06 Aug The Digital Currency Impact on Equity Crowdfunding
Chances are you’ve heard about Bitcoin, the virtual currency controlled by cryptography (rather than by a central bank) that’s used for online transactions. It’s the first digital currency of its kind in what’s now known as the peer-to-peer (P2P) economy.
Bitcoins at a glance
- Bitcoins are generated by mining, which requires a specific type of software
- Bitcoin owners have a virtual wallet, and use a key to make transactions
Digital currency, as a whole, uses what’s known as a block chain, which is a public ledger and record of all transactions. This block chain impacts currencies, wallets and more. As it currently operates, block chains don’t require any type of authority to oversee it (such as a bank). A series of computers running the necessary software automate the entire process.
The lack of a central bank backing has made many believe that Bitcoin, and its inevitable alternatives, are worthless. But a closer look at how currency markets work reveal that no currency holds any value beyond what users place on it. Ever since the disbandment of the gold standard in 1971, currency has value simply because, well, we say so.
That global understanding seems to be finding its way into the world of virtual currency. According to Mashable, two of Bitcoin’s payment processors (Bitpay and Coinbase) claim that more than 75,000 businesses accept the currency, including Amazon, Target, and CVS. If these titans say Bitcoins have value, then you can believe that belief will soon be widespread.
There’s no avoiding that while it may be unconventional, a virtual currency isn’t a bubble, or a glorified scam. In fact, it may be the future of crowdfunding.
Digital currency = Real crowdfunding?
Rewards-based crowdfunding platforms, as they stand now, act as a third party that houses entire campaigns. Sites like Kickstarter and Indiegogo give backers peace of mind that any contribution made through the platform will make its way to the intended project, so long as the total amount of the campaign is reached. In return for their contribution, the investors receive some type of reward, such as early access to a product, or producer credits (if the campaign is for a film). If the campaign fails to reach its target, the backer’s investment is returned.
But this traditional way of online fundraising –for both rewards and equity– could be interrupted, if the “crypto community” has anything to do with it. If an established crowdfunding channel forms , founded on virtual currency, there’d be no need for third-party sites such as Kickstarter and Indiegogo. Instead, you’d have a P2P economy.
In this environment, a startup could create its own, unique currency. The company could then sell cryptographic shares, or tokens that represent shares of the startup. This share’s value would (ideally) appreciate, thus benefiting early backers. How long would an ideal scenario like this last without the inevitable regulatory hand of government entering to regulate? Not. Long. At. All. In fact, probably never.
While most people would consider value appreciation to be a far more rewarding investment prospect than receiving some form of giveaway or exclusive benefits, it’s not likely the complete marriage of equity crowdfunding and digital currency to be a complete “#lovewins” scenario. Cash is still king and virtual cash, may not be queen for a long time, but that doesn’t mean we’re not moving that direction.
The battle between virtual currency and real cash is similar to the value gap had between rewards and equity-based crowdfunding—at least on the surface. The Oculus Rift campaign comes to mind. Facebook bought Oculus Rift for $2 billion, less than two years after the company raised $2.4 million on Kickstarter. Early backers of the company didn’t benefit at all from this buyout and value appreciation. It’s just not how Kickstarter operates.
“Kickstarter won’t switch to an equity-based model,” CEO Yancey Strickler told Popular Science. “We believe the real disruption comes from people supporting things because they like them, rather than finding things that produce a good return on investment.”
But what’s wrong with a return on investment?
There are, undoubtedly, segments of the population who want to back something because they believe in the product, concept, or company. But there are certainly those who want to actually benefit from valuation appreciation, which is why we’re beginning to see a wave of decentralized crowdfunding platforms come to light, such as Swarm. Even Indiegogo has lobbied for equity crowdfunding and has stated it’ll likely be introduced in some manner, eventually.
The 2012 JOBS Act has helped to influence this wave, since it allows startups to issue shares to investors (as much as $50 million) so long as they complete rather expensive financial and legal paperwork.
Virtual currency and early investors
The introduction of virtual currency into crowdfunding creates a mutually beneficial relationship for investors and startups.
Investors are able to jump in the game much earlier, before a product is even fully established. The earlier they invest, the greater value accretion they have the potential to realize (in a perfect world, of course).
Startups without a tangible product would historically struggle finding backing on platforms such as Kickstarter. But by offering shares of their young company through virtual currency, they’d be able to raise the capital necessary to fulfill their products, at which point they’d then likely be capable of finding more traditional investors to continue their growth.
Creating a decentralized crowdfunding platform also expands the avenues in which startups can raise funds. By utilizing both traditional and decentralized crowdfunding, these companies could first try their luck with a rewards campaign on Kickstarter and then thereafter run an equity crowdfunding campaign on a separate site for stock.
Obstacles to overcome
While the existence of decentralized crowdfunding channels may be in our future, there are still some issues that need to be addressed. The SEC, of course, is at the forefront of the discussion. Ongoing debates and discourse are focused on the legality of the exchanges of tokens for equity—even if it is all virtual.
Another issue involves the potential negative impact on late-stage investments. Will traditional venture capitalists think twice before investing in a company that’s sold shares of its equity via crypto-currency?
There are many questions left unanswered, but the concept of crowdfunding with digital currency is still relatively new and attempting to establish its identity. One thing’s for certain: there are exciting potentials for both investors and startups if a peer-to-peer economy based on a digital economy is finally realized.