Working Papers

Decentralized Finance, Crypto Funds, and Value Creation in Tokenized Firms

Published: July 17, 2023

R&R at Journal of Business Venturing (with D. Cumming, N. Dombrowski, W. Drobetz)

→ Coverage: Duke Law School FinReg Blog, Columbia Law School BlueSky Blog

Abstract: Crypto Funds (CFs) represent a novel investor type in entrepreneurial finance. CFs intermediate Decentralized Finance (DeFi) markets by pooling contributions from crowd-investors and investing in tokenized startups, combining sophisticated venture- and hedge-style investment strategies. We compile a unique dataset combining token-based crowdfunding (or Initial Coin Offerings, ICOs) data with proprietary performance data of CFs. CF-backed startup ventures obtain higher ICO valuations, outperform their peers in the long run, and benefit from token price appreciation around CF investment disclosure in the secondary market. Moreover, CFs beat the market by roughly 2.5 percent per month. Their outperformance is persistent, suggesting that CFs deliver abnormal returns because of skill, rather than luck. These performance effects for CFs and CF-backed startups are driven by the investor network centrality. Overall, our study paves the way for research on what some refer to as the >>crypto fund revolution<< in entrepreneurial finance.

Decentralized Finance (DeFi) Markets for Startups: Search Frictions, Intermediation, and Efficiency

Published: July 16, 2023

R&R at Small Business Economics

Abstract: How efficient is Decentralized Finance (DeFi)? To answer this question, we study the efficiency and the role of intermediation in a large DeFi segment, namely, the market for Initial Coin Offerings (ICOs). In particular, we advance a search-related theory of DeFi, in which search frictions partly offset the efficiency gains from reduced transaction costs thanks to blockchain technology and smart contracts. The intensity of search, i.e. the process of identifying valuable projects, is increasing in market granularity. Blockchain technology increases market granularity through lower entry barriers. Lower-end entrants, however, increase aggregate search intensity but lack search skills. The resulting search-related inefficiency creates a niche for DeFi intermediaries. Consistent with this theory, our findings suggest that DeFi intermediaries reduce search frictions and extract economic rents for their services. Relative to the Walrasian equilibrium, DeFi is relatively inefficient, and search frictions reduce the welfare for society almost by half. The evidence indicates that perfectly decentralized finance markets would not be optimal for society.

Emotions in New Venture Teams: Affects as Signals, Emotional Diversity, and Valuation Effects in Initial Coin Offerings (ICOs)

Published: July 15, 2023

Rej&R at Strategic Entrepreneurship Journal

Abstract: New Venture Teams’ (NVTs’) collective emotions impact startup valuations through their intensity and diversity. I identify NVTs’ affective traits with artificial emotional intelligence by tracking 2,520 individuals across 165 NVTs during their Initial Coin Offerings (ICOs). The level of NVTs’ negative affects correlates with lower valuations, while within-NVT emotional diversity has a value-increasing effect. Intuitively, negative affects are associated with traits that may be prejudicial in dynamic entrepreneurial markets, but could be valuable if balanced by opposite traits in emotionally diverse NVTs. Moderated mediation analyses suggest that NVT affects have pronounced direct valuation effects. Overall, I extend the focus of the affective entrepreneurship literature from the entrepreneur to the team level, introduce the concept of emotional diversity, and explore the role of emotions in entrepreneurial finance.

A Hurdle-Rate Theory of Inventive Procyclicality

Published: April 19, 2023

(with D. Audretsch, W. Drobetz, E.E. Ernst, S. Vismara)

→ Coverage: R&D Today

Abstract: Schumpeterian arguments of “creative destruction” predict that innovation is countercyclical. However, empirical findings demonstrate the contrary. We apply corporate finance principles to macro- and innovation economics and propose a “hurdle-rate theory of inventive procyclicality”. High-ERP periods stifle innovation because many R&D projects do not pass corporate budgeting decisions when discount rates are high. Consistent evidence suggests that the hurdle-rate effect is less pronounced in firms with financial slack, institutional ownership with long-term orientation, and weak product-market competition. In an attempt to reconcile the procyclical evidence with Schumpeter’s countercyclical theory, we show that firms engaging in exploratory search suffer less during high-ERP episodes than those focusing on exploitative search, and patents developed during high-ERP periods have a higher technological impact and receive significantly more forward citations. Finally, we exploit the staggered variation in state-level R&D tax credits in difference-in-differences analyses to establish a causal link between the ERP and patent value.

Cybercrime on the Ethereum Blockchain

Published: April 19, 2023

(with L. Hornuf, R. Nam, Y. Yuan)

→ Coverage: Decrypt, CoinTribune
→ Best Paper Award: PDW for Financial Market Misconduct SI in the Journal of Banking and Finance

Abstract: We propose a taxonomy of cybercrime on the Ethereum blockchain and examine how cybercrime impacts victims’ risk-taking and returns. Our difference-in-differences analysis of a sample of victims and matched non-victims suggests that victims increase their long-term total risk-taking and earn lower risk-adjusted returns in the post-cybercrime period. Victims’ long-term total risk-taking increases because they increase diversifiable risk in the long term. The increased diversifiable risk correlates with victims’ withdrawal from altcoins after cybercrime. At the same time, the reduction in risk-adjusted returns correlates with increased trading activity and churn, due plausibly to managing cybercrime exposure. In the cross-section of Ethereum addresses, we show that the most-affluent victims take a systematic approach to restore their pre-cybercrime wealth level, while the least-affluent victims turn into gamblers. Finally, a parsimonious forensic model explains a good part of the addresses’ probability of being involved in cybercrime, both on the victim and the cybercriminal side.

The Financial and Non-Financial Performance of Token-Based Crowdfunding: Certification Arbitrage, Investor Choice, and the Optimal Timing of ICOs

Published: April 18, 2023

(with N. Dombrowski, W. Drobetz, L. Hornuf)

→ Coverage: Oxford Business Law Blog

Abstract: What role does the selection of an investor and the timing of financing play in initial coin offerings (ICOs)? We investigate the operating and financial performance of ventures conducting ICOs with different types of investors at different points in the venture life cycle. We find that, relative to purely crowdfunded ICO ventures, institutional investor-backed ICO ventures exhibit poorer operating performance and fail earlier. However, conditional on their survival, these ventures financially outperform those that do not receive institutional investor support. The diverging effects of investor backing on financial and operating performance are consistent with our theory of certification arbitrage; i.e., institutional investors use their reputation to drive up valuations and quickly exit the venture post-ICO. Our findings further indicate that there is an inverted U-shaped relationship for fundraising success of ICO ventures over their life cycle. Another inverted U-shaped relationship exists for the short-term financial performance of ICO ventures over their life cycle. Both the fundraising success and the financial performance of an ICO venture initially increase over the life cycle and eventually decrease after the product piloting stage.

Performance Measurement of Crypto Funds

Published: April 09, 2023

Economics Letters, Accepted (with N. Dombrowski, W. Drobetz)

Abstract: Crypto funds (CFs) are a growing intermediary in cryptocurrency markets. We evaluate CF performance using metrics based on alphas, value at risk, lower partial moments, and maximum drawdown. The performance of actively managed CFs is heterogenous: While the average fund in our sample does not outperform the overall cryptocurrency market, there seem to be some few funds with superior skills. Given the non-normal nature of fund returns, the choice of the performance measure affects the rank orders of funds. Compared to the Sharpe ratio, the most commonly applied metric in practice, performance measures based on alphas and maximum drawdown lead to diverging fund rankings. Depending on their ranking of preferences, CF investors should thus consider a bundle of metrics for fund selection and performance measurement.

Academic Freedom and Innovation

Published: March 12, 2023

(with D. Audretsch, C. Fisch, C. Franzoni, S. Vismara)

→ Coverage: LSE Impact Blog, Academe Blog, Research Europe, ProMarket, Univeristy of Chicago

Abstract: The first-ever article published in Research Policy was Casimir’s (1971) advocacy of academic freedom in the light of the industry’s increasing influence on research in universities. Half a centure later, the literature attests to the dearth of work on the role of academic freedom for innovation. To fill this gap, we employ instrumental variable techniques to identify the impact of academic freedom on the quantity (patent applications) and quality (patent citations) of innovation output at the country level. The empirical evidence suggests that improving academic freedom by one standard deviation increases patent applications and forward citations by at least 37% and 29%, respectively. The results hold in a representative sample of 157 countries over the 1900-2015 period, with a sample/population coverage ratio of 92%. This research note also is an alarming plea to policymakers: Global academic freedom has declined over the past decade for the first time over the last century. Our estimates suggest that the decline of academic freedom has resulted in a global loss quantifiable with at least 4.0% fewer patents filed and 5.9% fewer patent citations.

The Labor Economics of Inventing

Published: March 10, 2023

(with D. Harhoff, D. Heller)

Abstract: The majority of inventions generated in modern economies are developed by employed individuals on the behalf of their employer. This paper provides first representative evidence on the marginal income per patent (MIP) to employed inventors. To this end, we explore administrative data for a representative sample of 148,743 unique inventors in Germany linked to their income and patenting activities. We find the average inventor earns a MIP of 7% per annum over the patent lifecycle. These results are particularly pronounced for high quality patents and in firms for which the marginal contribution of patents is high. Moreover, exploring the labor mobility effects of across-firm variation in the MIP, we find that firms that pay above-average premium recruit a higher number of high-quality inventors.

The Economic Costs of the Russia-Ukraine War: A Synthetic Control Study of (Lost) Entrepreneurship

Published: March 05, 2023

(with D. Audretsch, H. Motuzenko, S. Vismara)

→ Coverage: R&D Today, LSE Business Review, Vox Ukraine

Abstract: This synthetic control study quantifies the economic costs of the Russo-Ukrainian war in terms of foregone entrepreneurial activity in both countries since the invasion of Crimea in 2014. Relative to its synthetic counterfactual, Ukraine’s number of self-employed dropped by 675,000, corresponding to a relative loss of 20%. The number of Ukrainian SMEs temporarily dropped by 71,000 (14%) and recovered within five years of the conflict. In contrast, Russia had lost more than 1.4 million SMEs (42%) five years into the conflict. The disappearance of Russian SMEs is driven by both fewer new businesses created and more existing business closures.

The Discount for Lack of Marketability in Private Investments in Public Equity

Published: January 27, 2021

Work in progress (with A. Bernardo, I. Welch)

Abstract: Our paper estimates that shares in Private Investments in Public Equity (PIPEs) offered a discount of 3-4% for each year during which these shares could not be resold. Our estimates make use of the duration of the resale restriction and information about the effects of a regulatory change. In 2008, the SEC amended Rule~144 to shorten the default statutory holding period. Our estimates are smaller than previous estimates and robust to various controls and endogeneity concerns. The discount can be twice as large in offerings in which marketability is a greater concern.