The Promise and Pitfalls of Crypto Crowdfunding

Daniel Cawrey, CoinSummit London saw a number of notable speakers, panels and announcements during its two-day run this July, but those issued by Swarm, a crowdfunding platform that seeks to use cryptocurrency to empower industry businesses, may have passed under the radar.

During a party to celebrate its efforts, Swarm announced campaigns for several initiatives, including an effort called SpaceBit that seeks to send remote-controlled satellites into orbit, and a kale farming collective that is raising cryptocurrency to grow its health-conscious snack business.

Both projects highlight how cryptocurrency provides a new way for investors to support interesting projects. Swarm has even raised capital through its own platform – it has crowdsourced $1m in funding from a distributed group of backers.

crowdfundingpiggybanks-300x185

Swarm further highlights an interesting discrepancy in the bitcoin ecosystem. While some startups like IT security specialist CrowdCurity raise part of their funding in bitcoin, most major bitcoin businesses still receive fiat currency from venture capitalists and investment firms.

With the introduction of Swarm and other similar platforms, those looking to raise money without forging connections with Silicon Valley’s tech elite certainly have a new avenue to obtain capital. The question is how this new and untested market will mature while responding to concerns that need to be addressed through regulation.

New need for crowdfunding

One of the primary reasons behind the rising interest in crowdfunding is that as the price of bitcoin and other altcoins becomes increasingly stable, entrepreneurs can no longer steadily rely on the increasing value of these assets to fund their ideas.

For example, the 2013 rise in the price of bitcoin and other alternative cryprocurrencies such as litecoin allowed savvy investors in the bitcoin community new economic freedoms.

According to CoinDesk’s historical pricing data, investors could have realized over an 80x return on investment had they played the bitcoin market right.

2013bitcoinprice

This increase in price also means that new businesses could be formed and developed without outside investment.

Issues arise

One of the most notable examples of cryptocurrency crowdfunding and its current issues was provided this year by decentralized platform provider MaidSafe, which raised money via cryptocurrency, converting bitcoin into a token called MaidSafeCoin.

The affair was not as smooth as organizers had hoped, an account that was covered in depth by Forbes.

In essence, many of the coins that MaidSafe ended up with were mastercoins, an altcoin that has be criticized as illiquid. According to Coinmarketcap, recent 24-hour volume for mastercoin was around $1,500, which would make any quantity of it difficult to sell on the open market.

Source: Coinmarketcap
Mastercoin’s price, market cap and volume. Source: Coinmarketcap
Jeremy Lam, co-founder of Vennd, offers a solution for what happened with the MaidSafe fund raiser. He said that the manual process of doling out digital shares of MaidSafeCoin is what caused problems:

“The incentive rate was much greater than the current market value for an illiquid asset [mastercoin]. Second, demand outstripped what was intended. When you have to process these things manually, it just becomes an impossible task entirely.”

An automated solution

Lam’s Vennd project automates the distribution of digital assets purchased with cryptocurrencies.

Used by Swarm, Lam likes to think of his project like a vending machine: people send cryptocurrency to a Vennd instance, and its code tracks digital asset inventory. When a project runs out of a set number of digital assets, Vennd automatically starts refunding those who didn’t get a share of a particular crowdfunding effort.

Unlike other crowdfunding efforts, the Swarm platform also claims it allows investors to have voting rights with the digital tokens that it dispenses through Vennd.

Joel Dietz, the founder of Swarm, told CoinDesk:

“Real cryptoequity [like Swarm] allows you to do things, like vote on a project, that you could never do before.”

Dietz says Swarm tokens are a “programmable set of rights”, allowing project investors a real say.

Lam offered a different take, saying that the Counterparty-based decentralized tokens that Swarm disburses for its projects are tangible instruments. This could include a share of profits or debt issuance. However, one risk with crowdfunding is that the collecting party may not use the money it raises for the express purposes detailed during fundraising.

“The tokens are worth as much as the issuer puts into them, strangely enough,” Lam said. “Obviously, there is a trust factor there.”

The appcoin alternative

Still, with any cryptocurrency crowdfunding opportunity, there remains the possibility that the issuers of the assets may default.

Swarm is not the only project seeking to tackle this cryptocurrency crowdfunding challenge. VC firm Andreessen Horowitz is looking into the concept of funding startup development with distributed coins.

Mentioned at Coinsummit San Francisco in March by Andreessen Horowitz’s Balaji Srinivasan and further outlined on AngelList founder Naval Ravikant’s blog, the firm has an idea to develop “appcoins” that would fund operational and technical development.

This type of coin would be pre-allocated for distributed ventures, which would then disburse appcoins as a scarce resource in return for contributions such as code development.

However, Ravikant told CoinDesk that the idea has not passed the conceptual stage. He called appcoin an “idle hypothesis that has yet to materialize”. Yet, the fact that major Silicon Valley venture capitalists are openly talking about appcoin gives it some validity.

The idea of an appcoin is not without its critics, however, as the topic broaches the sensitive topic of how assets are pre-allocated by cryptocurrency projects. In the altcoin world, where the development team commonly keeps a certain share of the initial coin offering, this process is known as premining.

A contentious subject, premining of any sort has caused a number of altcoins an early demise, as investors may believe that the only purpose of premining is to enrich the original creator of an asset.

Nevertheless, Ravikant believes that when it comes to application or other sorts of technology-related development, premining shouldn’t be an issue:

“I’m not sure most users of an app would care, especially if it’s an early mine rather than pre-mine, kept small, and explicitly used to compensate the OSS developers and to pay future bug bounties / development.”

US crowdfunding concerns

Yet another unsolved concern is the fiduciary duty that crowfunders might take on when raising money with cryptocurrency in bitcoin’s biggest market to date: the US.

The state of Washington, for example, has decided to take companies to task for failing to provide a return on investment for investors who participate in crowdfunding campaigns.

That state passed a bill allowing equity crowdfunding back in March. But, it is stepping up its enforcement of crowdfunding projects that don’t provide meaningful recompense. In May, the Wasahington State Attorney General filed charges against a Kickstarter-funded game that produced no return for at least 31 Washington state-based investors.

In fact, the Washington State Department of Financial Institutions has offered up this warning in regards to crowdfunding:

“When you see an offering on the Internet — whether it is on a crowdfunding portal, in an online newsletter, on a message board or in a chat room — you should assume it is a scam until you have done your homework and proven otherwise.”

Consumer involvement in such investments is still relatively low, but already regulators are issuing warnings – another example is an SEC alert that was put out just weeks after the MaidSafeCoin fundraising.

The future for crypto-crowdfunding

Cryptocurrency crowdfunding is a way to access funding without knowing accredited investors. However, it can be argued investors in these types of projects are unable to properly evaluate the risk associated with such investments.

In crowdfunding, that sort of criticality is not necessarily present. In fact, it seems traditional crowdfunding through sites like Kickstarter attract people who are looking to devote resources towards charitable causes, not necessarily business ventures.

Source: VentureBeat
Source: VentureBeat
Dietz, Swarm’s founder, is aware of the regulatory issues that his effort presents, but he believes that with proper legal guidance, these issues can be mitigated.

He told CoinDesk:

“Because regulations and compliance is such a gray area, we are looking very exhaustively for everything we are legally allowed to do and evaluating every regulation that is brought to our attention by our legal consul.”

AngelList’s Ravikant seems fairly certain that there could be a divide in the future, with above-the-board crowdfunding sales and perhaps a ‘dark web’ of funding both proliferating. This could perhaps be done with alternative cryptocurrencies like the now-popular darkcoin or in certain localities.

Ravikant said:

“[Compliance is] a big one. This could easily be interpreted as selling securities, which might stifle innovation, drive it underground, or move it out of countries that apply securities regulations to it.”

Golden Piggybanks image via Shutterstock
http://www.coindesk.com/promise-pitfalls-crypto-crowdfunding/

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