Andreas Park PRO
Professor of Finance at UofT
Data: coinschedule
native to a blockchain for payment
examples: Bitcoin, Bitcoin Cash, Ether, Lumens, Cardano
Recently permitted by the SEC in the US and the CSA in Canada; restrictions (among others)
Limits for investors (per firm and total portfolio value)
Must used registered platform
Lower commissions with cryptocurrencies (no intermediaries to feed).
Can be pre-programmed to carry out the company’s incentive payouts — or returns — as set out in White Papers and Investor Prospectuses.
Contingent fundraising.
Milestone automation.
Venture financing open to everyone
Small minimum investment amounts
Global investor base
Tokens are immediately tradable
“I believe every ICO I’ve seen is a security. … ICOs that are securities offerings, we should regulate them like we regulate securities offerings. End of story.”
Jay Clayton, Chairman, U.S. Securities and Exchange Commission, testimony before the United States Senate, February 6, 2018
“I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws”
Payment
Asset
Utility
in pre-financing and pre-sale phases of an ICO, tokens that confer claims to acquire tokens in the future
treated as securities
Payment
Asset
Utility
if additionally or only has an investment purpose at the point of issue:
=> treated as security
Source: Harbour (a tech firm)
Classification (Source: Satis Group LLC)
Source: Satis Group LLC
Source: Satis Group LLC
Lessons?
Is there economic merit to tokens?
Do tokens solve an economic problem?
This paper & nascent literature: tokens can achieve more economically than just regulatory arbitrage
Traditional economy
Decentralized economy
Traditional "centralized" economy
Chod and Lyandres (2018):
Davydiuk, Gupta, and Rosen (2018)
Lee and Parlour (2018)
Malinova and Park (2018)
entrepreneur wants to produce a good or service
Setup cost for production \(C_0\)
Marginal cost of producing \(c\)
Demand is uncertain: revealed after the setup cost has been paid but before production.
Inverse demand \(p(q)=x-q\)
\( x\) is uniform on \([0,\theta]\).
\(x_i\)
\(x_j\)
\(x_k\)
\(c\)
price
If financing with own funds
\(\Rightarrow\) entrepreneur
maximizes monopoly profits
\(\Rightarrow\) produces
monopoly quantity
demand
marginal cost
marginal revenue
Equity financing
\(\Rightarrow\) max \((1-\alpha)\)(monopoly profits)
=> no distortion
\(q^m=(x-c)/2\)
\(MR=x-2q\)
\(p(q)=x-q\)
general idea: sell future output
two approaches for token sales
sell a fraction of future revenue
sell units of future output
price
demand
marginal cost
marginal revenue
Entrepreneur does not internalize the effect of an extra output unit on the token value for the tokenholders!
Result: overproduction
entrepreneur issues \(t\) tokens
for \(x\le t\): earns zero
for \(x>t\): solves \[\max_q q (x-q-t)-cq.\]
effectively solves
\(q\) s.t. \(MR(q)+t=c\)
price
demand
marginal cost
marginal revenue
\(\Rightarrow\) tilts marginal revenue for
entrepreneuer left because
get only fraction of revenue
\(\Rightarrow\) solves \((1-\alpha)\)MR(q) = c
Result: underproduction
NB: Similar to Chod and Lyandres (2018)
revenue sharing: underproduction
output presale: overproduction
\(c\)
\(MR\)
"does not internalize" = externality
address externality: TAX!
here: tax future token income
incremental token income gets shared
\(\Rightarrow\) combine the two to get the monopoly quantity!
Presell \(t\) tokens.
As with equity, the entrepreneur receives the full NPV.
The entrepreneuer produces optimally at \(q^t=q^m\)
If \(q<t\) \(\Rightarrow\) redeem at rate \(t/q\) and tokenholders receive refund of \(c(t-q)\).
If quantity produced \(q>t\), then share \(\alpha_t\) of revenue from incremental \(q-t\) tokens with tokenholders
Idea:
entrepreneur can influence expected demand
with effort
without effort
common topic in corporate finance
very relevant in "decentralized" world where developers are scattered around the globe
also applicable to, e.g. established firms that do something new
assume \[\textit{NPV}(\text{effort})>0>\textit{NPV}(\text{no effort})\]
Investors (equity or token holders) only finance the project if the entrepreneur undertakes the effort
Solve for the optimal funding conditional on the entrepreneur taking the effort
Derive conditions such that the entrepreneur undertakes effort
1.
2.
Key insight: a token contract incentivizes effort better than equity (similarly to canonical debt vs. equity insights)
Optimal token contract has debt features:
get nothing if demand is low (only original
tokenholders get anything)
benefit if demand is high
all projects that can be financed by equity can be financed by the optimal token contract but
some projects that can be financed by optimal tokens contracts cannot be financed by equity.
Simple model of revenue-based ICO vs equity financing from the standard corporate finance + IO toolbox
Theorem 1: Without frictions, an optimal token contract finances the same
projects as equity
Theorem 2: With entrepreneurial moral hazard,
any equity-financeable project can be financed by an optimal token
some token-financeable projects cannot be financed by equity
\(\Rightarrow\) There is economic and conceptual merit to token financing
By Andreas Park
This set of slides describes tokens as a form of financing of operations.