A critical look at crowdfunding

Whats the matter?

Technical innovations (Web 2.0) and a growing acceptance of the internet as a place of cultural, social and economic activities, makes new connections between creative and financial interests possible. The resulting need for exchange of creativity, knowledge, labor and capital is the basis for the emergence of crowdfunding platforms as interfaces between the involved actors. The so- enabled exchange brings a variety of advantages, but it also leads to a commercialization of the involved processes. To get an overview of economic risks associated with crowdfunding, the process of crowdfunding from idea to its realization is observed. It describes which actors are involved, the existing risks and issues.

Chart - The process of crowdfunding

Process of crowdfunding

The process of crowdfunding (risks, criticism and requirements)

Phases

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Phase 1

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Phase 2

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Phase 3 - Implementation

The goal of these projects is their realization, not their funding. Since the project can fail at any state, this goal moves out of focus although funding was a success. As next step, the money transaction from platform to funder is taking place. The platforms charge considerable fees, but they are hardly mentioned in their General Terms and Conditions subscription. The platforms themselves keep roughly 5% (percentage varies) of the collected amount. Additional 3-5% charges are deducted for the money transaction as credit card fees ^[1]. Therefore it makes no difference for big companies and the financial industry (e.g. PayPal) whether the funding is successful; they are making a profit regardless of the outcome of the project. ^[2] Transferring the money to the creator carries a considerable risk: high amounts can mislead the creator to embezzle the transferred money. In some cases fraud is the real motivation behind a funding campaign. Prosecution is not feasible, because of the small amounts transferred by individuals.

Underestimating the actual effort is another risk which can lead to missed deadlines. There are several factors which are typically underestimated: project scope, implementation effort, budget till, product quality, etc. Creating a new product always carries many risks and unknowns which are impossible to be determined in advance, especially by inexperienced entrepreneurs.

Phase 4 – Realization

Customer satisfaction is hard to determine even if the project was delivered successfully. All expectations cannot be fulfilled, of course, but it is unclear if the project rewards are useful. In most cases they can be described as gift articles like coffee mugs or a thank-you card. The future success of the creator is not guaranteed, just because of a single successful project.

Economic issues Particularly in times of low rates and yields, investors and speculators are interested in new investment opportunities. Crowdfunding allows them to invest in processes and services that previously have not been a capital good. This leads to a shift of capital in these new markets. Investors and speculators often look for investment opportunities here. The interest burden is shifted into these areas as well, because of higher interest rates than in the regular market. Looking at markets like the peer-to-peer loan market, money supply has increased.

Can you donate me a click?

The area of fundraising is also affected by crowdfunding. The platforms provide opportunity for donors to send (small) amounts of money to a variety of projects through service providers such as PayPal, credit cards, etc. Donating small amounts of money through easy transactions can make the donors only superficially inform themselves about the project. Even in fundraising, fees need to be paid, so the intermediary platforms (financial services, etc.) benefit from each donation.

However, small amounts and easy payment entice also the donor to inform himself or herself just superficially with the project. A further discussion of the causes or the output of a project also appears to elaborate.