Crowdfunding is on the rise and many believe it represents an alternative to capitalism, as well as a way to democratize investments and to allow new ideas to emerge. Is it really so? We will see whether it could be, and also the main criticisms it is facing.

Among the many social innovations that have emerged in the last years, crowdfunding is probably one of the best-known. Based on principles of openness, transparency and community creation, it is considered by many as a revolutionary practice. At the same time, several criticisms and questions exist, which should not be overlooked. Can crowdfunding really be an alternative to capitalism?

In the last decade, crowdfunding websites have been emerging first in the US and then across Europe, with some becoming more famous than others. In 2014, 1.250 platforms were active worldwide, raising $16,2 billion, a 167% increase from the previous year. In 2015, crowdfunding platforms raised $34,4 billion (+112% from 2014). If we compare crowdfunding’s growth trend with that of more traditional investment tools such as venture capital (VC) and angel investors, we see that a surpass could well be under way. 

Such growth rates, especially over a period of less than ten years, led many observers to believe that crowdfunding is the key for redistributing capitals and making them accessible to any creative individual or enterprise with a good idea: in a few words, for democratizing the financial market and increasing grassroots participation.

What is crowdfunding?

Crowdfunding is commonly known as “a collective effort of many individuals who network and pool their resources to support efforts initiated by other people or organizations. This is usually done via or with the help of the Internet. Individual projects and businesses are financed with small contributions from a large number of individuals, allowing innovators, entrepreneurs and business owners to utilize their social networks to raise capital” (1). Its core elements are the openness of the call (anyone who is interested in a project can make a donation), the use of the Internet and the transparency that should ensue from it: backers should be informed on the progress of the campaign and on how their money will be spent.

Crowdfunding mainly started through donation-based and reward-based models, which means that contributions to a specific project could either be “donations” (not getting anything in return) or they could be met with a reward, depending on their entity and on the project itself: most common rewards include special mentions and thank-you’s on the project’s website and/or on the final product, signed cards and samples of the product. It then evolved towards lending-based models, where private individuals lend money to other individuals (consumer lending) or to companies (peer-to-business lending) and the interest rate on the loan is the remuneration for participants. Today, the fastest-growing model is equity crowdfunding, where individuals’ contributions buy them shares in the company asking for funds: private investors, however, normally receive class B shares, meaning that they have no voting or pre-emption rights.

Civic crowdfunding is also on the rise, consisting of the collective financing, by citizens and/or private and nonprofit organizations, of projects whose ultimate output is a public good; sometimes, projects can be jointly financed by the civil society and local public administrations. There are a few famous examples. The first is the “I make Rotterdam” campaign, whose goal was to build a bridge between two neighborhoods in Rotterdam, which were only linked by a high traffic street. The basic idea was “the more donations, the longer the bridge”, and there were several rewards depending on the amount donated. The bridge was funded and built, and now the company promoting the campaign is looking to expand it to other areas of the city. Another famous example is when the Louvre Museum wanted to buy a painting by Cranach, The Three Graces, having only 3 of the 4 million euros needed: the solution was to launch a civic crowdfunding campaign to collect the additional amount, which was successfully funded in one month. The campaign’s success mostly depended on the museum’s prestige and on the promoters’ ability to engage the public.

A Key to the Future?

Many entrepreneurs, academics and analysts see it as the future of finance, a democratic tool that could allow “the crowd” to allocate its money wherever it pleases, helping innovators to bypass, at least partially, VC and institutional investors. This could translate into greater democracy in entering the demand side of the financial market: anyone can post a crowdfunding project to a platform (which needs to approve it), so innovative ventures and enterprise creation would be open to any person or group of people with a good idea, and not just to existing and established companies. At the same time, the fund supply could also become more democratic and more participative, since any private individual would choose to support the projects he/she believes in, without needing to be a professional investor (such as VC and angel investors). Funders could support any project they believe in, becoming part of a community of like-minded individuals, and innovators could have faster and easier access to financial support.

For what concerns the evaluation of investment opportunities, which is now in the hands of experts working for VC or angel investors, the “wisdom of the crowd” should end up supporting the best ones and neglecting the worst; in addition to this, the feedbacks and the reputation that is created within the community are also instruments that should reduce the risk of fraud and contribute to a virtuous selection mechanism. Equity crowdfunding is regulated by law in several countries (e.g. in the United States with the JOBS Act), and normally the amount of investment by private citizens is limited, so that they do not risk to invest all their savings into projects they may not be able to evaluate properly.

Civic crowdfunding, on the other hand, is seen as a great opportunity to engage and involve citizens in public matters: by contributing to a project, or by launching one, they become more active within their community and they also have the opportunity to choose how to invest their money with respect to public works (which they cannot do when they pay taxes). Furthermore, civic crowdfunding is increasingly considered as a way to overcome the shortcomings of the public administration and its lack of funding, as well as a pressure tool to signal the issues that citizens believe are the most pressing (if they are willing to fund them, even if they already pay taxes, they are sending a message to their local administration about the issues they care the most about).

Criticisms

The picture is not as rosy as it seems, with several criticisms being reported. First of all, regulation on equity crowdfunding is certainly important, but it cannot prevent individuals from investing into companies without having an adequate financial education and the ability to evaluate the prospects of the company or of the product they are supporting: crowdfunding platforms speak to the general public, which may be more exposed to the risk of fraud (and before feedback and reputation mechanisms uncover the fraudulent projects, many people could lose their money). On the other hand, it may also be possible that companies reverting to crowdfunding are weaker than their competitors, and were not able to raise funds from traditional sources such as VC and angel investors, whose due diligence is much more accurate than evaluation by everyday people.

In addition to this, these institutional investors are very thorough in the follow-up of their investment, requesting periodic meetings with the board of directors to be updated on the company’s situation: funders on a crowdfunding platform do not have the same strength and knowledge, which may lead the company to skip the part where it provides feedbacks on the investments it received.

It might also be true that crowdfunding is not really democratic, since it’s much easier for existing and recognizable brands or individuals to obtain funds from strangers on the Internet, than it is for actual newcomers with no previous credentials or reputation. Moreover, when campaigns are close to the end date and still did not reach the target, it is quite common that the fund-seeker himself adds the amount that is missing: platforms claim they do not allow this, but using a different email address and payment info is enough to bypass the rule. Clearly, this behavior goes against one of the basic principles of crowdfunding: the selection criterion of which project is successfully financed should be based on the wisdom of the crowd (which can be seen as a democratic principle), so if the crowd thinks that a project is not good enough to be funded, then the fund-seeker should respect this outcome.

It also looks like crowdfunding is becoming a fashionable tool, and a growing number of people are resorting to it to address their personal issues, asking for funds without really providing any value to the community (for example, campaigns such as “Help me to buy a new bike!”); in other cases, crowdfunding may not be the most adequate fundraising tool, but since it’s now so trendy people will adopt it anyway.

For what concerns civic crowdfunding, while it may be true that it fosters civic engagement and higher participation by citizens, it seems to be directed toward a specific ideology, i.e. that of privatizing public services that are not effectively managed and provided by public administrations: in this context, the privatization would occur when citizens agree to fund public works, often in partnership with private organizations, in addition to their taxes and somehow bypassing the public institution that is in charge of that work/service. While a more active civil society might be a positive outcome of crowdfunding, it is also true that taxes need to be paid anyway, and that the public sector continues to exist: rather than substituting themselves to it (and spending additional money), citizens should maybe require that it provides the services they pay for with their taxes. If civic crowdfunding became a routinary answer by citizens to the public sector’s failings, it might end up delegitimizing it altogether, which would be a counterproductive outcome since most countries are not close to overcoming its existence. In addition to this, if civic causes are intensively promoted and supported on the Internet, the consequence is the exclusion of a considerable share of population whose level of digital literacy is not adequate (for example the elderly, who experience greater difficulties with online payments).

So What?

Crowdfunding is certainly an interesting phenomenon, emerging from the wider trend of social innovation. On the one hand, it can improve the way financial resources are allocated, and it can help innovators who lack funds to emerge and build a trust-based community within the general public. Crowdfunding could also remove, at least partially, the filter of institutional investors from the picture, allowing a greater number of new and worthy ideas to come to light. However, its positive features are counterbalanced by the risk that it becomes the next poorly regulated financial instrument to promote speculation and fraudulent behavior; in addition to this, there are issues with the use of civic crowdfunding being compatible with the existing public sector model.

Crowdfunding’s based on a democratic idea, that everyone should be able to get support for their innovative ideas and worthy causes, and everyone should also have the chance to participate in supporting such projects, creating the possibility of democratic participation in the financing business.

However, it is not an alternative to the neoliberal capitalist economy, because it still follows capitalism’s basic assumptions: those who contribute to fund the project do not get a share of the profits it will generate (unless we speak of equity crowdfunding, in which the profit sharing does not happen out of democratic or socialist values, it’s just the consequence of holding shares in the company), and in general once the projects are funded they go on like any other capitalist venture, funders receive their reward (if any) but cannot claim any right on the product or company they helped finance. Moreover, crowdfunding is not a redistribution tool (in terms of financial resources): it just allows common individuals to dispose of a part of their wealth to support an initiative of their choice. Even civic crowdfunding, although based on the assumption of active citizenship, does not support its existence with an ideological framework or an actual alternative to capitalism: it seems like more of a temporary solution to the public sector’s inefficiency than a real shift in economic paradigms.

Finally, crowdfunding does not spread any message about changing the capitalist system: it is just a financing tool that constitutes an alternative to traditional ones, but it still well inside the perimeter of capitalism, and it does not challenge its core values of profit maximization, workers’ expropriation and its production system.

All in all, crowdfunding should be the object of regulations and further studies concerning its long-term effects, as well as careful consideration about the ideological perspective from which it originates.

Notes

1) De Buysere K., Gajda O., Kleverlaan R., Marom D., A Framework for European Crowdfunding, Available at http://www.fundraisingschool.it/wp-content/uploads/2013/02/European-Crowdfunding-Framework-Oct-2012.pdf, 2012, p. 9.