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What do Kickstarter and Blockchain fundraising have in common?

September 03, 2019
The rise of peer to peer fundraising on digital platforms has many questioning whether technology will usher in a new era for accessible capital formation.[1] Traditionally, investment in early stage ventures is restricted to ‘accredited investors:’ those of sufficient net worth and income levels.[2] Nonetheless, both Regulation Crowdfunding and ‘Initial Coin Offerings’ (ICOs) allow unaccredited investors to ‘get in on the action’, participating in early stage funding in return for equity.

Importance of these Forms

In the first half of 2018, more than 17 billion dollars were raised globally through ICOs.[3] At the end of 2017, one year after the SEC rules went into effect, small investors invested approximately $1.1 billion into U.S. equity crowdfunding.[4] While these numbers pale in comparison to the $53 billion invested in U.S IPOs in 2018, many hope that both ICOs and Equity Crowdfunding will bring early stage investing to the masses and close the $60 billion dollar gap in available startup funding.[5][6][7]

Crowdfunding

In 2015 the Securities and Exchange Committee adopted final rules permitting firms to engage in ‘equity crowdfunding’. This was the culmination of a multi-year long process precipitated by the Jumpstart Our Business Startups (JOBS) Act.[8] The JOBS act was designed to make it easier for small businesses to raise capital. Firms can use equity fundraising to raise up to $1 million annually from online platforms, but sums must be raised in small increments from large numbers of ‘unaccredited’ investors. In return, the firm grants small amounts of equity to these investors. This is similar to a familiar Kickstarter-style campaign; however, rather than receiving a product at the end of the campaign, investors receive the equivalent of a share.

Crowdfunding’s Mixed Success

Despite the optimism surrounding regulation crowdfunding, the amounts raised have been small relative to traditional IPOs.[9] Attorney Jo Won argues that the regulatory burden of disclosure is partially to blame for reduced uptake of the form.[10] While similar experimentation with crowdfunding in the EU has created small business growth, concerns of fraud and high risk remain.[11][12]

What is an ICO?

ICOs can be analogized to a crowdfunded fun-fair in which investors receive fair tickets instead of shares. While the operators of the fair may intend for the tickets to be used within the fair itself, they have some inherent value and can be redeemed for desirable goods or services (prizes and rides). An investor who buys tickets believes that the fair will be successful, and the tickets will appreciate in value. The investor can then sell the tickets to fair-goers or other investors for fiat currency, making a profit. The fun-fair tickets are akin to the ‘tokens’ of an ICOs: tradeable and redeemable records of ownership stored on a blockchain.

Problems with ICOs

However, ICOs, unlike fun-fairs, have to contend with some significant challenges. First, ICO token trades are difficult to reverse.[13] There is no built-in technical mechanism for doing so and there is no centralized authority to whom one can appeal to change the ownership records on the blockchain. Furthermore, operators and token owners are frequently homed in offshore jurisdictions, reducing the effectiveness of domestic legal judgements.[14] In many jurisdictions there is also no regulator ensuring that the token offerings are executed in a transparent and fraud-free manner. This lack of policing is in stark contrast to the developed investor protection regimes in traditional equity markets.

ICO Market Collapse

In mid-2018, researchers, including myself, highlighted these and other issues with ICOs.[15] Simultaneously, reports of market manipulation and regulator concern spooked investors.[16] In a matter of months, the ICO market cratered with the value of many investments declining by over 90%.[17] This raises the question: is ICO investment yet another instance of ‘tulip mania’? A meager $118 million was raised by ICOs in Q1 2019.[18] Even if the market can recover from this ‘crypto winter,’ it will require an investor protection regime on which investors can rely with greater confidence.

Haunted by the Past

This state of affairs parallels the information market failures that led to the securities legislation of the 1930s. Simon notes that in the absence of regulation, investors were “misled by exaggerated claims and inadequate disclosure.”[19] This contributed to the boom of the early 20s and subsequent bust. In response, Congress created the Securities and Exchange Commission. The Commission was empowered to police disclosures and protect investors from fraud by intervening in a previously ‘disintermediated’ market. Those who peddle the virtues of decentralization should take history’s lesson into account: intermediaries can be a source of value.

Image: Figure 1. Market Cap for Bitcoin. Most cryptocurrencies and tokens have prices strongl...Image: Figure 1. Market Cap for Bitcoin. Most cryptocurrencies and tokens have prices strongly correlated to Bitcoin's. Visible here is the 2018 'crypto winter'. Source: Wikimedia Commons.

Do We Need to Regulate?

Backers of ICOs have seen a significant decline in the value of their investments. However, regulators may not feel the need to intervene if investors are institutional. Regulators assume that such investors are sophisticated and can adequately assess the risk of speculative investments. In contrast, mom and pop investors have little ability to understand the tradeoffs involved. Regulators should first assess who is investing in ICOs, and on that basis decide if and how to intervene.

Crowdfunding or ICOs?

Properly structured regulation crowdfunding may strike the right balance for small time investors. Mom and Pop are better off dipping their toes into early stage ventures with the assurance that the SEC is guarding them against fraud. Rosy-eyed futurists must fortify ICO markets against mischief before inviting the hordes to cast their lots.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

References

  [1]https://news.earn.com/thoughts-on-tokens-436109aabcbe

  [2]https://www.strictlybusinesslawblog.com/2017/08/17/accredited-investors-vs-qualified-clients-vs-qualified-purchasers/

  [3]https://www.coinschedule.com/stats.html?year=2018

  [4] http://review.chicagobooth.edu/entrepreneurship/2018/article/equity-crowdfunding-inflating-bubble

  [5] https://www.ey.com/Publication/vwLUAssets/ey-global-ipo-trends-report-q4-2018/$FILE/ey-global-ipo-trends-report-q4-2018.pdf

  [6]https://www.congress.gov/112/crpt/hrpt406/CRPT-112hrpt406.pdf

  [7]https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1916184

  [8]https://www.congress.gov/bill/112th-congress/house-bill/3606

  [9] https://www.crowdfundinsider.com/2017/01/95074-2017-americas-alternative-finance-industry-study-university-chicago-university-cambridge-partner-research/5/

  [10]https://law.lclark.edu/live/files/27733-lcb224article7wonpdf

  [11]https://link.springer.com/article/10.1007/s11187-019-00210-4

  [12]https://www.telegraph.co.uk/finance/personalfinance/investing/12005303/First-crowdfunding-results-70-go-bust-one-makes-money.html

  [13]https://columbialawreview.org/content/coin-operated-capitalism/

  [14]https://stanford-jblp.pubpub.org/pub/ico-comparative-reg

  [15]https://ag.ny.gov/sites/default/files/vmii_report.pdf

  [16]https://www.technologyreview.com/s/612659/cryptocurrencies-crashed-in-2018-now-theyre-right-where-they-should-be/

  [17]https://ag.ny.gov/sites/default/files/vmii_report.pdf

  [18]https://cointelegraph.com/news/report-icos-raised-118-million-in-q1-2019-over-58-times-less-than-in-q1-2018

  [19]https://ideas.repec.org/a/aea/aecrev/v79y1989i3p295-318.html

PENN WHARTON PPI
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  • <h3>USDA Nutrition Assistance Data</h3><p><img width="180" height="124" alt="" src="/live/image/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg" class="lw_image lw_image485 lw_align_right" srcset="/live/image/scale/2x/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg 2x, /live/image/scale/3x/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg 3x" data-max-w="1233" data-max-h="850"/>Data and research regarding the following <strong>USDA Nutrition Assistance</strong> programs are available through this site:</p><ul><li>Supplemental Nutrition Assistance Program (SNAP) </li><li>Food Distribution Programs </li><li>School Meals </li><li>Women, Infants and Children </li></ul><p> Quick link: <a href="http://www.fns.usda.gov/data-and-statistics" target="_blank">http://www.fns.usda.gov/data-and-statistics</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>National Center for Education Statistics</h3><p><strong><img width="400" height="80" alt="" src="/live/image/gid/4/width/400/height/80/479_nces.rev.1407787656.jpg" class="lw_image lw_image479 lw_align_right" data-max-w="400" data-max-h="80"/>The National Center for Education Statistics (NCES) is the primary federal entity for collecting and analyzing data related to education in the U.S. and other nations.</strong> NCES is located within the U.S. Department of Education and the Institute of Education Sciences. NCES has an extensive Statistical Standards Program that consults and advises on methodological and statistical aspects involved in the design, collection, and analysis of data collections in the Center. To learn more about the NCES, <a href="http://nces.ed.gov/about/" target="_blank">click here</a>.</p><p> Quick link to NCES Data Tools: <a href="http://nces.ed.gov/datatools/index.asp?DataToolSectionID=4" target="_blank">http://nces.ed.gov/datatools/index.asp?DataToolSectionID=4</a></p><p> Quick link to Quick Tables and Figures: <a href="http://nces.ed.gov/quicktables/" target="_blank">http://nces.ed.gov/quicktables/</a></p><p> Quick link to NCES Fast Facts (Note: The primary purpose of the Fast Facts website is to provide users with concise information on a range of educational issues, from early childhood to adult learning.): <a href="http://nces.ed.gov/fastfacts/" target="_blank">http://nces.ed.gov/fastfacts/#</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
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  • <h3>Congressional Budget Office</h3><p><img width="180" height="180" alt="" src="/live/image/gid/4/width/180/height/180/380_cbo-logo.rev.1406822035.jpg" class="lw_image lw_image380 lw_align_right" data-max-w="180" data-max-h="180"/>Since its founding in 1974, the Congressional Budget Office (CBO) has produced independent analyses of budgetary and economic issues to support the Congressional budget process.</p><p> The agency is strictly nonpartisan and conducts objective, impartial analysis, which is evident in each of the dozens of reports and hundreds of cost estimates that its economists and policy analysts produce each year. CBO does not make policy recommendations, and each report and cost estimate discloses the agency’s assumptions and methodologies. <strong>CBO provides budgetary and economic information in a variety of ways and at various points in the legislative process.</strong> Products include baseline budget projections and economic forecasts, analysis of the President’s budget, cost estimates, analysis of federal mandates, working papers, and more.</p><p> Quick link to Products page: <a href="http://www.cbo.gov/about/our-products" target="_blank">http://www.cbo.gov/about/our-products</a></p><p> Quick link to Topics: <a href="http://www.cbo.gov/topics" target="_blank">http://www.cbo.gov/topics</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>National Bureau of Economic Research (Public Use Data Archive)</h3><p><img width="180" height="43" alt="" src="/live/image/gid/4/width/180/height/43/478_nber.rev.1407530465.jpg" class="lw_image lw_image478 lw_align_right" data-max-w="329" data-max-h="79"/>Founded in 1920, the <strong>National Bureau of Economic Research</strong> is a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works. The NBER is committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community.</p><p> Quick Link to <strong>Public Use Data Archive</strong>: <a href="http://www.nber.org/data/" target="_blank">http://www.nber.org/data/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
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