A Theory of ICOs: Diversification, Agency, and Information Asymmetry

Abstract

We develop a theory of financing of entrepreneurial ventures via an initial coin offering (ICO). Pre-selling a venture's output by issuing tokens allows the entrepreneur to transfer part of the venture risk to diversified investors without diluting her control rights. Issuing tokens, however, leads to an agency conflict between the entrepreneur and investors that is unique to ICO financing and manifests itself in underinvestment. We characterize conditions under which an ICO dominates traditional venture capital financing. Overall, our model suggests that an ICO can be a viable financing alternative for some entrepreneurial ventures. An implication is that while regulating ICOs is desirable, banning them outright is not.

Keywords: ICO, crypto tokens, venture capital, agency, information asymmetry