The Oxford English Dictionary defines crowdfunding as “the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet”. The crowdfunding industry is evolving and rapidly dispersing across many areas of finance, and institutional investors starting to enter the market. (That actually resulted in the adoption of the term “institutional crowdfunding”).
Funds are a form of crowd
So should the crowdfunding industry welcome the recognition and money institutional investors bring? And how can ‘the crowd’ make sure that it is not pushed out of crowdfunding? First of all, the appearance of institutional investors is actually giving strong evidence that crowdfunding portals offers significant benefits over traditional finance and that using them is an inevitable evolution of the finance industry. Looking at institutional investors more closely it becomes obvious that they are in fact a crowd itself. Pension funds, for example, are trustees of a large crowd of ordinary people which make investments on behalf of those people mainly via capital markets. Hedge funds or private equity funds are pools, in other words a crowd, of sophisticated accredited investors which invest in a wide range of financial instruments. It is well known by now that crowdfunding dis-intermediates the supply chain of capital allocation and that it allows investors to make direct ‘upstream’ investments, often referred to as capital injections into the bloodstream of the real economy.
Financing the economies of un-scale
Why should people, who invest in pension or hedge funds, pool their money in such funds in the first place, if they have access to alternative investments via crowdfunding which potentially pays higher returns, is expected to be less volatile and offers an intrinsically high degree of risk diversification? The only argument that withstands is that not every investor has the knowledge, time, resources or experience to invest directly. So there is justification for having a layer of professional expertise in the form of a funds management team or independent financial advisor. One of the qualities of crowdfunding is transparency, so any rent-seeking layer which does not add value will be squeezed out of the supply chain.
What the crowdfunding industry needs in order to keep the growth momentum are viable investment opportunities, across many asset classes not just the start-up sector. As investment opportunities increase so will the supply of money, but we have to be realistic and can not assume that the trillions, which are currently held in traditional forms of finance, are channeled overnight into crowdfunding opportunities. But if you believe that the economy of the 21st century will consists of lateral, distributed and collaborative networks of boutique professional and technical workforces which taking advantage of a host a modular services embracing ”economies of un-scale”1 , crowdfunding for “unlisted shares and debt instruments” has the potential to develop into the prevailing from of finance for SME’s (small-medium sized enterprises) and dwarf capital markets in importance for the real economy.
Finance with a Soul
But there is another important distinguishing factor between traditional finance and crowdfunding. Crowdfunding brings the soul back into finance. Crowdfunding is an industry which is built on community ethics and on investments which are more specialized or local by nature. Investments are more longer term and don’t require constant shifting. Crowdfunding gives the investor visibility where their money is going and what it is doing and it gives investors the opportunity to support things which they really love and want. In that context it has actually has been suggested that crowdfunding is actually “tribefunding” as the social media landscape is primarily tribal, consisting of lots of people banding together in ‘tribes’ around common passions.
In any case, no matter who you define crowdfunding or what other names you give it, one thing is for sure: the traditional world of finance is changing in front of our very eyes, slowly being eaten up by software (as other industries have been before), making way for the next generation of finance.
Economies of Un-scale, Why business Has Never Been Easier for the Little Guy, HBR, Hemant Taneja, October 2013
Photo credit: OpenEye. http://bit.ly/1uGoCNC
Rex is an innovative banker with more than 15 years experience in retail banking, treasury and commodity trading at Commerzbank, J.P. Morgan and ABB Financial Services. Through his passion for entrepreneurship and new markets he got involved during the dot-com era in building up a business incubation unit for ABB, subsequently spinning off a company which pioneered the implementation of the European emissions trading scheme. He continued his career in the climate change sector first by joining EcoSecurties, a leading startup company in developing carbon reduction projects worldwide, and more recently as director in the environmental markets team of BNP Paribas.
Rex strongly believes that crowdfunding will cause a paradigm shift in the financial service industry and that it will make a significant contribution to the transition towards a sustainable economy. Born and raised in Germany, he gained a qualification as banker and a Masters degree in economics from University Hamburg. He currently lives in the UK with his wife and two daughters.