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Traditional Fundraising vs Blockchain-based Fundraising
July 26, 2019
Fundraising has been occurring for as long as people have been using money to conduct business. Over thousands of years, the options available have expanded from self-funding and peer-to-peer loans, to early examples of what we now call angel investors, bank loans, government grants and internet-based crowdfunding. In recent years, a new option - blockchain-based crowdfunding - has arisen. In this article we will look at traditional fundraising options (up to and including crowdfunding through internet sites) and blockchain-based crowdfunding, comparing their potential and highlighting the benefits and drawbacks of each.
Traditional options
- Bootstrapping, Family and Friends, Credit cards
A number of simple traditional options are open to anyone looking to raise funds. All of these methods have some similarities in their benefits and drawbacks. By bootstrapping the project themselves, asking family or friends to invest, or using credit cards to cover costs, someone starting a new business can have the highest degree of control over the business. Whilst they try to succeed and pay back any investments, there is a great deal more potential efficiency and flexibility in running the business without having to justify decisions to others or getting approval. On the other hand, there is a great deal more personal risk involved, not only financially, but also through the risk of falling out with friends and family should the business not succeed. By relying on themselves, or those close to them, people using these methods are (usually) also limited in the amount of funding they can raise.
- Bank Loans
If a start-up or new business can produce a solid business plan, then approaching a financial institution for a loan is a viable option for raising capital. Being able to meet the requirements and be approved for the loan could be a good indicator that a business has potential and is not simply wishful thinking. Whilst the loan still has to be paid back, a bank is unlikely to lend the money if there is no collateral to back it, which should persuade people not to borrow beyond their means to repay but can leave them in a difficult situation if the business fails.
- Angel investment and Venture Capitalists
For those looking for more substantial investment, angel investors or venture capitalists represent a potential source of capital. Not only can these options provide substantial funding, but they are also a resource for expertise and assistance; angel investors and venture capitalists have a vested interest in the business doing well and most often have a wealth of experience to draw on which can assist the business in growing and succeeding. However, the reason that the angel investors and VCs have a vested interest is that they are typically given a significant stake in the company. As they will vet a project before investing, securing angel or VC funding is harder to secure; on the other hand, if it does come through, then the risk to the business owner is much lower than other methods. The reverse of this is that the company or business will be far less autonomy, and will have oversight from the investors. Accelerators and incubators could also be considered in this vein.
- Crowdfunding websites
As a relatively recent method, the first crowdfunding websites having been launched around 2012, crowdfunding is nevertheless a hugely popular fundraising method. Websites like Kickstarter, Indiegogo and GoFundMe are used to raise a huge amount of funds for any and all reasons. The main advantage of crowdfunding is that pool of potential investors to a company is opened up to a massive proportion of the population compared to other methods, and the public can pool their resources to support whatever they wish, showing the popularity of an endeavour and giving an idea of how well a product or service would be received in addition to financing the endeavour. Bonuses or incentives to investment can be offered at set milestones, allowing the scale of the business to be altered depending on how popular it is. Running a successful campaign on crowdfunding websites can be very tricky as the potential or need for a project has to be explained to those who may have no knowledge or interest in it. It may be difficult to get the idea to stick out in the crowd; those that would be interested in it need to come across it. Likewise, the amount of work that has to be done to follow through with the campaign is high, as investors expect regular updates. Projects usually have to hit their funding goals to be successful, and a portion of the funding is usually taken by the website. Putting an innovative idea out to the masses might not be the best idea if funding isn’t guaranteed as others could take the idea and run with it themselves.
- Government Grants and Business Loans
Many countries may have specific grants or loans that can be allocated to new businesses. These can provide the required funds but can be difficult and time consuming to secure. Prospective projects would need to investigate what options are open to them in the countries they are located in, or able to work in.
Blockchain options
Blockchain fundraising methods have a number of advantages over traditional methods, though there has been worry with regards to regulations and compliance for blockchain funding since its inception. This is largely being overcome by the introduction of new types of blockchain funding options.
- ICOs
Not long after the first crowdfunding websites launched, the blockchain space responded with ICOs - Initial Coin Offerings - opening up crowdfunding to the blockchain ecosystem. This allowed anyone, from anywhere, to finance the development of a company or project. There were a number of other benefits due to the nature of blockchain technology, which are discussed below. As this space was brand new and fairly niche, there was a lack of regulatory oversight around ICOs and by the end of 2017, the system quickly grew to a huge fundraising source which unfortunately was abused by some bad actors who threw the new option into disrepute. Subsequently, many countries banned or restricted ICOs and many more began to develop regulations.
- STOs
Developed as a response to the knee-jerk reaction of ICOs, STOs aimed to bring regulation to blockchain-based crowdfunding. In a previous article, we discussed the STO and its benefits, which can be seen here.
- IEOs
Initial Exchange Offerings are the latest iteration and improvement to ICOs and STOs. They achieve similar goals but in a much more efficient and accredited way. The benefits of an IEO were the topic of one of our recent articles which can be found here. Broadly speaking, IEOs combine the public accessibility of crowdfunding websites, ICOs and STOs with some aspects of assistance and guidance for various parts of the project that an incubator/accelerator or angel investor might bring (though not to such a great extent). There is still an application process to pass but control of the project is likely to remain in the hands of the project’s team.
Conclusion
As seen in the articles on STOs and ICOs, blockchain fundraising has a number of benefits over traditional methods, which are highlighted below. Whilst there is a space for many traditional fundraising options - whether bootstrapping for a small project or partnering with angel investors for both funding and advice, the benefits of blockchain-based crowdfunding are enormous and will likely take over from many traditional fundraising options in the future.
Immutability
Using cryptographic certainty and immutability of blockchains, and coding of smart contracts, allows blockchain-based crowdfunding methods to facilitate trustlessness. Once a smart contract is entered into, the outcome (funding of a project, the result of a vote etc) will occur once the conditions have been met, or (if specified, the funds will be returned. You don’t have to trust the intentions and morality of a person you are dealing with or have external safeguards; however, you do need to be sure that the coding of the project and any smart contracts are sound.
Removal of middlemen
As a trustless system, blockchain-based crowdfunding can avoid the need for middlemen and the inefficiencies that they create. This opens up a host of benefits including making it less prohibitive to invest and allowing trading to be carried out 24/7. This reduction of third parties also means that there is less chance of skullduggery. Crowdfunding websites are usually expected to take around a 5% cut, though this can be higher. Blockchain-based crowdfunding might not be free (particularly with IEOs) but it is cheaper than traditional methods and the fees paid are not simply a charge for using the crowdfunding service.
Automation
Automation through smart contracts is one of the main ways that blockchain-based crowdfunding can be made more efficient than traditional methods. You are not waiting for a person to approve or progress at various points. Once a goal is met it can be instantly executed.
Speed
Both removing middlemen and automation lead to a faster and simpler process when compared to traditional methods.
Efficiency
The reduction of middlemen and automation also leads to greater cost savings through efficiency.
Global
A borderless system, blockchain opens up the potential pool of investors to a much wider, global level, which is also unrestricted based on biases and prejudices. This is similar to crowdfunding websites though some crowdfunding websites are restricted to certain countries.
Fractionalisation
Using a blockchain-based system with an infinitely-divisible token allows for investment at a micro-level. For example: 1 token could be offered for $100, or 100 tokens could be offered for $1. This provides a much deeper pool of potential investors across the world who would never be able to afford to participate in traditional investment. This can also allow for people to invest with others to own a fraction of, for instance, a piece of art or real estate.
Liquidity
Tokens and coins in blockchain-based crowdfunding options can enjoy vastly superior liquidity due to the ability to be offered at potentially infinitely small denominations, the removal of middle men making transfers fast and efficient, and the option to trade on digital exchanges with no down-time.
Flexibility
Smart contracts and tokens can be customised to do anything that can be coded, providing limitless potential options to benefit the investor. This could be anything from increased dividends for those who hold the tokens longer, to proportional voting rights for token holders.
Useful links:
https://blog.mycorporation.com/2017/12/ready-to-expand-your-business-here-are-6-ways-to-raise-capital/
https://appinstitute.com/how-to-raise-money-for-business/
https://www.moneycrashers.com/money-start-small-business-financing-options/
https://www.finextra.com/blogposting/15065/10-funding-options-to-raise-startup-capital-for-your-business
https://www.themuse.com/advice/show-me-the-money-7-ways-to-get-funding-for-your-business-idea
https://thetechpanda.com/seven-types-of-funding-sources-for-your-startup/11238/