many of the biggest ICOs promised in their white papers aren’t found in their code—and that could pose a serious problem for investors. That’s the conclusion of a study that came out this week titled “Coin-Operated Capitalism”.

The 104-page report bills itself as “the legal literature’s first detailed analysis of the inner workings of Initial Coin Offerings” and their findings show troublesome inconsistencies on the part of many popular ICOs. A University of Pennsylvania team headed by law professor David Hoffman with comp sci doctoral student Shaanan Cohney, JD/MBA grad Jeremey Sklaroff, and CTIC fellow David Wishnick wrote the piece.

“We began with simple curiosity about smart contracts,” said Wishnick to Modern Consensus. “How are people—whether legitimate entrepreneurs or bad actors—putting them to use? The ICO boom that began in 2017 provides a great glimpse into that question.”

The analysis dives into the white papers and other documents of the 50 top-grossing ICOs of 2017. From there, it tackles the “smart contract” aspects of these ICOs’ codes by laboriously drilling into each of them, line by line. As they describe it:

“We then analyze how the software code controlling the projects’ ICOs reflected (or failed to reflect) their contractual promises. Our inquiry reveals that many ICOs failed even to promise that they would protect investors against insider self-dealing. Fewer still manifested such contracts in code. Surprisingly, in a community known for espousing a technolibertarian belief in the power of ‘trustless trust’ built with carefully designed code, a significant fraction of issuers retained centralized control through previously undisclosed code permitting modification of the entities’ governing structures.”

In other words, what one sees in a white paper isn’t what one gets in the code.

Specifically, “Coin-Operated Capitalism” looks at four factors with 47 of last year’s 50 biggest ICOs (because three were only in “byte code” and not readable by the analysts):

Scarcity of tokens. Ten out of 47 ICOs promised to restrict supply but didn’t put it into their code. Token burning. Seventeen out of 47 vowed they would “burn” unsold tokens but six of those had nothing in their code to make good on it. Vesting. Of the 37 who claimed they had vesting rules to keep key personnel at their firms, a whopping 30 of them didn’t include such rules in their code. Modification rules. Such rules allow potentially drastic changes to code even after the ICO is in place. Six ICOs had those rules tucked into their code even though they never mentioned it in their white papers.

Just 11 out of the whole lot had code that matched their white papers’ promises.

“When people are evaluating ICOs—whether as investors or from a regulatory or political perspective—it’s important to understand how they function in practice,” said Wishnick. “Grand claims of code’s ascendance and perfectly automatic, trust-minimized designs didn’t bear out in our sample.”

One would suspect the market would punish such egregious differences between what was promised and what was coded. Alas, the study discovered the investing public either didn’t know or didn’t care; the amount of money the ICOs raised wasn’t affected at all and the subsequent return performance wasn’t hindered.

In fact, the average return for those with just one difference (870 percent) was multiples higher than those with none (180 percent). OmiseGo’s OMG token was the only one in the sample to have all four factors mismatch what was in their white paper yet its returns were 570 percent from ICO to the time the paper was published.

Then again, last year was particularly frothy for ICOs. A study published on July 11 by Statis Group showed that 78 percent of all ICO projects were plain scams that never even got to market, though 70 percent of all capital invested went to the small amount of “higher quality projects”.

The analysis in “Coin-Operated Capitalism” calculates some $3.8 billion went to 200 ICOs in 2017. “By July of 2018, an additional 430 ICOs had raised almost $10 billion,” it said.

The report speculates that there are four main groups of investors driving the ICO market: those trying to play a bubble (“irrational exuberance”), those trying to park their illicit assets, those using their crypto market gains to expand their portfolio, and “smart money” like venture capitalists and hedge funds. This last group is of interest because they would most likely to have the resources to look into the codes to see what’s really valuable and congruent with what’s promised. However, the report couldn’t elaborate on whether the relatively insignificant amount of smart money in this sector was putting their cash into the more honest set of ICOs.

Yet it’s the smart money that the authors put their trust in to eventually weed through mess that could eventually come.

“But over a long enough time horizon, every bubble must pop. This leaves open the possibility that fundamental aspects of smart-contract quality will, eventually, sway the outcomes of the market, with smart money at the helm,” wrote the authors in the study

As well, the government may catch up, according to Wishnick. “When it comes to ICOs, regulators are learning along with everyone else. Though regulators face many demands on their attention and resources, we’ve seen some enforcement work from the SEC and state securities agencies. I think it’s likely that we’ll see more as time goes on.”

Publication of this study may also lead to some changes in investor behavior, according to a major player in the cryptocurrency legal world.

“‘Coin-Operated Capitalism’ is a truly important paper for our industry,” said Joshua Klayman—one of the world’s top ICO attorneys and a former law student of Hoffman’s—to Modern Consensus. “The piece poses important questions for the future. In my view, Hoffman, Sklaroff, Coney and Wishnick’s landmark research and analysis are likely to have an impact on how the crypto and blockchain community, and the broader business community, may choose to proceed and be perceived with respect to future token sales and related smart contract governance.”

According to CoinSchedule, there are currently 127 ICOs underway, with dozens more coming up soon. But based on the conclusions of “Coin-Operated Capitalism,” few putting money into any of these will bother looking at the code.