An Examination of Velocity and Initial Coin Offerings

Blockchain technology offers firms a novel method of raising capital via so-called initial coin offerings (ICOs). In the most common form of an ICO, a firm creates digital assets called “utility tokens” that are tracked on a blockchain-based ledger, requires that its product be purchased only with those tokens, and then, raises capital by selling these tokens to investors prior to creating any saleable product. (Some nonfungible tokens (NFTs) may function in a similar fashion.) We model a fundamental paradox with the use of ICOs involving utility tokens and similar structures. To increase capital raised by an ICO, the firm may attempt to reduce blockchain operating costs, thus expanding the quantity of goods sold. However, because of the mechanics of miner compensation, doing so increases the number of utility token transactions that take place in any time interval (i.e., increases token velocity and thus, the effective supply of tokens). By Fisher’s equation, this lowers the dollar value of tokens and the amount investors are willing to pay for them. We show that this paradox limits the value of utility token ICOs as an alternative to traditional financing options. We discuss alternatives to and variations of utility tokens that can mitigate the conundrum and promote ICOs as a more viable form of financing.

This paper was accepted by Joshua Gans, business strategy.