Inventory, Speculators and Initial Coin Offerings
48 Pages Posted: 27 Mar 2019 Last revised: 19 Aug 2019
Date Written: March 27, 2019
Initial Coin Offerings (ICOs) are an emerging form of fundraising for Blockchain-based startups. We propose a simple model of matching supply with demand with ICOs by companies involved in production of physical products. We examine how ICOs should be designed---including optimal token floating and pricing for both the utility tokens and the equity tokens (aka, security token offerings, STOs)---in the presence of product risk and demand uncertainty, make predictions on ICO failure, and discuss the implications on firm operational decisions and profits. We show that in the current unregulated environment, ICOs lead to risk-shifting incentives (moral hazard), and hence to underproduction, agency costs, and loss of firm value. These inefficiencies, however, fade as product margin increases and market conditions improve, and are less severe under equity (rather than utility) token issuance. Importantly, the advantage of equity tokens stems from their inherent ability to better align incentives, and hence continues to hold even in unregulated environments.
Keywords: Initial Coin Offering (ICO), Security Token Offering (STO), Inventory, Strategic Agents, Moral Hazard, Crowdfunding, Firm Operations
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