Crowdfunding is a way of funding a project by collecting money directly from buyers.
Similarities between crowdfunding and digital currencies
The ideas behind crowdfunding are similar to the ideas behind cryptocurrencies.
The first idea is to allow projects to interact with investors and buyers directly.
During a typical initial public offering (IPO), a company first needs to hire a banker to underwrite the IPO and lawyers to make sure the IPO is complying with all the legal regulations. Then, the company becomes a part of an exchange and makes its shares available on the exchange. This is a lengthy, expensive and highly regulated process.
Crowdfunding works in a much simpler and streamlined way. Websites such as Kickstarter and Indiegogo provide a turnkey solution that allows businesses and individuals build and showcase their ideas, products, and services. You do not need to be spending time building your personal network or meeting with prospective investors. Crowdfunding platforms allow you to present your opportunity to millions of people and give businesses and individuals new ways to grow their businesses, from finding investors willing to invest thousands of dollars to selling first-run versions of products at deeply discounted prices.
The second idea that crowdfunding and cryptocurrencies have in common is transparency. Most crowdfunding platforms require users to establish a goal. The goal is visible on the page that describes an opportunity so that all users and visitors can see what the goal is and how many backers the goal has. In some cases, businesses and individuals only get the funds when they reach their announced in advance goal, which means that those who want to start and showcase a project on a crowdfunding site need to prepare well and think all the details through.
Crowdfunding with bitcoin
Crowdfunding with digital currencies allows businesses and individuals looking for investors take decentralization of the process to the next level. When you start accepting crowdfunding pledges in digital currencies, you can reach a truly global audience because digital currencies are global currencies. If your investors are located in different countries, they will not have to deal with figuring out how to convert the funds from their regular local currency to your regular local currency. When such a conversion occurs, one of the parties or both parties often have to pay taxes on the transaction. The amount that parties have to pay depends on the country and the size of the transaction.
With digital currencies, these issues do not exist. Your investors will simply send you funds in bitcoins or some other altcoin directly, without having to deal with banks, taxes or currency conversions.
As of the writing of this article, bitcoin is not taxable in most countries. For this reason, many people view bitcoin crowdfunding as a “tax-free” way to obtain funds and to invest in projects.
Issues with crowdfunding
When discussing crowdfunding, it is important to discuss the issues surrounding the process of obtaining funds from multiple small investors. One of the biggest issues is that some project creators are not capable of delivering the final product or service to their backers. Because of the easiness of collecting funds with crowdfunding, some people view it as a quick way to make some money before they figure out all the details of the project. Most crowdfunding platforms, including those that collect funds in regular currencies, have implemented protective measures against such scenarios, but when you back a project, sometimes there is still a chance that the creators will not deliver on their promises.
These risks are present in all crowdfunding projects, not just the ones funded with digital currencies. Whenever you participate in a crowdfunding project as a backer, always determine what award the creators of the project are promising for your payment. Crowdfunding is not the same as buying shares in a company or pre-ordering a product. Generally speaking, when sending funds to creators of a crowdfunding project, you are giving someone money to help them turn their dreams and visions into reality. This is why it is always a good idea to find out more about the people behind the projects that you consider investing in. One of the biggest red flags is a person or a team trying to do something in a new industry. The team may have the best intentions, but if they have no experience in doing what they are promising, chances are very high that at least some of things may go wrong.
Whenever you participate in a crowdfunding project, be it a project on a platform like Kickstarter, where you pay in regular local currency, or a bitcoin crowdfunding project, always make sure you fully understand what award you are doing to get for participating in the project.
Generally speaking, when you back a crowdfunding project, you are not buying a product, service or shares in a company. You are simply providing funds to help someone have their dream and vision come into reality. This help may or may not come with a reward. Most crowdfunding projects do offer rewards, yet some reward may have nothing to do with the product that you are supporting. For example, a typical low-pledge reward may include a signed photo, a hat or a t-shirt. Projects may also offer a dinner with co-founders, a tour of the facility or a recorded video as a thank you for your participation. This is why you always want to read the terms and conditions carefully.
An example of a crowdfunding project in which things went terribly wrong: Coolest Cooler
Even when you are pledging funds in a crowdfunding project for a product that you hope to receive, giving funds does not guarantee that you will get your product. About 75% of projects on Kickstarter have run into delays. Giving money to a project is very different from clicking a “buy now” button, even though the process is very similar because the crowdfunding sites look like online stores in which you can browse products and click a button to pay.
Coolest Cooler is an example of a crowdfunding project in which things went terribly wrong.
In 2014, Ryan Grepper broke a record on Kickstarter and has raised over $13 million in pre-orders for his cooler that came with a USB port, a speaker, an inside partition, blender, and wheels designed for sand. His goal for the project was $50,000. The project turned out to be so successful that he pre-sold his cooler to over 60,000 backers. The price tag during the crowdfunding project was $165-$185 per cooler. The originally planned product ship date was February of 2015. However, Grepper ran into multiple problems. In 2016, he announced that the funds that Coolest Cooler received from backers in 2014 were not enough to cover all the manufacturing and shipping costs.
In order to get quotes from manufacturers, Grepper needed to send them all the engineering specifications that he didn’t have when he ran his projects. After the crowdfunding project ended, Grepper needed to engineer and design all the parts first, then find manufacturers and build infrastructure to deliver all the coolers. The project turned out to be much more complex and expensive than Grepper thought. As of 2017, the company still didn’t ship around 20,000 coolers to its original backers and was planning to finish shipping the product by the middle of 2020.
Understanding digital currency initial coin offerings (ICOs)
An initial coin offering is a launch of a new digital currency, typically called a coin or a token. Most of such currencies use the source code from Bitcoin and try to improve on the idea of bitcoin in some way or form. ICOs have become a very popular way of crowdfunding that allows project creators to collect funds bypassing many of the existing financial regulations.
During an ICO, a company typically offers the backers either utility tokens or equity tokens. Utility tokens give backers a right to a utility, meaning a product or a service that the company is promising to create. Equity tokens give a right to ownership in the company. Regulating authorities, such as the United States Securities and Exchange Commission, have states that they view equity tokens as securities. While regulations about equity tokens do not yet exist in many countries, countries that view them as securities plan to regulate them as such. Utility tokens are different in that they represent a form of pre-sale of goods. Because of this, in most countries, government officials do not think that it is necessary to apply the same level of regulatory control to them as to equity tokens.
However, the things can be very different from country to country. For example, China has banned all ICOs on September 4, 2017. The government of China demanded that all the proceeds from all the previous ICOs that happened in the country be refunded to investors. This event has resulted in a large price drop of most cryptocurrencies because ICOs were becoming really popular in China. Prior to the September 4, 2017, decision by the Chinese government, ICOs in the country have raised about $400 million from over 100,000 investors. About a week after the ban one of the Chinese government officials stated that the ICO ban was temporary and that China would allow the ICOs once it develops necessary regulations for the process.
The first ICO has been conducted by Mastercoin in July of 2013. The idea behind Mastercoin was to develop a cryptocurrency network with complex financial functions. Ethereum was yet another successful ICO. Ethereum raised over 3,500 bitcoins in the first 12 hours of the ICOs. At the time of the ICO, this amount was equal to approximately $2.3 million.