Decentralized Finance (Defi) Markets for Startups: Search Frictions, Intermediation, and the Efficiency of the ICO Market

Abstract

Decentralized Finance (DeFi) markets may require a substantial degree of centralization to function efficiently. We show that centralization in the form of institutional investors that intermediate Initial Coin Offerings (ICOs) lead to, first, shorter time periods to reach fundraising goals and, second, higher valuations. In a search-theoretical model, we quantify the extent to which centralization mitigates frictions in a decentralized market. Centralization reduces trading delays and improves decentralized market efficiency especially in times of market downturns and when there is uncertainty about the team or product quality. Thus, the principal implication of our study is that decentralized markets for startups may not be optimal for society. Centralization is valuable because it improves the speed with which entrepreneurs and investors meet, and because it mitigates market frictions arising from asymmetric information.

Keywords: Entrepreneurial finance, Blockchain-based crowdfunding, Initial Coin Offering (ICO), Tokenization, Crypto funds, Decentralized Finance (DeFi)

JEL Classification: G23, G24, L26