Christian Catalini and Joshua Gans’s paper, Initial Coin Offerings and the Value of Crypto Tokens, presents a framework for comparing tokens sales as a funding mechanism to traditional equity sales. They highlight some ways in which a token sale might be more (or less) attractive to a blockchain venture than raising traditional funding.
One important feature of an ICO that they underscore is its ability to leverage network effects — which are vital to the adoption and growth of platforms — to increase the probability of a successful raise.
An ICO, unlike an equity sale, can help a startup identify and demonstrate demand for its product. Because tokens are the means by which future customers can gain access to the product, the purchase of tokens by interested consumers is directly indicative of future demand. For equity, which entitles holders to future profit flows but not to the product itself, this link is clearly weaker.
Catalini and Gans draw an important conclusion based on this feature of tokens. They demonstrate that when network effects are present and there is uncertainty over demand, a token sale can publicly demonstrate high demand and allow projects to proceed that would not be able to launch in the absence of that public information. In other words, for those consumers who would only adopt if the user base was sufficiently high, observing a token sale can convince them that adoption would be worthwhile.
The informational role of an ICO can only be fulfilled if speculative investment does not crowd out investment by future platform users. The paper assumes that all token buyers are future platform users, so further research is needed to help us better understand the impact of speculators in the market: to what extent does crowding out occur, and what is the long-term viability of token ecosystems for which consumers make up a minority of token holders?
It is clear that if all token buyers are speculators and not future platform users, then the pre-launch demand for the token is uninformative of demand for the platform or product. In this case, Catalini and Gans’ conclusion — that an ICO would help a startup launch in the presence of network effects — would not hold. Therefore, implementing strategies that deter speculators in favor of consumers (such as lockup periods, uncapped sales, and longer sales windows) will improve the informativeness of a token sale, better enabling these startups to leverage network effects by demonstrating their value to future users.
Of course, deterring speculation also decreases the size of the pool from which funding can be raised. Startups face a tradeoff in deciding how to weigh the importance of bootstrapping network effects for future platform success versus raising more funds now.
That being said, if startups begin to use different token sale strategies, they can show potential investors where their priorities lie. Those investors, then, can choose between projects catering toward speculators and those catering toward future platform users.