How fear of the unknown shapes the crypto fundraising landscape
image: Distorted expected demand, the optimal ICO token financing ratio α*, the expected optimal output and the value function V (α*;θ) with the varying ambiguity aversion coefficient θ under high and low expected demands with probability measure π for the robust ICO financing model without moral hazard.
Credit: Aifan Ling (Shanghai International Studies University, China) Jie Sun (National University of Singapore, Singapore)
Background and Motivation
ICOs have emerged as a vital fundraising tool for blockchain startups, which often struggle to secure traditional bank financing due to a lack of credit history. By pre-selling digital "utility tokens" that grant access to future platform services, these ventures can raise capital directly from the public. However, the products offered by these platforms are often novel, making their market demand highly unpredictable. Misjudging this demand can lead to significant losses or even platform failure, as seen in early ICOs like Tezos and DAO. In this context, China Finance Review International (CFRI) brings you an article titled "A robust financing theory of ICOs under demand uncertainty of products of token platforms". The study investigates a critical question: How should an entrepreneur design an ICO when they are fundamentally uncertain—or "ambiguity-averse"—about the future demand for their product?
Methodology and Scope
The researchers developed a "robust optimisation" model to solve for the optimal ICO design. Unlike previous models that assume a known probability distribution for demand, this innovative approach incorporates ambiguity aversion—the entrepreneur's distrust of any single demand forecast. The model analyses how this aversion affects key decisions:
- The ICO financing ratio (α): the fraction of tokens sold to investors.
- The optimal output level (Q) of the platform's good or service.
- The entrepreneur's optimal effort level (a).
- The resulting expected token price.
The study also provides a direct comparison between this robust ICO model and a traditional Venture Capital (VC) equity financing model under the same conditions of demand uncertainty.
Key Findings and Contributions
- Higher Uncertainty Drives Higher Token Sales: The ICO financing ratio (α) is positively related to the entrepreneur's degree of ambiguity aversion. The more uncertain an entrepreneur is about demand, the more tokens they will sell to outside investors to transfer this risk.
- The "Ambiguity Premium" in Token Markets: The expected token price is negatively related to the entrepreneur's ambiguity aversion. This creates an "ambiguity premium," where tokens from projects with highly uncertain demand are priced lower to compensate investors for the added risk, a phenomenon well-documented in stock markets but newly identified in crypto.
- Effort and Incentives are Intertwined: The optimal effort level is negatively related to the ICO financing ratio. When entrepreneurs retain a larger share of tokens (a lower α), they are more incentivised to work hard, leading to higher platform quality and a greater probability of ICO success.
- ICO vs. VC: A Contextual Choice: On average, ICO financing can dominate VC because it allows the entrepreneur to retain 100% ownership and raise funds with a lower capital share, leading to stronger incentives. However, VC financing becomes more attractive when the degree of ambiguity aversion is very high, as VC investors directly share the burden of demand uncertainty.
Why It Matters
This study makes a significant contribution by applying ambiguity aversion theory to ICOs for the first time. It moves beyond simple risk models to capture the more profound uncertainty faced by innovators in nascent markets. The findings help explain real-world phenomena, such as why projects with strong technological fundamentals and transparent information (which reduce ambiguity) tend to have higher token prices and greater success rates. The identification of an "ambiguity premium" provides a new lens for investors to assess token value.
Practical Applications
- For Entrepreneurs: To increase ICO success, focus on reducing demand uncertainty by strengthening technological innovation and conducting thorough market research. Greater transparency and information disclosure can lower perceived ambiguity, thereby increasing token prices.
- For Investors: Before investing, scrutinise the issuer's technology and product-market fit. Projects with demonstrable fundamentals and clear communication are better positioned to overcome the "ambiguity discount" and succeed.
- For Regulators: The findings underscore the need for regulatory frameworks that reduce information asymmetry and fraud in the ICO market, creating a safer environment for genuine innovation to flourish.
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