Optimal joint initial coin offering and production under regulation

Initial coin offerings (ICOs) have recently gained prominence as an innovative fundraising mechanism for blockchain-based startups. Despite their growing popularity, the relatively unregulated nature of ICOs has precipitated a surge in fraudulent activities. A primary factor attributed to the swift proliferation of ICOs is believed to be that this financing method can circumvent traditional regulatory frameworks to facilitate rapid investment in production processes. This paper investigates whether regulatory intervention will significantly affect the production and profits of the company while protecting investors. An estimate by the research group SATIS suggests that 78% of all ICOs to date that successfully raise their targets have turned out to be scams. As the SEC released the DAO Report on July 25, 2017, and has increased its enforcement activity in connection with ICOs, understanding the impact of ICO regulation adoption and its interaction with company production and profitability is practically relevant and of great importance. Also, modeling the effect of the ICO regulation complements the existing academic literature. In this study, we delineate two types of fraud risks inherent in ICO financing. We develop a two-stage game-theoretic model, comprising three phases, to analyze and compare the production and profit of the firm under scenarios with and without regulatory intervention, thereby elucidating the regulatory impact. We find that in an ideal scenario devoid of regulatory costs, regulations tend to enhance both the firm’s and investors’ profitability versus non-regulated ICOs. Furthermore, in cases where the consumers’ willingness-to-pay is high and the demand fluctuation is low, there is no difference between the supervision situation and no supervision situation. Specifically, we portray the firm’s profit change under different circumstances to measure the firm’s ability before the firm bears the regulatory costs in reality. Our findings provide guidelines for and insights into when regulatory intervention should be adopted and its interactions with the total social welfare. In particular, regulatory intervention does not always benefit the total social welfare.