Platform Tokenization: Financing, Governance, and Moral Hazard

Abstract

This paper highlights two channels through which blockchain-enabled tokenization can alleviate moral hazard frictions between founders, investors, and users of a platform: token financing and decentralized governance. We consider an entrepreneur who uses outside financing and exerts private effort to build a platform, and users who decide whether to join in response to the platform's dynamic transaction fee policy. We first show that raising capital by issuing tokens rather than equity mitigates effort under-provision because the payoff to equity investors depends on profit, whereas the payoff to token investors depends on transaction volume, which is less sensitive to effort. Second, we show that decentralized governance associated with tokenization eliminates a potential holdup of platform users, which in turn alleviates the need to provide users with incentives to join, reducing the entrepreneur's financing burden. The downside of tokenization is that it puts a cap on how much capital the entrepreneur can raise. Namely, if tokens are highly liquid, i.e., they change hands many times per unit of time, their market capitalization is small relative to the NPV of the platform profits, limiting how much money one can raise by issuing tokens rather than equity. If building the platform is expensive, this can distort the capacity investment. The resulting trade-off between the benefits and costs of tokenization leads to several predictions regarding adoption.