Reward-Based Crowdfunding Versus Initial Coin Offerings

Abstract

Inspired by emerging financing techniques that offer additional financing options for entrepreneurs, we establish a stylized model to compare two prevalent crowdfunding strategies: Reward-based crowdfunding and Initial Coin Offerings (ICOs). First, we highlight that the fundamental difference between reward-based crowdfunding and ICO lies in the distinct types of price distortion, resulting in different agency costs. Specifically, compared to the first-best benchmark, reward-based crowdfunding sets a lower funding price to attract more consumers to pre-order, while ICO sets a higher market price due to speculators’ revenue-sharing in the market stage. Second, we show that the financing limit (i.e., the maximum funds raised) of reward-based crowdfunding is driven by the platform traffic, whereas that of ICO is driven by the marginal production cost. Therefore, even with numerous speculators, ICO may result in a lower financing limit than reward-based crowdfunding when the platform traffic or the marginal production cost is high. Third, we explore how products’ cost structures shape entrepreneurs’ financing preferences. ICO suits intangible products with high fixed cost and low marginal production cost, while reward-based crowdfunding aligns better with products exhibiting the opposite cost structure. Finally, we extend our model to show the robustness of our findings and offer some additional insights. For example, ICO may amplify the risk of market uncertainty compared to reward-based crowdfunding; Security Token Offerings (STO) benefits from the absence of agency costs between the entrepreneur and speculators compared to ICO while it may suffer from equity loss, particularly in risky and regulated markets, etc.