for comparison:

• IPOs on TSX in 2018: $2.2B

• VC funding in Canada in 2018: $3.5B

• Market Cap of TSX Venture (01/19): $51B

Is there economic merit to tokens?

Do tokens solve an economic problem?

\(x_i\)

\(x_j\)

\(x_k\)

 \(c\)

price

• If financing with own funds  
• \(\Rightarrow\) entrepreneur maximizes monopoly profits
• \(\Rightarrow\) produces monopoly quantity

marginal cost

marginal revenue

• Equity financing 
• \(\Rightarrow\) max \((1-\alpha)\)(monopoly profits) 
• => no distortion

\(q^m=(x-c)/2\)

\(MR=x-2q\)

\(p(q)=x-q\)

Benchmark: equity

general idea: sell future output

two approaches for token sales

• sell a fraction of future revenue
• we call it revenue sharing
• formally: sell \(\alpha_t\) of \(T\) tokens
• produce \(q\) units a require \(T/q\) tokens per unit

• sell units of future output
• we call this output presale
• formally: sell \(t\) tokens
• produce \(q\) units and keep revenue from \(q-t\) tokens

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. \(MR(q)+t=c\) 

• \(\Rightarrow\) 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

• "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!

• issue \(t\) tokens ex ante
• share \(\alpha_t\) of new tokens
• token share \[\alpha_t=\frac{t}{c+t}\]

Token financing is NOT inferior!

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

• costs her \(0\)
• \(\theta\sim U(0,\theta_l)\)
• \(\theta_l<\theta_h\)

• costs her \(C_e\)
• \(\theta\sim U(0,\theta_h)\)

• 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

1. Solve for the optimal funding conditional on the entrepreneur taking the effort
2. Derive conditions such that the entrepreneur undertakes effort

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