(R)Evolution in Entrepreneurial Finance? The Relationship between Cryptocurrency and Venture Capital Markets

We propose a model of entrepreneurial finance where start-ups raise capital via Initial Coin Offering (ICO) and/or traditional funding methods such as Venture Capital (VC). While token sales allow startups to leverage network externalities, VC's value-adding services enhance profitability. We show that, even when projects have large potential network effects, ICOs may not be optimal if entrepreneurial ability is low and the share of speculators among investors is large. Moreover, despite the complementarity between network effects and value-adding services, entrepreneurs combine VC and ICO funding only in highly efficient VC markets and for projects with moderate network externalities. Using data on funding rounds of blockchain startups, we empirically validate the main assumptions and implications of the model.