Token vs Equity for Startup Financing

TL;DR

This paper compares token-based and equity-based startup financing, analyzing liquidity differences and showing that entrepreneurs benefit more from issuing tokens, especially with risk-averse investors and liquid markets.

Contribution

It introduces a three-period model to analyze liquidity and payoff differences between token and equity financing for startups.

Findings

Entrepreneurs gain higher payoffs by issuing tokens.

Liquidity needs influence the choice of financing method.

Token market depth enhances the benefits of token issuance.

Abstract

Why would a blockchain-based startup and its venture capital investors choose to finance by issuing tokens instead of equity? What would be their rates of return for each asset? This paper focuses on the liquidity difference between the two fundraising methods. I build a three-period model of an entrepreneur, two types of investors, and users. Some investors have unforeseen liquidity needs in the middle period that can only be met with tokens. The entrepreneur obtains higher payoff by issuing tokens instead of equity, and the payoff difference increases with investors risk-aversion and need for liquidity in the middle period, as well as the depth of the token market.