TWO ESSAYS ON BLOCKCHAINS AND CRYPTOCURRENCIES

Abstract:

This thesis consists of two essays on ICO (Initial Coin Offering) financed code development and operation of open-source blockchains and corresponding cryptocurrencies.

The first essay, which is titled "An economic analysis of ICO and post-ICO blockchain development", uses a two-period model to analytically depict the fundraising phase followed by the development phase. In the first period, the entrepreneur seeks investments from investors in the form of seed capital through an ICO token sale. In the second period, the entrepreneur creates the blockchain, often with the help of open-source developers. To encourage open-source developers to contribute, entrepreneurs typically offer two kinds of incentive schemes - ICO tokens, and seed capital tokens (henceforth referred to as seed capital). The ICO token incentive scheme explores the scenario where open-source developers are compensated for their effort in tokens issued for the purpose of the ICO. The seed capital incentive scheme considers the case where open-source developers are compensated in seed capital raised from the investors. For instance, in Brave Token ICO, investors got Basic Attention Tokens (ICO tokens) in exchange for their investments, which were denominated in Ether tokens (seed capital). The question this study explores is: Should open-source developers be compensated in Basic Attention Tokens or Ether tokens? Three key findings are made. First, the results reveal that open-source developers contribute more when incentivized with seed capital relative to ICO tokens. Second, the entrepreneurs are better off raising capital through debt rather than an ICO if the cost of capital is high. Third, under generalized Nash bargaining when investors have all the bargaining power (potentially when raising the funds from a Venture Capital), the entrepreneur raises lower capital and the blockchain project delivers lower returns.

The second essay titled "Seeking cryptocurrency-to-fiat exchange rate stability: the viability of blockchain protocol parameters" examines the problem of exchange rate volatility in public blockchains such as Bitcoin. We present a two-period infinite horizon model that incorporates decisions of users and miners on their cryptocurrency holdings and blockspace consumption (blockspace production for miners). Two main findings are made. First, calibrating blockchain protocol parameters, such as block rewards and probability of getting blockspace, influence the exchange rate; therefore, these protocol parameters can be used as instruments to enforce price stability in the crypto-economy. In conjunction with the analytical model, we perform policy simulations that support the model findings. Second, the crypto-holdings of users are influenced by the anticipated exchange rate. In contrast, miners do not retain any crypto-holdings. Additionally, we show that the proposed model can incorporate variability in the bargaining power of miners and users and changes in blockchain consensus protocols.

In summary, the insights gained from the two essays provide important implications on how to conduct an ICO, offer what kind of incentives to open-source developers, and how to stabilize the cryptocurrency-to-fiat exchange rate.