Group 1 Crowd Fin Inclusion

WORKING PAPER
Crowdfunding and
Financial Inclusion
Ivo Jenik, Timothy Lyman, and Alessandro Nava
March 2017
TABLE OF CONTENTS
ACKNOWLEDGMENTS..................................................................................v
ACRONYMS AND INITIALISMS.....................................................................vi
EXECUTIVE SUMMARY................................................................................ vii
SECTION 1. WHAT IS CROWDFUNDING?.................................................... 1

1.1. Definition and Evolution................................................................................................. 1
1.2. Ecosystem and Categorization..................................................................................... 4
SECTION 2. MAIN CATEGORIES OF CROWDFUNDING............................... 5

2.1. Donation-Based Crowdfunding................................................................................... 5
2.1.1. Model Description and Use.......................................................................... 5
2.1.2. Benefits and Risks........................................................................................... 6
2.1.3. Regulation........................................................................................................... 7
2.2. Reward-Based Crowdfunding....................................................................................... 8
2.2.1. Model Description and Use.......................................................................... 8
2.2.2. Benefits and Risks........................................................................................... 9
2.2.3. Regulation.........................................................................................................10
2.3. Debt Crowdfunding.........................................................................................................10
2.3.1. Model Description and Use........................................................................10
2.3.2. Benefits and Risks.........................................................................................13
2.3.3. Regulation.........................................................................................................16
2.4. Equity Crowdfunding.....................................................................................................17
2.4.1. Model Description and Use........................................................................17
2.4.2. Benefits and Risks.........................................................................................18
2.4.3. Regulation.........................................................................................................20
SECTION 3. EVOLVING FRONTIERS........................................................... 21
SECTION 4. CROWDFUNDING AND FINANCIAL INCLUSION................... 24

4.1. Opportunities....................................................................................................................24
4.2. Risks and Challenges......................................................................................................26
SECTION 5. NEXT STEPS............................................................................ 29
ANNEX 1. EXAMPLES OF CROWDFUNDING PLATFORMS........................ 31
ANNEX 2. EXAMPLES OF CROWDFUNDING PLATFORMS

SERVING EMDES��35
BIBLIOGRAPHY........................................................................................... 37
iii
ACKNOWLEDGMENTS
This paper was prepared by Ivo Jenik, financial sector specialist (CGAP), and
Alessandro Nava, senior associate (the Financial Conduct Authority [FCA]), with
guidance from Timothy Lyman, lead financial sector specialist (CGAP). Peer re-
view comments were provided by Kate Lauer, senior policy consultant (CGAP);
Margaret J. Miller, lead financial sector specialist (World Bank); and Marianna Nunan,
senior publishing officer (CGAP). Invaluable insights were provided by Fod Barnes,
senior advisor (FCA) and Jason Pope, technical specialist in the Strategy & Competi-
tion Division (FCA).
The authors would like to thank the International Organization of Securities

Commissions; the World Bank Group; FSD Africa; Matthew Gamser, CEO at the SME
Finance Forum; Simon C. Bell, global lead for SME finance at the World Bank; and
others for their previous work on the topic as well as contributions to this working
paper.
The authors especially thank FCA of the United Kingdom, which supported the work
on this working paper by seconding Alessandro Nava to CGAP for six months.
v
Crowdfunding and Financial Inclusion
ACRONYMS AND INITIALISMS

ASIC Australian Securities and Investments Commission
B2P Business-to-Person
B2B Business-to-Business
BoP Base of the Pyramid
CGAP Consultative Group to Assist the Poor
EMDEs Emerging and Developing Economies
EU European Union
FCA Financial Conduct Authority (United Kingdom)
FinTech Financial Technology
FSP Financial Service Provider

GPFI Global Partnership for Financial Inclusion
IOSCO International Organization of Securities Commissions
IPO Initial Public Offering
MSME Micro, Small, Medium Enterprise/Entrepreneur
NGO Nongovernmental Organization
OECD Organization for Economic Co-operation and Development
P2P Person-to-Person/Peer-to-Peer
P2B Person-to-Business
SME Small- and Medium-Sized Enterprise
SSBs Standard-Setting Bodies
WBG World Bank Group
vi
EXECUTIVE SUMMARY
Crowdfunding has been touted as a financial innovation, a FinTech, the fastest grow-
ing financial industry, and the next big thing in finance. “Crowdfunding” typically de-
scribes a method of financing whereby small amounts of funds are raised from large
numbers of individuals or legal entities to fund businesses, specific projects, individ-
ual consumption, or other needs. It involves bypassing traditional financial interme-
diaries and using online web-based platforms to connect users of funds with retail
funders. Definitions of crowdfunding vary, but they often include the following key
components: (i) raising funds in small amounts, (ii) from many to many, (iii) using
digital technology.
The idea of matching people who need money with the people who have money to
invest is not new; what is new is the way this concept of intermediation is facilitated
(and made easier) by technology. Crowdfunding has the potential to transform retail
financial services as the use of technology, increasing connectivity through mobile
phones and other devices, the legal and regulatory framework, and constantly
changing economic conditions allow new and innovative firms to compete with
incumbents. This competition could foster economic growth and entrepreneurship,
especially in countries with less developed financial systems.
A down side of crowdfunding is that it has the potential to be harmful to customers

at the base of the pyramid. By design, a crowdfunding platform often matches
consumers (funders) with a consumer (a fundraiser). This creates a peculiar reg-
ulatory challenge that requires a framework to be in place to protect funders and
fundraisers. However, thus far, policy makers are predominantly focused on the risks
faced by the supply side (investors, lenders, and other suppliers of funds), while
neglecting the fact that the platform is often the only “professional” in the crowd-
funding transaction, where both the investor and the fundraiser are equally vulnera-
ble and inexperienced individuals or small businesses.
In this paper we argue that crowdfunding is a phenomenon that can play an im-
portant role in financial inclusion if an enabling and safe environment is in place.
Examples of how crowdfunding may potentially benefit financially excluded and un-
derserved people include improving access to finance to unserved and underserved
borrowers; creating cheaper, community-based insurance products; and facilitating
access to digital investments by people who currently have limited or no options to
get financial returns on their savings. There are many stories illustrating this po-
tential, such as the one of Lydiah from Kenya, who has been using crowdfunding
to finance her small electrical supply shop and her side business of serving M-Pesa
customers.1 Moreover, crowdfunding first emerged in developed countries, but took
off fairly recently, with some of the emerging markets and developing economies
leading the peloton.
This paper aims to map the crowdfunding phenomenon globally, explain its main
characteristics and modalities within the framework of financial inclusion, and
highlight the areas that require further attention of policy makers. It is based on
a combination of secondary, desk-based research and interviews with stakehold-
ers, including independent researchers, policy makers, regulators, supervisors,
1 See https://www.zidisha.org/loan/zidisha-loan-to-boost-my-business-capital-1.
vii
standard-setting bodies (SSBs), and development professionals. This paper is

written for a broad audience because the topic requires engagement by multiple
stakeholders, including SSBs responsible for the regulatory and supervisory issues
relevant to crowdfunding, other global bodies, and development agencies.
Section 1 of this paper defines crowdfunding, provides an overview of its evolution,

and outlines a crowdfunding ecosystem; Section 2 explains in detail four basic cat-
egories of crowdfunding (donation, reward, debt, and equity), and lists their key
benefits and risks; Section 3 focuses on modalities of the four categories of crowd-
funding (hybrid models) with specific emphasis on the most recent trends; Section 4
highlights benefits of crowdfunding for broadening and deepening financial inclu-
sion, while it also acknowledges risks and emphasizes the need for policy makers to
keep up with the industry and intervene accordingly when necessary; in conclusion,
Section 5 suggests possible directions for further research.
viii
SECTION 1. WHAT IS CROWDFUNDING?

1.1 Definition and Evolution for consumer and business lending, in-
voice trading, and third-party payment
Crowdfunding is part of the broader uni- platforms.
verse of financial innovations enabled
by technological advancements (Euro- “Crowdfunding” describes a mechanism
pean Commission 2016a) also known of sourcing capital by soliciting to a pool
as FinTech. FinTech has been changing of individuals or organizations through
the way the financial sector operates an online platform or mobile phone. The
(see Box 1). Crowdfunding is specifically idea is simple: a large number of people,
part of FinTech’s subcategory called al- through small individual contributions,
ternative finance (AltFi). AltFi refers to can raise big amounts to finance other
technology-enabled market-based fund- individuals and projects without the in-
ing outside the traditional financial sys- volvement of conventional financial in-
tem and includes online marketplaces stitutions. This is usually done through
BOX 1. Examples of the Areas Disrupted by FinTech (R)evolution
Banking and Payments. The rapid spread of digital innovations, such as Internet
banking, mobile payments, and mobile wallets, is changing traditional banking for
consumers and businesses. New start-ups promise to deliver traditional services
in a cheaper, faster, and more transparent way than traditional banks. Providers
include, for instance, Atom Bank, Mondo, TransferWise, and GoCardless.
InsureTech. As with banking, technology facilitates

access to and handling of insurance policies. Sim-
ple insurance policies (car, travel, home) can be pur-
chased and managed over a smartphone. Phones are
also used to optimize and tailor insurance products
to reflect the risk profile of an individual customer by
tracking his or her driving style, or monitoring his or
her mobile money balance. Technology has been an
important factor driving two products with impact on
customers in emerging markets and developing econ-
omies (EMDEs): (i) index crop insurance and (ii) “freemium” life insurance bundled
with mobile money products. It also helps assess property damage and moni-
tor compliance with insurance policy. Providers include, for instance, Metromile,
Oscar, Zhong An, and CoverFox.
RegTech. This term refers to the use of technology to address regulatory and
compliance challenges efficiently and effectively (see, e.g., IOSCO 2016).
RegTech is changing how companies perform identity verification (biometrics) and
know-your-customer policy, protect their clients’ data (cryptography), and settle
transactions (distributed ledgers). To keep pace with the industry, supervisors are
now more intensely exploring ways to improve their capacity by implementing
new technology solutions. Providers include, for instance, Suade, Trulioo, KYC
Exchange Net, and Vizor.
Note: The examples of providers listed in this box have been selected solely to illustrate practical use of FinTech.
1
the Internet on so-called crowdfunding from funders to fundraisers through a

platforms, where projects are presented given platform (Terry, Schwartz, and
and where each individual in the “crowd” Sun 2015).
of funders chooses which fundraiser
to finance. Definitions of crowdfund- The emergence of crowdfunding has
ing vary as demonstrated in Box 2, but its origins in “collaborative finance”2
they have the following key components and the “crowdsourcing” idea. While
in common: (i) raising funds in small crowdsourcing taps into the power of
amounts, (ii) from many to many, while the crowd to increase efficiency and
(iii) using digital technology. The key realize tasks that would be impossi-
disruptive effect of crowdfunding is that ble for a single individual to undertake
the intermediation by traditional finan- alone (Brabham 2008) (e.g., Wikipedia),
cial institutions is reduced to a mini- crowdfunding taps into the wallet
mum as funds are channeled directly of the crowd, bringing together an
BOX 2. Examples of Crowdfunding Definitions
Global Standard-Setting Bodies and Financial Inclusion the Evolving

Landscape (GPFI 2016)
“In the financial inclusion context, crowdfunding refers to a market-based financ-
ing technique where funds are raised from large numbers of individuals or legal
entities in small amounts, bypassing traditional financial intermediaries, and us-
ing mobile phones and online web-based platforms to connect with borrowers,
whether to fund a business, a specific project, or other needs.”
Crowd-funding: An Infant Industry Growing Fast (IOSCO 2014)

“Crowd-funding is an umbrella term that describes the use of small amounts of
money, obtained from a large number of individuals or organizations, to raise
funds for a project, business/personal loan or other financing needs through on-
line web-based platforms. Peer-to-peer lending is a form of crowd-funding used to
fund loans, which are paid back with interest. Equity crowd-funding is the raising
of capital through the issuance of stock to a number of individual investors using
the same method as crowd-funding.”
Crowdfunding in the EU Capital Markets Union (European Commission 2016)

“Crowdfunding refers to an open call to the public to raise funds for a specific
project. Crowdfunding platforms are websites that enable interaction between
fundraisers and the crowd. Financial pledges can be made and collected through
the platform.”
Crowdfunding’s Potential for the Developing World (World Bank 2013)

“Crowdfunding is an Internet-enabled way for businesses or other organizations to
raise money—typically from about US$1,000 to US$1 million—in the form of either
donations or investments from multiple individuals.”
2 The development of collaborative finance was made possible through digital networking and communication infrastruc-
tures that provided a platform for instantaneous communication and cooperation. This new form of finance is character-
ized by highly personalized loan transactions, providing much more flexibility for borrowers in terms of loan purpose,
interest rates, collateral requirements, maturity periods, and debt rescheduling. See, e.g., https://en.wikipedia.org/wiki/
Collaborative_finance.
2
individual or entity in need of funding to credit, especially for smaller

with community members willing to loans because of cost efficiency
contribute. concerns and for loans to clients
who do not have sufficient collat-
Crowdfunding that targets a mass mar- eral because of prudential consid-
ket started in the United Kingdom in erations. This has created a new
2006, followed by the United States demand for capital (fundraisers).
in 2007, and (after the 2008 financial On the supply side (funders),
crisis) other markets, including in EM- the protracted low-interest rate
DEs (Kirby and Worner 2014). The environment, which diminished the
global financial crisis meant a big push returns on traditional saving prod-
for the crowdfunding industry because ucts, has driven a “search for yield”
it caused a fall in confidence in the fi- (BIS 2012) and pushed funders and
nancial system, especially in the bank- retail savers to alternative forms of
ing sector. Since then, crowdfunding income generation.
has grown rapidly in markets across the
income spectrum, with high demand at ■■ Regulatory factors. Crowdfunding
both ends of the transaction. The fast platforms have been benefitting from
growth of crowdfunding is driven by the regulatory changes that took
technological, as well as macroeconomic place after the crisis (Terry, Schwartz,
and regulatory, factors: and Sun 2015). The more strin-
gent regulatory requirements signi
■■ Technological factors. Improved ficantly increased banking costs of
access to the Internet via mo- competing in certain markets. Be-
bile phones and other devices, cause crowdfunding is just starting
user-generated web content, boom to be regulated across the globe,
of online applications, increasing use many jurisdictions do not impose
of social networks, “Big Data” ana- stringent regulations on crowd-
lytics,3 and the FinTech revolution funding just yet (IOSCO 2015a). This
made crowdfunding viable by reduc- approach gives the crowdfunding
ing operational costs and increasing industry advantage over its compet-
the potential reach of crowdfund- itors, particularly incumbent finan-
ing platforms (Terry, Schwartz, and cial service providers. The question
Sun 2015). as to whether this amounts to the
level of regulatory arbitrage remains
■■ Macroeconomic environment. The to be answered.4
financial crisis and the subsequent
credit crunch presented a major Since its infancy, the crowdfunding
challenge for the financial system industry has grown tremendously
(Terry, Schwartz, and Sun 2015). around the world. The volume of funds
Banks and other financial inter- raised grew from US$1.5 billion in
mediaries have tightened access 2011 to over US$100 billion in 2015
3 “Big Data” has been defined in various ways. Many tend to highlight the following definitional features: (i) high-volume data,
(ii) produced, collected, and processed with high speed, (iii) variety information assets, and (iv) technology-based process-
ing of data in a meaningful way to enhance insights and decision-making. Examples of Big Data being used in a financial
services context include Ant Financial (the Alibaba financial services arm), M-Shwari, Cignifi, and Lenddo. See, e.g., Gartner
IT Glossary (http://www.gartner.com/it-glossary/big-data).
4 “This development [in the crowdfunding industry] leads to questions over the extent to which loan-based crowdfunding
platforms allow for regulatory arbitrage with banking business, without being subject to the same consumer protection
requirements, or whether the way they describe their business models or the products on offer could be misleading to
consumers” (FCA 2016, p. 14).
3
FIGURE 1. Crowdfunding around the World
worldwide (see, e.g., Massolution 2015 supply. The demand side consists of peo-
and Zhang et al. 2016a). Regardless of ple and entities seeking funds. Depend-
recent signs of a slowdown (European ing on the specific model, we talk about
Commission 2016a), the crowdfund- beneficiaries (donations, reward-based
ing industry keeps growing fast—the crowdfunding), borrowers (debt), or is-
fastest in Asia, with 210 percent year- suers (equity), who can range from in-
on-year growth (Massolution 2015), dividuals to micro, small, and medium
driven by countries such as China enterprises (MSMEs), nongovernmental
(estimated between US$60 billion and organizations (NGOs), nonprofit entities
US$100 billion), India (US$27.8 million), (e.g., charities), start-ups, and financial
the Philippines (US$26.9 million), and businesses. The supply side consists of
Nepal (US$25.5 million) (Allied Crowds donors (donation), backers (reward),
2016). In Africa, crowdfunding plat- lenders (debt), and investors (debt, eq-
forms raised US$37.2 million in 2015 in uity). Funders range from private indi-
Kenya, Rwanda, Tanzania, and Uganda viduals, to angel investors and venture
(Allied Crowds 2016b). Figure 1 shows capitalists, businesses, and large finan-
a global picture that combines numbers cial institutions. In this paper we refer
from various reports. to the supply side as “funders” and to
the demand side as “fundraisers,” unless
1.2. Ecosystem and Categorization otherwise specified. Besides the plat-
form, the fundraisers, and the “crowd”
A crowdfunding ecosystem can be com- of funders, other entities are neces-
plex and may vary substantially from sary for the crowdfunding ecosystem
model to model. The central point of to work (enablers), including payment
every crowdfunding ecosystem is a systems and payment service provid-
platform—a technologically enabled ers, technology infrastructure, and data
solution used to match demand with analytics.
4
SECTION 2. MAIN CATEGORIES OF CROWDFUNDING

The most common classification of donation and reward-based crowdfund-
crowdfunding features four main ing. While these two categories were
categories—donation, reward, debt, and crucial for the overall emergence and de-
equity (Kirby and Worner 2014). These velopment of the industry, and in some
categories are based on what funders ex- instances may even create a gateway for
pect in return for their money (and their users (funders or fundraisers) into more
primary motivation to invest). While complex forms of crowdfunding, they
this basic, supply-side-oriented cate- typically are not considered financial
gorization allows us to explain the key activities and are less important to the
variations of crowdfunding, it may not overall focus of this paper. Excluded and
be fit-for-purpose as a means of under- underserved people may benefit from
standing the financial inclusion issues of donations made over the platform that
crowdfunding at the base of the pyramid facilitate mobility of funds among com-
(BoP), where a categorization based on munities and beyond, but those cate-
customer use cases (e.g., crowdfunded gories of crowdfunding are likely to be
credit, crowdfunded insurance) might less scalable and sustainable in the long
be at least as important to the risk pic- term to meet the ultimate objective of fi-
ture for the platform as a whole as are nancial inclusion and poverty elevation.
expectations of suppliers of funds. It would be a mistake to exclude the two
categories or to put too much emphasis
This section is further divided into four on them.
subsections, each dedicated to an individ-
ual category of crowdfunding, that are pre- 2.1. Donation-Based Crowdfunding
sented in terms of (i) model description
and use, (ii) key benefits and risks, and 2.1.1. Model Description and Use
(iii) regulatory approaches. Annex 1 pro-
vides practical examples of each model that Donations-based crowdfunding allows
illustrate how the model operates. The key individuals (donors) to send money to
benefits and risks presented in this section people (or projects) in need (beneficia-
can be connected to the innovative aspects ries), with no financial (return) consid-
of crowdfunding platforms, particular seg- eration in exchange for their money. This
ments of funders and fundraisers attracted form of crowdfunding is used primarily
by crowdfunding, regulatory framework, in the nonprofit sector to support vari-
and/or a mix of several factors. ous causes (social, environmental, po-
litical, charitable). The platform derives
This section follows the chronologi- its revenue stream primarily from fees
cal order in which the categories have collected from each donation (typically
emerged. Therefore, it starts with 5 percent or more, see Box 3).
BOX 3. Example of Charges
“All donations go through the GlobalGiving Foundation, a registered 501(c)3

nonprofit organization. There are no costs for nonprofits to join GlobalGiving, but
GlobalGiving retains a 15% fee on donations. When a donor makes a $100 do-
nation, $85 goes to the project(s) of his/her choosing, and $10 goes to fund the
many programs and services we offer nonprofits. Then $3 goes to cover standard
credit card or transaction fees, and the remaining $2 goes to administrative costs
of running GlobalGiving” (www.globalgiving.org/aboutus/).
5
There are two common subcatego- 2.1.2. Benefits and Risks5

ries of donation-based crowdfunding:
(i) personal campaigns and (ii) charity A. Benefits
fundraising (Vargas, Dasari, and Vargas The nonprofit character of donation-
2014). Personal campaigns typically based crowdfunding limits the key
involve an individual beneficiary, a benefits donors enjoy to nonmonetary
household, or a small community raising values:
money for a cause of its own interest.
Typical examples include campaigns to ■■ Community participation and a
fund medical treatment, education, or feeling of glow. Besides “good vi-
personal hobbies. Charity fundraising brations,” a big attraction of donating
involves a registered charity. Both per- money to a crowdfunding campaign
sonal campaigns and charity fundraising lies in the opportunity for donors to
can be promoted as either all-or-nothing stay closely in touch with the projects
or keep-what-you-raise campaigns. In they support. Platforms (and benefi-
case of the former, the beneficiary re- ciaries) often allow donors to see how
ceives the collected funds only if the ini- their money is being spent, thus pro-
tial threshold has been met. In case of viding a unique level of transparency.
the latter, the beneficiary can keep the
funds even if below the threshold. ■■ Voting with money. By supporting a
certain project, cause, or individual,
The largest market for donation-based donors are effectively using their
crowdfunding is in North America, money to voice their own views,
with $210.38 million funded in preferences, and support.
2015. For the whole American con- ■■ Formalization of support. Donors
tinent, the volume generated from who contribute to the campaigns of
donation-based crowdfunding increased their relatives and friends may find it
from US$151.09 million in 2014 to beneficial to use the platform to for-
US$215.56 million in 2015 (Latin Amer- malize their contribution (e.g., for tax
ica accounted for US$5.18 million). purposes). This can bring the addition-
This represents a yearly growth rate of al benefit of discouraging excessive
43 percent (Wardrop et al. 2016). In the risk-taking, because project failure
Asia-Pacific region (excluding China), may also negatively impact the social
donation-based crowdfunding raised relationship (Lee and Persson 2012).
almost US$25 million in 2015, up from
US$12 million in 2014 and US$6.3 million For beneficiaries, the key benefit is ac-
in 2013. In China, donation crowdfund- cess to cheaper funds regardless of geo-
ing raised US$141.69 million in 2015 graphical barriers. Beneficiaries can
(Zhang et al. 2016). In Europe (excluding leverage social networks to raise funds
the United Kingdom), donation-based in an efficient and cheap way (liquidity
crowdfunding has been growing steadi- farming) (Mas and Gitau 2014). Using
ly, raising €19.91 million (approximate- social networks helps to give visibili-
ly US$22 million) in 2014 (Wardrop ty to the campaign and reach individu-
et al. 2015). In the United Kingdom als outside the beneficiary’s immediate
alone, it raised £12 million (approxi- social circle. Beneficiaries also benefit
mately US$15 million) in 2015 (Zhang from additional services provided by
et al. 2016b). platforms, including the formalization
5 Most risks and benefits in donation-based crowdfunding apply to other categories of crowdfunding as well.
6
of donations, basic accounting, advice, any transaction; this creates currency

education and training, and marketing. exchange risk on the beneficiary’s (and
to a lesser extent donor’s) side. Dona-
B. Risks tions received are subject to taxes, fur-
ther diminishing the total amount. Some
The most obvious risk donors face is pledged money might not be collected
fraud, either in the form of fake cam- because of other reasons, such as ex-
paigns or cyber-attack. The risk of fake pired credit card or incorrect payment
campaigns is particularly relevant when information, insufficient funds, or death
a campaign is not run by an institution, of the donor. The higher the number of
such as a charity, that is often registered donors, the greater the variety of risks
in a public register and subject to some and the higher likelihood of the risks ma-
minimum requirements (e.g., financial terializing. Thus the beneficiary may not
statements disclosure). Individual-run be able to collect all the money initially
campaigns can be created for any law- expected, or may collect the funds later
ful purpose, including for purely selfish than initially planned.
reasons initially not disclosed to donors.
When the platform does not guarantee Donors and beneficiaries may be affect-
enough transparency, donors may not ed by issues faced by the platform. Be-
be able to check whether or not their sides cyber-attack, other risks concern
donations were used for the intended failure of the platform’s technology or
purpose. closure of the platform potentially re-
sulting in the loss of data as well as funds.
Risks that beneficiaries face have to do Another common risk has to do with the
with the cost of the campaign. As men- international character of most transac-
tioned earlier, platforms typically charge tions. This has implications in many ar-
fees. In addition, beneficiaries need to eas, including intellectual property law,
spend extra money to design and run the tax law, and contractual law.
campaign, administer donations (often
in small increments), and manage rela- Crowdfunding platforms may be abused
tionships with donors (e.g., send regular for money laundering and terrorist fi-
updates on how the donations have been nancing purposes, particularly where
spent). Academic research has shown platforms escape the regulatory frame-
that while donations are positively cor- work for anti-money laundering and
related to charity efficiency (and argu- counter terrorist financing due to a gap
ably the size and brand of the charity) in their regulation and oversight.
because donors value the importance
and likelihood of “having an impact”; 2.1.3. Regulation
they are negatively correlated with high
competition (the more similar projects Given the nature of the activity,
are, the less probability of raising funds) donation-based crowdfunding per se
(Meer 2013). This means that, for some is typically not regulated. The platform
types of campaigns, crowdfunding is not provides administrative services to fa-
an optimal solution. cilitate transactions between donors
and beneficiaries, and it is not subject to
Fees and the cost of the campaign licensing or any ongoing regulatory re-
are only some of the reasons the final quirements, unless it provides additional
amount disbursed to the beneficia- services that are regulated (e.g., payment
ry may be diminished. International services). General laws and regulations
crowdfunding platforms offer only ma- would apply to parties transacting over
jor global currencies as a default for the platform, typically (i) contract law/a
7
civil code, (ii) tax law, (iii) a law regu- campaign, entrepreneurs raise aware-
lating charities and public fundraising, ness about new projects and products,
(iv) consumer protection law, (v) data and receive feedback from potential
protection law, and (vi) criminal law customers. For instance, a start-up may
(fraud, cyber-attack). test interest in an innovative idea6 or an
established company may test potential
uptake of a new product.7
2.2. Reward-Based Crowdfunding
The Asia-Pacific region is leading in
2.2.1. Model Description and Use reward-based crowdfunding numbers.
Reward-based crowdfunding allows Excluding China, the total reward-based
funders (donors) to contribute to crowdfunding volume within the
campaigns in exchange for a nonfinan- Asia-Pacific region in 2015 was more
cial reward. Rewards often take the form than US$81 million, almost double the
of tokens of appreciation (artist’s auto- US$41.7 million raised in 2014. In China,
graph, mentioning the donor’s name in the earliest reward crowdfunding plat-
the credits, T-shirt) or the prepurchas- forms were start-ups, but a number of
ing of a product or service (the actual China’s largest e-commerce companies
invention) according to the contributed have launched reward-based crowdfund-
amount. Reward-based crowdfunding ing platforms since 2013. It is estimated
shares many commonalities with dona- that it raised US$829.52 million in 2015
tion-based crowdfunding, and sometimes (Zhang et al. 2016a). In the Americas,
is included in the same category (Vargas, the market volume of US$658.37 million
Dasari, and Vargas 2014). In addition to was generated in 2015, up 22 percent
the key motivations described for dona- from 2014’s US$513.96 million. This
tion-based crowdfunding, donors expect model accounted for 2 percent of the
a more tangible outcome of their invest- total market in 2015. North America ac-
ment. Revenues for a platform come counted for US$645.70 million (Wardrop
from the fees deduced from each contri- et al. 2016). Reward-based crowd fund-
bution (see Box 4). There are two main ing is the second largest sector within
common subcategories of reward-based the European online alternative finance
crowdfunding: (i) all-or-nothing and (ii) market (excluding the United Kingdom)
keep-what-you-raise. with €120.33 million (approximately
US$130 million) raised in 2014 (com-
This category of crowdfunding is pared with €63.18 million in 2013).
primarily used to fund art (movies, In the United Kingdom, £42 million
music) and for the development of (approximately US$55 million) was fa-
new products and innovations. In ad- cilitated through reward-based crowd-
dition to financing, crowdfunding can funding platforms in 2015 (Wardrop
serve marketing purposes: through the et al. 2015).
BOX 4. Example of Charges
“Fees are only charged on successfully funded projects. We charge 5%, in addition
to any fees from our payments partners” (www.kickstarter.com/terms-of-use?ref=
footer/).
6 See, e.g., www.kickstarter.com/projects/1523379957/oculus-rift-step-into-the-game.

7 See, e.g., https://www.kickstarter.com/projects/1016374822/risky-adventure.
8
2.2.2. Benefits and Risks to trade in traditional markets (e.g.,

nonpecuniary rewards, such as
A. Benefits recognition).
The benefits for donors largely over- ■■ Technological innovations—including
lap with the benefits mentioned for streamlined online procedure to set
donation-based crowdfunding with up a campaign, social media mar-
some additional points to mention: keting, increased transparency and
■■ Pioneer status. For many donors, competition.
investing on a crowdfunding plat-
Entrepreneurs may also seek nonmone-
form is an inherently social activity,
tary benefits such as customer feedback.
and part of the reason for the in-
Crowdfunding campaigns may serve as
vestment is to obtain preferential
a particularly informative type of mar-
access to the inventor (e.g., for up-
ket research, provide feedback on the
dates, direct communication) and
project, and predict potential demand
the invention (early-adopter status)
for the product or service concerned.
(Schweinbacher and Larralde 2010).
In addition, crowdfunding was found
■■ Crowd due diligence. Typically, to “democratize” finance and alleviate
“crowdsourcing” of experience and some of the geographic and gender
variety of perspectives due to higher biases associated with traditional ven-
numbers of funders who review any ture capital financing (Agrawal, Catalini,
given campaign can improve the and Goldfarb 2011).
collective ability of funders to spot
and assess risks. In fact, academic B. Risks
studies compared the decisions of
In addition to the risks described for do-
venture capitalists to funders and
nation-based crowdfunding, donors face
found that both groups assess en-
the following risks (which often have to
trepreneurial quality in similar ways
do with funding start-ups):
(Mollick 2013).8
■■ Incompetence. Donors and benefi-
Reward-based crowdfunding enables
ciaries may be initially over-optimistic
beneficiaries to access capital at a lower
about outcomes. Entrepreneurs may
cost compared to traditional sources for
have little experience in building a
three reasons (Agrawal, Catalini, and
product and dealing with logistics and
Goldfarb 2013):
suppliers, which may lead to delays
■■ Better outreach and targeting— or subquality products. For instance,
donors are not constrained by their in the technology and design catego-
geographical location, and cam- ries on Kickstarter, estimates suggest
paigns can have global reach, thus that more than 50 percent of products
targeting interested crowds with no are delivered late (Mollick 2013) and
or limited geographical barriers. 9 percent are not delivered at all.9 Even
when a reward is delivered, it may
■■ Monetization of assets—beneficiaries not have the promised (or expected)
can leverage assets that are difficult quality.
8 Similar findings are echoed by another study of artistic projects, where the investor decisions were compared to “expert”
evaluators of art quality. The authors found no differences between projects selected by the crowd and those selected with
involvement of experts. See Mollick (2015), pp. 1533–53.
9 www.kickstarter.com/fulfillment
9
■■ Lack of due diligence. Relying on 2.2.3 Regulation

“the wisdom of the crowd”10 may
discourage donors from proper due Similar to donation-based crowdfund-
diligence. In the short-term perspec- ing, reward-based crowdfunding is not
tive, this appears to be a rational de- subject to any particular regulatory re-
cision, because they typically have gime comparable to other financial in-
a much smaller stake and therefore termediaries. Crowdfunding platforms
less incentive to spend time and act as matchmakers that enable bene-
money investigating creators. In the ficiaries to enter into agreements with
long term, however, wisdom of the multiple donors, but bear limited liabil-
crowd may get corrupted (also due to ity in case of violation of the contract by
the adverse selection and free-rider either party. At its best, the key obliga-
problem). tion of the beneficiary is to spend the
donated money on a (often vaguely) de-
Beneficiaries face the risk of high oppor- fined purpose and deliver the promised
tunity costs because running a successful reward within a (often vaguely) defined
crowdfunding campaign requires many time frame. Should either of the parties
elements and resources. In addition, ben- fail to perform, the platform would likely
eficiaries face risks, such as the following: offer some assistance to mediate the dis-
pute, but ultimately it would be up to the
■■ Compromised intellectual pro aggrieved party to enforce compliance
perty rights. Beneficiaries disclose before a court of law.
their plans and innovations in a pub-
lic forum. This can create a risk of Despite recent lawsuits, case law is lack-
imitation and unfair competition and ing (Grella 2015), and there are reasons
have repercussions on intellectual why donors may hesitate to sue a bene-
property protection as illustrated ficiary. The monetary value concerned is
by the following quote from the often too small and, unless class action is
terms of use of one of the largest available, the aggrieved donors may find
reward-based platforms: “[w]hen it too costly to sue. Some rewards may be
you [. . .] launch a project, you [. . .] difficult to obtain, even with assistance
grant to us, and others acting on our of courts, and instead another form of
behalf, the worldwide, non-exclusive, compensation would need to be sought.
perpetual, irrevocable, royalty-free, The international nature of transactions,
sub-licensable, transferable right where different legal regimes may apply
to use, exercise, commercialize, regardless of a (common) arbitration
and exploit the copyright, publicity, clause used by platforms, can also be a
trademark, and database rights with big hurdle.
respect to your [c]ontent.”
2.3. Debt Crowdfunding
■■ Crowding out professional inves
tors. Angel investors and venture 2.3.1. Model Description and Use
capitalists, who often bring additional
value to the company, such as industry Debt crowdfunding allows funders (lend-
knowledge, professional networks, ers) to directly lend to fundraisers or invest
and status, may be crowded out by in debt obligations issued through a plat-
nonprofessional donors. form. Debt crowdfunding is also known
10 The term “wisdom of the crowd” has been used in a study focused on accuracy of the collective decision-making process.
See Surowiecki (2004).
10
as lending-based crowdfunding, market- loans. There are different subcategories

place lending, or person-to-person (P2P) of debt crowdfunding distinguished by
lending—terms that are not as broad as who the funders and fundraisers are:
debt crowdfunding. Debt crowdfunding
is best thought of as a new approach to ■■ P2P lending where individual
lending rather than a completely new funders lend to individual fund-
financial product. By leveraging the In- raisers and entrepreneurs. In many
ternet’s interconnectivity, this form of cases, the loan is unsecured. Based
crowdfunding builds a direct relationship on the information disclosed by the
between the funder and the fundraiser. fundraiser, funders decide to cov-
er all or a certain amount of the re-
Based on the key objective promoted quested loan sum (Savarese 2015).
by the platform, we can distinguish If the campaign is successful, the
(i) nonprofit lending, (ii) socially loan is disbursed to the fundraiser,
oriented lending, and (iii) commercial and later repaid with interest to the
lending. Funders on nonprofit platforms funder(s). To mitigate the default
actively seek to reach communities with risk, some P2P platforms pool, slice,
limited access to formal lenders with- and sell packaged loans correspond-
out expectations of a financial return. ing to the risk appetite indicated by
Many of these platforms rely on volun- the funder.
teer work, donations, and/or grants to
operate. The most prominent example ■■ Peer-to-business (P2B) lending
is Kiva,11 which lends money collected where individual funders lend to
from lenders leveraging local microfi- SMEs. The loans are not secured.
nance infrastructures in the hardest to Speed, flexibility, and cost (Savarese
reach places. Zidisha, another example 2015) make P2B lending a viable
of nonprofit lending, describes itself as business funding alternative13 that is
the first direct philanthropic microlend- attractive mostly for start-ups, small
ing community.12 Socially oriented lend- enterprises with growth potential,
ing is driven by the opportunity to earn and medium-sized enterprises with
profits and support specific communi- specific plans for diversification and
ties or geographic regions. For instance, expansion to new markets.
MYC4 enables funders to lend money to
SMEs in developing countries in Africa ■■ Business-to-business (B2B) lend
for a small yield. Platforms for commer- ing where the funder is made up of
cial lending usually do not target specif- different businesses—often very
ic groups of fundraisers or social causes. small companies—that want to
Examples of these include CreditEase in lend money for good rates of return.
China, RainFin in South Africa, Crowdo Lending to businesses (both P2B and
in Malaysia, Zopa in the United Kingdom, B2B) may also involve funding of
and LendingClub in the United States. pooled investment vehicles instead
of individual businesses. We can
Debt crowdfunding is used to raise funds also argue that there is a business-
for all sorts of purposes ranging from to-peer subcategory where large
individual consumption to business institutional funders provide funds
11 www.kiva.org/about/where-kiva-works
12 www.zidisha.org/why-zidisha
13 For instance in the United Kingdom there is a product called “mini-bonds.” Similar to traditional bonds, mini-bonds allow
issuing companies to crowdfund unsecured debt at competitive rates; however, the regulatory requirements are much less
stringent for mini-bonds than for regular bonds (see, e.g., https://www.syndicateroom.com/crowd-investing/mini-bonds).
11
to lend to individual fundraisers as lenders increasingly rely on a range of

described in the following. capital sources, including credit facilities,
whole loan sales, and securitizations to
Debt crowdfunding platforms are di- fund origination.
verse in their operational models, which
largely depend on the legal and regulatory In the notary model, loans are originated
framework. Based on categorization in- by a partner bank and distributed
troduced by IOSCO and other researchers through the platform. This model reflects
(Kirby and Worner 2014), there are five the regulatory requirement that lenders
major operational models of debt crowd- need to be authorized (e.g., hold a li-
funding: (i) client-segregated account, cense). The loans issued by the partner
(ii) balance sheet lending, (iii) notary, bank are held on its balance sheet for one
(iv) “guaranteed” return, and (v) offline. to two days before they are purchased
and resold by the platform to the crowd
In the client-segregated account model, (funders) in the form of notes (which, in
an individual funder is matched to an many jurisdictions, are regulated as se-
individual fundraiser through the plat- curities). Funders receive repayments
form, and a contract is set up between directly linked to the performance of the
them. The platform is not a contractual underlying loan proportional to their ini-
party to the loan agreement between the tial investment (Figure 3). This shifts the
funder and the fundraiser, and all funds risk of default to the crowd away from
from the funder and the fundraiser are both the issuing bank and the platform.
separated from the platform’s balance
sheet through a legally segregated ac- The “guaranteed” return model and off
count (Figure 2). The platform derives its line model are both related (although
revenues and covers expenses, including not exclusively) to the Chinese crowd-
debt collection and fundraiser screen- funding market. In the guaranteed
ing, from fees and other costs charged model, the platform guarantees a cer-
to either or both the fundraiser (e.g., an tain return agreed on with the funder.
origination fee, administration fee) and A third-party provider, who effectively
the funder (e.g., an administration fee). insures the investment, guarantees the
return. This model may resemble the
In the balance sheet lending model, the model in which the platform creates
platform lends directly to fundraisers and a provision fund from which nonper-
holds the loan on its balance sheet. Plat- forming loans are covered. However, in
forms generate their revenue through that case, the provision fund is funded
interest rate spread (the difference be- from mandatory contributions charged
tween the platform cost of borrowing to fundraisers (or funders). Until its
and the interest rate it charges to fund- recent ban, guaranteed return model
raisers). The platform also charges addi- was prevalent in China. Also operating
tional fees as in other models, including in China was the “offline” model, where
fees for servicing loans sold to the crowd. fundraisers were typically recruited
As the industry evolves, balance sheet
FIGURE 3. Notary Model
FIGURE 2. Segregated Account Model
Plaorm Plaorm
Account
12
offline through direct channels and offers more tangible benefits to funders
in-person sales techniques, including (investors):
the process of creditworthiness assess-
ment. Once the loan was funded and
■■ Access to a new asset class. Kirby
disbursed, the platform collected repay- and Worner (2014, p. 21) argue
ments in person on behalf of funders that “[p]eer-to-peer lending plat-
(Aveni et al. 2015). forms have in effect provided in-
vestors with a brand new asset in
Debt dominates crowdfunding markets the form of un-collateralised debt.”
around the world, with the Asia-Pacific They further argue that this may al-
region ranking at the top. In China, P2P low for better portfolio diversifica-
lending is the largest category of Inter- tion, ultimately leading to reduced
net finance, with reported market vol- systemic risk as funders invest
ume of US$52.44 billion in 2015 (Zhang small amounts in diversified assets
et al. 2016a) compared to US$36.16 instead of over-relying on a single
billion in North America (Wardrop et asset. Whether or not crowdfunded
al. 2016). In Latin America and the Ca- loans would be treated as a new as-
ribbean, between 2013 and 2015, P2P set class ultimately depends on the
platforms raised US$19.43 million in relevant regulatory regime. Regard-
2015 (Wardrop et al. 2016). In Eu- less, debt crowdfunding widens
rope, debt crowdfunding is estimated access to an investment class not
to have raised €3.21 billion (approxi- easily available to retail investors in
mately US$3.60 billion) in 2015 (Euro- the past. Putting aside institutional
pean Commission 2016a). P2P lending investors and professional lenders,
reached £909 million (approximately some of the funders lending money
US$1.2 billion) in the United Kingdom over the platform to individuals,
alone in 2015, compared with £547 mil- MSMEs did not previously have
lion (approximately US$700 million) in this option and would instead place
2014 (Zhang et al. 2016b). their savings in savings accounts, in
collective investment schemes, or
2.3.2. Benefits and Risks the like (although the risk inherent
in such savings/investment prod-
A. Benefits ucts is likely to be different from
that of investment in crowdfunded
The major benefits of debt crowdfund- assets).
ing are convenience, efficiencies, and
potential to improve access to credit ■■ Higher financial return. Crowd-
by excluded and underserved groups. funding offers a thigher return for
Application for a loan typically takes funders than savings (corresponding
only a couple of minutes, can be done to a higher risk). This is particular-
from a distant location, does not require ly important in the current low-in-
credit history, and may concern per- terest environment where many
sonal loans and business-development investors and savers search for yield.
loans. The same convenience benefits In particular, crowdfunding can help
funders. In addition, debt crowdfunding satisfy a demand from funders who
preserves the advantages described for want the higher average return and
the previous two categories of crowd- are prepared to accept the high
funding (donation and reward-based), volatility of that return and/or low-
including community participation and er levels of consumer protection
philanthropy, formalization of contracts, and funders who are willing to com-
and wisdom of the crowd. In addition, it promise on services traditionally
13
offered by intermediaries, such as ■■ Provides convenience. As men-

banks, to increase their average tioned, online platforms are acces-
(gross) return. sible to a fundraiser 24/7 from the
comfort of his or her home. Technol-
For fundraisers, the key advantag- ogy allows for less documentation,
es overlap with donation and reward making application and disburse-
crowdfunding; the most important one ment processes quicker.
being improved access to finance. In
particular, debt crowdfunding may offer B. Risks
the following benefits:
In addition to common dangers associ-
■■ Enables access to capital at a lower ated with crowdfunding and investment
cost than traditional sources. On- products, there are risks specific to debt
line platforms, unlike banks, have crowdfunding. The risks simultaneously
little need for a physical presence. affect funders and fundraisers, raising
This, coupled with the use of in- consumer protection concerns for both
novative algorithms to determine sides of the crowdfunding transaction,
the creditworthiness of applicants, because the platform is often the only
streamlined application and approval professional involved.
processes, and specialization in a
limited number of products and ser- Funders face many risks, and to a large
vices allow platforms to operate with extent, these risks stem from the very
a relatively low infrastructure cost, nature of the underlying asset—the
which reduces the cost of the loan to unsecured loan:14
the fundraiser, although this may not
necessarily be true for all platforms. ■■ Risk of financial loss. Funders may
Platforms may also create incentives lose their money if the fundraiser
for traditional financial institutions defaults. The risk of default is higher
to innovate (European Commission due to the nature of unsecured loans
2016a). to individual consumers, SMEs, and
start-ups. Regulatory safeguards,
■■ Fills a gap left by banks. The tighter such as deposit insurance or in-
restrictions on traditional lenders vestor protection schemes, do not
introduced post-crisis have reduced protect these investments (Euro-
their appetite for lending (see, e.g., pean Commission 2016a). In ad-
IMF 2016), particularly to the least dition, credit assessment methods
profitable and the riskiest segments, used by platforms are largely new
including uncollateralized personal and untested through the credit
loans or SME loans (see, e.g., EBA cycle.15 To mitigate this risk, some
2016, OECD 2014, OECD 2009). platforms have established a pro-
Particularly in some markets, crowd- vision fund (a contingency/reserve
funding has stepped in as an alterna- fund) or introduced third-party
tive to traditional lending. guarantees.
14 Some platforms require or allow borrowers to provide collateral (see, e.g., www.crowdo.com, where borrowers often offer
jewelry or gold as collateral).
15 Debt crowdfunding has grown mainly during a period of relatively stable economic recovery, but the platforms that experi-
enced the global financial crisis saw greater loan losses. For instance, Zopa claims to have one of the best loan performances
among all P2P lenders with post-crisis (since 2010) bad debt at only 0.25 percent (see www.zopa.com/lending/risk-
management); however, Zopa’s default rate in 2008 was 4.33 percent (see www.zopa.com/lending/risk-data). For Prosper,
currently the second biggest P2P platform in the United States, the 2008–2010 loan portfolio in 1–14 day arrears was
nearly 30 percent, according to Lendstats (see lendstats.com/wordpress/?p=218).
14
■■ Lack of transparency. When dis- focus on volume, rather than on the

closure is not standardized across quality of loans.
the market and emphasizes benefits
rather than risks, funders may not be
■■ Costs. Crowdfunding can be more
in a position to make informed deci- difficult and costly than most
sions (EBA 2015). Moreover, funders fundraisers anticipate. Running a
may wrongly assume that offerings successful campaign requires signif-
are endorsed by the platform or are icant human and financial resources.
subject to an approved credit scoring Fundraisers should also consider op-
methodology. portunity costs when other sources
of financing may be available. In ad-
■■ Illiquidity. Investment in a crowd- dition, and specifically with regard to
funded loan is locked until the loan entrepreneurs, crowdfunding works
matures. Funders are paid back in well for a one-off injection of capital,
regular installments or as a lump not necessarily for longer-term or
sum. They cannot withdraw the in- ongoing support.
vested amount, unless the platform
allows funders to do so (typical-
■■ Weak protection. Safeguards com-
ly for a fee). A platform that offers mon to consumer loans (standard-
early withdrawals (and thus effec- ized disclosure, a cooling-off period,
tively engages in maturity transfor- the early repayment right, the right
mation) can pay funders either to access an effective complaints
from its own balance sheet, build a handling process, ban on unfair col-
liquidity-improvement fund, or use lection practices)16 may not neces-
money from other funders. sarily apply to debt crowdfunding
(see Section 2.3.3).
Risks faced by fundraisers often re-
late to the key benefits mentioned, There are also more general risks asso-
most importantly the convenience and ciated with platforms and the way they
the ease of credit access. These risks operate. As mentioned for the other
should not be underestimated given that categories of crowdfunding, there is a
over-indebtedness, one of the key risks, risk of failure of the platform’s technol-
has become a serious economic, social, ogy or closure of the platform, which
and political issue in many countries. may lead to loss of data and funds.
Key risks include the following: Platforms that hold the loans on their
balance sheets are exposed to a high-
■■ Mis-selling and over-indebted er risk of failure should the underly-
ness. In many jurisdictions, plat- ing loans prove to be of bad quality
forms are not obligated to assess or funders’ appetite for buying drop.
whether the fundraiser can afford Even failure of a platform that only in-
the loan. To the contrary, platforms termediates contracts between the
have incentives to make loan appli- funder and the fundraiser may have
cation as easy as possible because significant impact on them. Although
they derive their income from origi- the funder-fundraiser contract would
nation fees, which are not contingent naturally outlive the failure, it might be
on successful repayment. In other difficult to restore information about
words, platforms face a conflict of the disbursed amounts, repayments,
interest because their incentive is to interest rates, etc.
16 See, e.g., OECD/G20 (2011).
15
Platforms have limited access to credit specifically prohibited (until recent-

history in many jurisdictions and need ly, this was the case in Israel and
to rely on innovative, yet unproven, al- Japan).
ternative ways of credit scoring (Miller
and Jenik 2016). As long as access to ■■ Regulated as an intermediary.
bank-generated data on credit and credit Crowdfunding platforms are clas-
bureaus is limited to the banking sector, sified as intermediaries or brokers,
crowdfunding platforms have no option and are required to register or even
but to rely on alternative credit scoring to obtain a license. Obligations and
methods. This may lead to inaccurate requirements for intermediaries
assessment of the default risk, but also vary by jurisdiction. Generally, there
to discrimination where a bias is em- are rules regulating access to the
bedded in the underlying algorithm. market (regulation/licensing) and
Access to credit history is now available conduct of business. In the United
to crowdfunding platforms in the United States, at the federal level, each plat-
States and China, for instance, with more form is required to be registered
countries likely to follow. with the Securities and Exchange
Commission (SEC) and is treated as a
2.3.3. Regulation public company that has to fully dis-
close its finances, loan origination,
Approaches to regulation of debt crowd- and practices. In addition, each state
funding vary by business model and ju- has its own regulations.
risdiction. The great variety of business
models, together with dynamic evolu- ■■ Regulated as banking. Crowd-
tion of the industry, makes the develop- funding platforms are classified and
ment of a single regulatory regime for regulated as banks because of their
debt crowdfunding difficult. IOSCO has credit intermediation function; all
identified the following regulatory ap- platforms must obtain a banking
proaches (Kirby and Worner 2014): license and meet (modified) pruden-
tial and business conduct require-
■■ Exempted or unregulated. Some ments. Examples include France,
countries have opted for a “wait- Germany, and Italy.
and-see” approach and require
lending platforms to comply only In addition to regulatory frameworks
with existing general rules govern- put in place by governments, in some
ing lending, such as financial con- countries, several industry associa-
sumer protection rules, usury laws, tions have introduced self-regulation
and laws against misleading and (European Commission 2016a). For
aggressive sales practices. However, example, in the United Kingdom, the
since platforms do not issue loans Peer2Peer Finance Association (repre-
(with the exception of the balance senting 90 percent of the market) asks
sheet lending model), they may not its members to apply the operating
be subject to rules that bind direct principles setting out the standards of
lenders. Examples include Ecuador, business conduct, such as transparency,
Egypt, South Korea, and Tunisia. risk management, and reporting.17
These align with, and in some areas
■■ Prohibited. The practice of debt supplement, requirements of the Finan-
crowdfunding (P2P lending) is cial Conduct Authority (FCA).
17 http://p2pfa.info/wp-content/uploads/2015/09/Operating-Principals-vfinal.pdf
16
2.4. Equity Crowdfunding online private placements, this region

raised over US$64 million in 2015
2.4.1. Model Description and Use (excluding China) (Zhang et al. 2016a).
Equity crowdfunding allows individual As equity crowdfunding platforms con-
and institutional investors to invest in tinue innovating, different business
unlisted entities (issuers) in exchange for models have emerged (Gabison 2015),
shares in the entity. By definition, equity such as (i) a club model where platforms
crowdfunding serves funding of legal en- recruit potential funders as members of
tities that can raise funds by selling their a closed “investment club” to avoid reg-
equity. It is suitable for start-ups and ulation of public offerings and investor
SMEs, in particular. If an investment target protection typically enjoyed by “non-
is reached, the deal is closed between the qualified” investors; (ii) a cooperative
pool of funders, the issuer, and the plat- model (also known as a holding model
form. The platform charges a commission or vehicle model) where platforms cre-
based on the amount raised and, in some ate a special-purpose cooperative vehi-
cases, on the basis of future profit. cle to pool money to be invested in an
Equity crowdfunding is relatively small, individual project;19 (iii) an investor-led
model; and (iv) a coinvestment model.
but it has experienced dramatic growth
in recent years. In 2015, it made up In the investor-led model (also known
merely 11 percent of the total crowd- as syndicate funding), an accredited
funded amount; however, in terms of lead investor carries out due diligence,
year-on-year growth, it has been outpac- negotiates the investment terms directly
ing the growth of the wider crowdfunding with the company raising finance, and
industry by 60 percent versus 53 percent invests its (or if an individual, his or her)
(AlliedCrowds 2016). On the American own money. The crowd is then invited
continent, US$598.05 million in equity to co-invest alongside the lead investor.
was sold over crowdfunding platforms This gives other funders peace of mind
in 2015 (120 percent more than in by investing alongside professional in-
2014), mostly in the United States and vestors, as equity crowdfunding can be
Canada (Wardrop et al. 2016). In Europe, very complex for inexperienced funders.
equity crowdfunding was estimated Platforms benefit by taking a slice of the
to reach €422 million (approximate- carry on deal. For example, AngelList
ly US$467 million) in 2015 (European allows funders to form “syndicates,”
Commission 2016a). In the United King- which are similar to investment funds
dom alone, equity-based crowdfunding for potential contributors to invest
(excluding real estate crowdfunding) together in a project.20 (See Figure 4.)
increased on a year-to-year basis by
295 percent to £245 million (approxi- Similarly, the co-investment model al-
mately US$325 million) in 2015 (Zhang lows funders to co-invest alongside
et al. 2016b). Although many countries established venture capitalists. The
in the Asia-Pacific region lack a regu- platform looks for deals and is respon-
latory framework18 and equity-based sible for due diligence and investment
crowdfunding typically consists of small management; it usually sources, vets,
18 Exceptions include Indonesia, Korea, Malaysia, and Taiwan, which have passed a special tailored regime to allow equity
crowdfunding, while Indonesia, Thailand, and Vietnam are working toward it.
19 See, e.g., Symbid investment, which is done through a cooperative vehicle established in the Netherlands (http://symbid
.com/pages/model).
20 https://angel.co/syndicates
17
FIGURE 4. Investor-led Model
Plaorm
and organizes investments and presents financial intermediaries and venture

them to potential “backers,” as well as in- capitalists. Equity crowdfunding
vests its own funds. Some of these plat- opens these opportunities to a much
forms also retain preemptive rights and broader funder group (Gubler 2013).
provide a framework to help funders
raise and investors invest additional ■■ Unlimited potential for financial
funds in future rounds and follow-ons.21 gain. Unlike in debt crowdfunding,
(See Figure 5.) funders have (at least theoretically)
the possibility to unlimitedly multi-
2.4.2. Benefits and Risks ply their investment if they bet on a
new start-up that becomes the next
The key benefit lies in efficient and ef- market leader.
fective intermediation of funds allowing
funders to invest in a new asset class for ■■ Aligned incentives between fun
higher yield and entrepreneurs to ac- ders and fundraisers. More than in
cess funding (Kirby and Worner 2014). any other category of crowdfunding,
In that regard, equity crowdfunding is interests of funders and fundraisers
similar to debt crowdfunding, and it also are aligned because they share the
retains the benefits (and risks) of the same risks (including the risk of di-
donation and reward-based crowdfund- lution and financial loss) and have
ing, such as community participation similar options to exit the invest-
and voting with the money. In addition, ment (a sale, merger, or initial public
there are more specific benefits: offering [IPO]). This reduces conflict
of interest between the two parties.
(i) Benefits for funders
(ii) Advantages for fundraisers
■■ Access to investment opportuni
ties. Access to investment opportu- ■■ Limited liability. In case of default,
nities concerning start-ups and SMEs the fundraiser is not burdened with
used to be restricted to traditional unlimited liability for unpaid debts,
FIGURE 5. Co-investment Model
Funds
Plaorm
21 For instance, OurCrowd has a due diligence team that vets deals before they are presented to investors and is an active
investor in the deal; it retains preemptive rights, thus providing the companies and investors a framework to raise and
invest additional funds in future rounds and follow-ons (www.ourcrowd.com/how_it_works/an_introduction).
18
and instead, funders take the hit enough evidence yet regarding whether
alongside the fundraiser. and how likely these scenarios are. Un-
til they exit, funders are unlikely to re-
■■ Global reach. Equity crowdfunding ceive any payment because early-stage
allows access to funders all around and growth-focused businesses rarely
the world. This is particularly rele- pay dividends. Should a funder realize
vant in countries with underdevel- a profit, complex tax obligations may be
oped capital markets. triggered as a result of the international
■■ Improved investment attractive nature of crowdfunding.
ness. A successful campaign may
Issues surrounding the gap in protection
act as a signal to established in-
of fundraisers in debt crowdfunding are
vestors (including venture capital-
even more relevant in equity crowd-
ists), showing potential consumer
funding. Equity crowdfunding is mar-
demand, thus attracting additional
keted to fundraisers as a simpler and
sources of funding.
cheaper way to fund business develop-
Equity crowdfunding is highly risky ment (as compared to more traditional
and illiquid. A recent study shows that sources of capital). Fundraisers may
of the 367 businesses that attracted in- then underestimate actual campaign
vestment through the United Kingdom’s costs, compliance costs (e.g., of regular
five major equity crowdfunding plat- reporting), investor management costs
forms between 2011 and 2013, only (e.g., communication with hundreds and
22 percent have gone on to raise funds thousands of funders), and opportunity
at a higher valuation or have realized a costs in terms of foregone expertise be-
return for their funders through a sale cause venture capitalists often bring
or other form of exit (Altfi 2015). This is industry knowledge and networking
most likely because early-stage ventures opportunities. Traditional equity inves-
and SMEs are inherently risky,22 and the tors may even be able to offer capital at
risk is further exacerbated by the lack of a lower price than equity crowdfunding
incentives for individual funders to con- because of their capacity to assess and
duct due diligence given typically small price risks better.
equity stakes.
The regulatory requirements, with
Investments made through crowdfund- which fundraisers need to comply,
ing are likely to be subject to dilution may expose fundraisers to unwanted
when the business raises additional public scrutiny. Other sources of fund-
capital at a later date and issues new ing, including nonequity private debt,
shares to the new investors. Illiquidi- home-equity loans, and loans from
ty poses another major risk to crowd- friends and family members, allow fund-
funding and available options for exit raisers to keep their business know-how
are limited. In the absence of a sec- and innovation hidden from the gener-
ondary market, funders may either al public, while crowdfunding requires
sell their position over the counter to a higher level of disclosure. In addition
any interested party or wait until the to the risk of disclosing too much infor-
company is acquired by a strategic in- mation to competitors, this may have
vestor, merges with another company, negative repercussions on intellectual
or issues an IPO. However, there is not property protection (patentability).
22 See, e.g., www.statisticbrain.com/startup-failure-by-industry.
19
TABLE 1. Special Regime for Equity Crowdfunding

Special Regime in Place Special Regime under Way
Canada Japan Spain Australia Mexico
China Korea Taiwan Brazil Thailand
France Malaysia United Kingdom India Vietnam
Germany The Netherlands United States
Indonesia New Zealand
Israel Portugal
Italy Singapore
2.4.3. Regulation include Title III of the Jumpstart Our

Business Startups Act in the United
In the jurisdictions where equity crowd-
States and the new Capital Market Ser-
funding is not prohibited, it is either
vices Act in Malaysia (see Table 1). Light-
subject to general securities law or to
er entry requirements, special conduct
a specific regime (Kirby and Worner
of business provisions for the platforms,
2014). A clear disadvantage of the for-
and limited reporting requirements for
mer is that general securities law is of-
fundraisers (issuers) typical of tailored
ten cumbersome to comply with and
regimes are counterbalanced by sever-
is often at odds with the innovative as-
al limits on the services and activities
pects of crowdfunding, thus increasing
a platform is permitted to perform, the
barriers to entry by imposing strict lim-
duty to appoint a third-party custodi-
its on who can intermediate the invest-
an to hold funder’s assets, investment
ment (the platform), who can issue se-
limits, and the imposition of risk ac-
curities and under what circumstances
knowledgement and funder education
(the fundraiser), and who can invest in
regimes. Moreover, to address most
this form of equity (qualified investors).
common risks of equity crowdfunding,
Lack of clear rules also makes for an
additional requirements are often im-
environment that platforms find diffi-
posed, such as requiring the platform
cult to navigate.23
to conduct due diligence on the issuer
To promote equity crowdfunding as a and/or the crowdfunding offerings and
viable alternative to capital markets, to have “a living will,” as well as a limit
some jurisdictions have recently adopt- on the amount nonqualified funders can
ed a special tailored regime. Examples invest (IOSCO 2015).
23 A World Bank study of the Kenyan securities regulatory environment determined that various pieces of secu-
rities legislation allow for crowdfunding, but they are subject to interpretation, making it hard for businesses
to set up a crowdfunding platform (Raymond 2014).
20
SECTION 3. EVOLVING FRONTIERS

As crowdfunding has grown in scale of future revenue (or profits) of the
and expanded globally in its geograph- business (e.g., Startwise, Quirky).
ic reach, it has evolved and diversified
in different ways, sometimes departing Another innovation that has been par-
quite decisively from its original con- ticularly successful in Asia is the use
cept. In this section we focus on the most of debt and equity crowdfunding for
recent trends of (i) hybridization, (ii) in- real estate projects. As a variation of
stitutionalization and complexity, and debt crowdfunding, real estate lending
(iii) consolidation and how these trends funders provide a loan to property de-
may affect excluded and underserved velopers secured against property of a
customers. consumer or business fundraiser. In eq-
uity real estate crowdfunding, funders
A. Hybridization invest in a property through the pur-
chase of an equity instrument issued by
Platforms combine features of different a special purpose vehicle established to
crowdfunding categories, but also ca- facilitate financing for a single project
ter to niche markets with a specific fo- (e.g., Patchofland, RealtyShares, Real-
cus on transactions in real estate, art, or tyMogul.com, and Lendinghome). Real
video game financing. Examples include estate may also open equity crowdfund-
(i) invoice trading, (ii) royalty crowding to individual fundraisers by allowing
funding, (iii) revenue sharing, (iv) real them to sell stakes in their home equity.25
estate crowdfunding, and (v) P2P in- In P2P insurance, a group of individuals
surance. Invoice trading is another way pools its members’ premiums and pays
for businesses to raise capital by using out some or all of the claims made by the
their invoices or receivables, usually group. Advantages include less fraud,
selling those at a discount to a pool of lower acquisition costs (through refer-
primarily high net worth individuals or rals/social networks), greater loyalty,
institutional investors (e.g., Invoicefair, and better pricing over time. Some ex-
Invoiceinterchange). amples are Guevara in the United King-
dom and Friendsurance in Germany.
In the royalty crowdfunding model,
funders receive a share in a unit trust, The trend of hybridization demon-
which acquires a royalty interest in the strates the flexibility of crowdfunding
intellectual property of the fundraising and different use cases on the demand
company. A percentage of revenue is side. Most of the hybrid examples cited
paid out over time, and the payout var- earlier could benefit primarily MSMEs,
ies depending on the periodic revenue. but concepts such as P2P insurance
Royalty crowdfunding platforms typ- may have a large impact on individu-
ically invest in art and entertainment als as well. For instance, the concept
(e.g., Tubestart for videos and films, of P2P insurance better adapts to the
AppsFunder for mobile apps, and Gideen system of Takaful,26 an equivalent of
for music) and natural resources.24 The insurance in Islamic finance, which is
idea of revenue sharing is similar, where based on the idea of risk-sharing rather
funders fund a business, and repay- than risk-shifting. Crowdfunded insur-
ments are determined by a percentage ance may, therefore, become a driving
24 www.energyfunders.com
25 See, e.g., Foley (2016).
26 See, e.g., Gönülal (2013).
21
force to increase coverage in many 10 percent of all loans originated by the

under-insured regions. crowdfunding sector in the United States.
During the last quarter of 2014, almost
Another example where a hybrid model 60 percent of the US$1.1 billion in loans
may benefit unserved and underserved originated by Lending Club were bought
regions is remittances. Crowdfunding by institutional investors (Aquilina and
platforms could potentially facilitate Kraus 2016).
the use of remittances as collateral by
applying alternative credit scoring mod- The involvement of institutional in-
els to reflect the estimated inflow from vestors raises concerns that platforms
remittances and carrying securitization may ramp up origination before the
of the remittance inflows on behalf of strengths and weaknesses of their mod-
the fundraiser. els are properly tested (Aquilina and
Kraus 2016). This is because of the pres-
B. Institutionalization and sure they face from institutional inves-
Complexity tors, who are attracted by higher yields,
but their increasing demand may soon
Some crowdfunding models evolved outpace the capacity of the industry,
from relying on “the crowd” to more thus putting stress on the technology,
complex models involving hedge funds operations, infrastructure, and under-
and banks feeding in institutional mon- writing capabilities of platforms. More
ey (institutional investors not only in- importantly, crowdfunding platforms
vest in crowdfunded assets, but also may become more aggressive in seeking
take stakes in platforms27). The involve- new customers and adopt mis-selling
ment of institutional investors is likely practices used by some consumer credit
to become more prominent in the fu- providers, for instance. If the business
ture, according to recent evidence. For model shifts toward push sales, it may
example, in 2015, 45 percent of debt have a significant impact on custom-
crowdfunding platforms in the United ers as in many countries the regulatory
Kingdom reported institutional involve- framework for crowdfunding does not
ment as compared to 28 percent in 2014 provide enough protection to fund us-
and just 11 percent in 2013 (Zhang et al. ers. This is a particularly serious risk
2016b); 26 percent of business loans given the changes in the underwriting
and 32 percent of consumer loans were process enabled by the technology and
funded by institutions (FCA 2016, p. 14). the speed with which thousands of cus-
One of the risks potentially affecting tomers can be offered and instantly ap-
nonprofessional users of crowdfunding proved for a loan, including over their
is the risk that professional investors feature or smart phone.
will keep the best projects, leaving only
the worst for the crowd. The increased demand from institu-
tional investors has provided a pow-
The most active institutional players erful incentive for securitization of
are hedge funds: San Francisco-based crowdfunded assets. The first large
fund Colchis Capital Management had deal occurred in October 2013, when
US$663 million of P2P loan investments hedge fund manager Eaglewood Capital
at the end of 2014, which represented closed on a US$53 million securitization
27 For instance, Australian Westpac has acquired a stake in SocietyOne, Australia’s leading P2P lending platform. Barclays
Africa has acquired a stake in RainFin, the leading South African P2P lending platform. See, e.g., Renton (2014).
22
deal involving loans originated by use cases to sustain growth at current

Lending Club (see, e.g., Renton 2013). rates. Compliance cost could be another
The recent launches of several funds in- reason because costs increase as new
vesting in loans originated on P2P lend- regulation is put in place. Finally, the
ing platforms underscore the growing growing complexity of crowdfunding
interest from institutional investors in business models may also discourage
this sector. This may potentially create a new entrants. While setting up a plat-
situation with important similarities to form is fairly easy and cheap, coping
the origination of subprime mortgages with the dynamic and often uncertain
that preceded the global financial cri- regulatory environment and strong
sis. On the other hand, so far the num- competition can be daunting.
ber of new securitizations of P2P loans
has been lower than expected because Although it is not a trend yet, the devel-
of a combination of rising defaults, mar- opment of secondary markets for crowd-
ket volatility, and corporate governance funding related securities is noteworthy.
issues. For example, two major Wall The emergence of functional and trans-
Street investment banks, Goldman Sachs parent secondary markets, particularly
Group Inc. and Jefferies LLC, decided to for equities and loans, may substantially
stop buying Lending Club’s loans after boost interest of retail funders. Second-
the company’s CEO Renaud Laplace re- ary markets can take different forms. One
signed (Rudegeair and Baer 2016). model entails the direct involvement of
the crowdfunding platform, which may
C. Consolidation provide an online bulletin board that
connects funders who intend to sell their
Another trend is consolidation of the investments to potential buyers who are
crowdfunding sector. After years of looking to invest in previously funded
platform proliferation, a recent study in projects. In this case, funders can offer
the United Kingdom shows that sever- or bid on equity shares and directly ne-
al crowdfunding platforms have either gotiate a price. Another model involves a
“gone quiet” or disappeared altogeth- crowdfunding platform or a third party
er, and the year-on-year growth rate that is running a marketplace for crowd-
is slowing, from 161 percent between funding-based securities as an online
2013 and 2014 to 84 percent between trading venue. This type of secondary
2014 and 2015 (European Commis- market that has well-defined and regu-
sion 2016a). This is also happening lated rules can bring together multiple
across borders. One reason for this buyers and sellers. Finally, crowdfund-
slowdown could be that, after the ini- ing platforms may team up with existing
tial boom, it is now difficult for existing marketplaces for unlisted companies
platforms to find new projects or other (European Commission 2016a).
23
SECTION 4. CROWDFUNDING AND FINANCIAL INCLUSION

4.1. Opportunities providing benefits to a broader group
of customers excluded from certain seg-
Crowdfunding has the potential to con- ments of the financial system because
tribute to financial inclusion efforts by of limited financial sector development.
providing improved access to funds and In the following we further explain our
financial assets. A GPFI White Paper key hypotheses and how they are likely
(2016, p. xix) notes that crowdfund- to play out with regard to different cus-
ing may support financial inclusion tomer segments.
as it “. . . can be a quick way to raise
funds with potentially few regulatory A. Improved Access to Finance
requirements; it can be cost-efficient
and can produce a good return for the The most immediate benefit of all
lender; and its potential market reach the categories of crowdfunding is im-
is limited only by access barriers to the proved access to finance by traditionally
platform and regulatory restrictions excluded and underserved groups of
where applicable.” The hypothesis is individuals and legal entities. A 2013
that crowdfunding can benefit financial World Bank study indicates that there
inclusion efforts in the following ways: is an opportunity for up to 344 million
(i) it improves access to finance by ex- people in developing economies to par-
cluded and underserved individuals and ticipate in crowdfunding. In particular,
MSMEs; (ii) it allows for innovations of debt crowdfunding, as a form of digi-
existing models to serve BoP customers, tal credit, is highly relevant. Because of
such as microfinance and mobile finan- their alternative scoring feature, crowd-
cial services; and (iii) it opens access to funding platforms may be positioned
more complex investment products for to serve MSMEs, start-ups, and individ-
resilience and asset building. uals with limited or no credit history.
Crowdfunded loans then may become a
Existing crowdfunding platforms re- gateway to traditional lenders, because
quire some minimum infrastructure they will allow fundraisers to build their
to be in place for them to operate (see credit history over time.
Section 1.2), and therefore, this inno-
vation will more likely benefit different Crowdfunding platforms could also
customer segments disproportionately. out-compete traditional lenders as
Access to a crowdfunding platform transactions can take place more
requires the ability to send and re- quickly and cheaply. Thus, crowdfund-
ceive money electronically over a ing can help poor people with limited
transactional account, such as a bank access to formal financial institutions
account or a mobile money account. to smooth their consumption and face
Therefore, the most likely users of financial shocks (e.g., unemployment,
crowdfunding are customers who al- illness, conflict, crop failures, natural di-
ready own or have access to such an sasters, or accidents) without the need
account. These customers, however, to take extreme measures such as re-
may still be underserved or excluded ducing food consumption or selling pro-
with regard to other financial products ductive assets (DFID 2012). The velocity
and services, such as credit, insurance, of crowdfunding transactions and the
savings, and investment products; this agility of crowdfunding to accommodate
would be particularly the case for BoP various use cases play an important role
customers. Crowdfunding may also in emergency situations more broadly
help deepen the financial market, thus (UNOCHA 2015).
24
Equity crowdfunding may be an im- from developed to developing econ-

portant mechanism MSMEs can use omies. The most prominent instance
to bridge the funding gap that exists is the work done by platforms such as
in many countries. The issues of lim- Kiva, which has helped facilitate more
ited access to finance and shortage of than 1 million loans from funders in
market-based financing are particu- developed economies to low-income
larly pressing in countries with un- entrepreneurs in developing countries.
derdeveloped capital markets and lack An example of a commercial lending
of venture capital offerings (IFC and platform is an equity crowdfunding
McKinsey 2010). Equity crowdfund- platform called EmergingCrowd, which
ing provides an opportunity for more offers retail investors the opportunity
traditional investors in businesses or to directly buy shares and bonds in
projects (including angel investors and companies based in emerging markets.
venture capitalists), by reducing trans- Homestrings provides investment op-
action costs and information asym- portunities in real estate, financial ser-
metries, and it may pave the way for vices, telecoms, and SMEs in 13 African
other market-based funding opportu- countries.
nities to grow over time, particularly if
an adequate regulatory framework is Crowdfunding can play an import-
implemented. ant role in promoting government
schemes to effectively channel remit-
B. Innovative Models for Financial tance and investment flows. Platforms
Inclusion can facilitate the outreach to diaspora
communities by offering investment
Crowdfunding may facilitate digitiza- opportunities in their respective home
tion of traditional forms of finance. New countries. The Syrian refugee crisis
technologies have already disrupted the provides another example of mobiliz-
business’ landscape with mobile money, ing fund transfers from developed to
digital credit, and digital microinsurance. EMDEs, while lowering transaction
Crowdfunding platforms can follow the costs and engaging retail consumers
same trend driving the use of basic fi- as well as diaspora (www.kickstarter.
nancial products and services and/or com/aidrefugees).
adapting new technologies to substitute
or complement traditional financial in- Annex 2 provides examples of platforms
stitutions. An example of this potential that target EMDEs, unserved and under-
is M-Changa, a crowdfunding platform served customers, and BoP consumers.
in Kenya that “digitizes” the practice of
“Harambee”—community fundraising— C. Access to New Asset Class
by allowing people in the same commu-
nity to use their mobile money to make Crowdfunding opens access to invest-
donations to individuals (e.g., to support ment opportunities that are currently
a relative’s education) or to community widely unavailable to customers at the
causes. Another example is digitization BoP. A new theory of change for the
of the rotating savings and credit asso- microfinance industry suggests that
ciations practice, such as eMoneyPool, the use of financial services by poor
Monk (an app-based crowdfunding), households helps them anticipate,
and Puddle. See Section 3.A for examples adapt to, and/or recover from the ef-
of P2P insurance and Takaful. fects of shocks in a manner that pro-
tects their livelihoods, reduces chronic
More generally, crowdfunding can facil- vulnerability, and facilitates growth
itate more and new types of investment (resiliency) (Gash and Gray 2016).
25
This higher resiliency, besides credit A. Inadequate Legal and Regulatory

and insurance, can also be achieved Framework
through asset building (saving, invest-
ment). In the future, crowdfunding can The lack of clear rules hinders the in-
offer such an investment opportunity dustry, fundraisers, and funders. An
as currently excluded and underserved inadequate legal and regulatory frame-
customers have very limited access to work exists not only where there are
formal financial products designed for no rules on crowdfunding whatsoever,
resilience and asset building. but also where different crowdfunding
models fall under different regulatory
The lack of available options exposes (and supervisory) regimes, or where
them to a variety of risks, includ- the applicable regulatory regimes vary
ing the risk of fraud. In recent years, based on the nature of parties involved
many people, including the very poor, in the transaction (e.g., an institutional
have fallen victim to fraudulent invest- investor versus a consumer) without
ment schemes such as Ezubao in China any specific guidance on how such a
(900,000 investors lost US$7.6 billion), situation should be addressed. In the
Sardaha in India (1.7 million investors absence of regulatory clarity, the crowd-
lost US$4 billion) (see, e.g., Karnik and funding industry may remain under-
Balachandran 2016), and Clip Invest- developed or not develop at all, while
ment Sacco, Ltd., in Kenya (more than funders and fundraisers may be exposed
5,000 investors lost US$18.7 million) to unfair practices from unregulated or
(see, e.g., Kamau 2016). under-regulated and unsupervised or
under-supervised platforms.
4.2. Risks and Challenges
Across jurisdictions, a frequent gap in
Despite the potential benefits men- crowdfunding regulation concerns pro-
tioned, a significant impact of crowd- tection of participants on the demand
funding on financial inclusion is yet to side—fundraisers. Thus far, policy mak-
be seen. From a development perspec- ers have focused predominantly on risks
tive, the key test of crowdfunding lies in faced by the supply side (investors,
the extent to which this form of finance lenders, and other funders), neglect-
is used to promote and support financial ing the fact that the platform is often
inclusion and economic growth rather the only “professional” in the crowd-
than generate funds rapidly and cheaply funding game, while both the funder
to finance risky and unsustainable in- and the fundraiser are equally vulner-
vestment opportunities. In contrast to able and inexperienced individuals or
microfinance, which emerged with a small businesses. In jurisdictions where
specific purpose to reach the poor, finan- crowdfunding falls under capital mar-
cially excluded, and underserved, only a kets regulation, the focus on investor
fraction of crowdfunding platforms to protection is nearly exclusive, with rules
date have been designed to target this prescribing disclosure requirements, the
segment. Challenges include (i) inade- suitability test, the access to a dispute
quate legal and regulatory frameworks, resolution mechanism, and the like. Yet,
(ii) untested credit scoring models, inexperienced fundraisers/issuers may
(iii) limited access to technology, and underestimate the rules with which
(iv) lack of awareness and trust. These they need to comply (e.g., disclosure and
challenges are not necessarily unique reporting), and they may not fully ap-
to crowdfunding and, in some jurisdic- preciate the legal implications of equity
tions, may concern broader areas. distribution and future repercussions
26
of “managing the crowd” of creditors or shown to work for individuals over

stockholders. time, its value for credit assessment of
complex business fundraisers remains
Debt crowdfunding exposes fundrais- unclear. In addition, platforms hesitate
ers to the same risks as any other form to fully disclose their proprietary algo-
of (digital) credit. Fundraisers may be rithms, which they consider a part of
steered into borrowing beyond their their know-how and thus commercially
financial means without appreciating sensitive. However, behind this secrecy,
the risk of over-indebtedness, credit bu- there are a number of privacy and data
reau blacklisting, and a range of possible protection concerns, including trans-
penalties. To address those risks, some parency (what data are being used and
jurisdictions have adopted rules to pro- where did they originate), consent (was
tect individual fundraisers (e.g., Austra- permission provided), and access (can
lia, Malaysia, the United Kingdom, the the consumer see their own data) (Miller
United States). However, even in those and Jenik 2016), as well as the risk of dis-
jurisdictions, the rules may not apply crimination and bias (U.S. Department
when the funder is another individual of Treasury 2016).
and not a financial institution (FCA 2016,
p. 12). This obvious gap in consum-
C. Limited Access to Technology
er protection may become particular-
ly dangerous as crowdfunding reaches While some countries have fairly high
scale in lower income countries and be- Internet penetration rates, the majori-
gins reaching poorer market segments. ty of Africa’s population does not have
access to the web (www.internetworld
Another important regulatory challenge
stats.com/stats.htm). This makes it
is the inherent conflict of interest in
harder for entrepreneurs to reach po-
most platforms’ business model. Many
tential international funders and to
platforms have incentives built into their
build a global network, thus foregoing
business model to prioritize volume over
some of the main advantages and oppor-
quality, thus reducing their motivation
tunities of crowdfunding. This situation
to properly screen prospective fund-
will improve as technology becomes
raisers and their projects. This type of
more affordable, for example, according
the conflict of interest affects fundrais-
to one report, over half of the urban res-
ers (the risk of over-indebtedness) and
idents in Africa are online, and the price
funders (the risk of financial loss) and
of basic smartphones has fallen below
may translate into a conflict of interest
US$100, making them accessible to the
between them, too (e.g., leveraging in-
growing middle class (Manyika 2013).
formation asymmetry to borrow more).
A specific problem for developing coun-
B. Untested Credit Scoring Models tries is represented by the fact that
payment systems impact the choice of
One true innovation of crowdfunding platform. Most international crowdfund-
platforms—innovative credit scoring platforms offer a limited number of
ing techniques—may extend access to payment options (e.g., a credit card, Pay-
credit, but it may also exacerbate the Pal), hence excluding funders without
risk of over-indebtedness and discrim- access to these payment methods
ination. The real predictive value of al- (World Bank 2015). Locally based
ternative scoring models is yet to be platforms are likely to be better suited to
tested through the credit cycle. While engage in EMDEs, but they have a much
Big Data-driven credit scoring may be smaller pool of potential contributors.
27
D. Lack of Awareness and Trust GeoPoll, GES, and the U.S. State Depart-
ment African Entrepreneurship Survey
Finally, another challenge for crowd- 2015 found that 13 percent of respondents
funding in developing markets is a lack mentioned crowdfunding as a source of
of general awareness and trust. Because online funding (Mobile Accord 2015).
crowdfunding is a recent phenomenon, in
many markets there is little overall aware- Table 2 summarizes the key benefits of
ness among potential users (funders crowdfunding, while highlighting im-
and fundraisers) of this innovation. This portant measures to put in place to ad-
is changing, however. For example, the dress key challenges.
TABLE 2. Benefits of Crowdfunding in Financial Inclusion, Safeguards &

Enabling Factors
Benefits Specific Conditions
• Asset building, resilience enhancing • Liability of the platform defined
• Portfolio diversification 1 skin in the game
• Formalization of agreements • Standardized due diligence (access
• Digitization of existing schemes to credit bureaus)
(collaborative financing) • Standardized disclosure
Debt
• Resolution regime (living will)

SUPPLY
• Funder education
• Liquidity enhancement
• Restrictions—profile, stakes
• Guarantee mechanisms/diversifica-
tion/portfolio management rules
• Access to a new class of assets [Note: Equity crowdfunding does not
Equity
seem to be particularly appropriate

for BoP funders.]
Benefits Specific Conditions
• Fast access to loans • Rules to prevent over-indebtedness
• Access to cheaper loans • Regulation of collection practices
• Ability to leverage social capital • Liability of the platform defined
• Improving access to formal finance and skin in the game
Debt
(creating credit history) • Standardized scoring in place

DEMAND
• Democratization of finance • Standardized disclosure in place

• Resolution regime (living will)
• Fundraisers education
• Access to capital markets Restrictions—legal form, type of
• Access to cheaper capital business
Equity
• Wisdom of the crowd [Note: Equity crowdfunding does not

• Access to professional investors seem to be particularly appropriate
• Democratization of finance for BoP entrepreneurs.]
28
SECTION 5. NEXT STEPS

This paper summarizes the results of our Committee for Banking Supervision for
initial mapping exercise aimed at shed- areas where crowdfunding intersects
ding light on the crowdfunding phenom- with the banking industry, International
enon from the financial inclusion angle. Association of Insurance Supervisors for
Crowdfunding can potentially play an crowdfunded insurance, and Financial
important role in financial inclusion by Action Task Force for issues relevant to
improving access to (digital) credit by money laundering and terrorist financ-
unserved and underserved borrowers; ing, to name a few examples. Other global
creating cheaper, community-based in- bodies such as the G20/OECD Task Force
surance products; or facilitating access on Financial Consumer Protection and the
to digital investments by people who International Financial Consumer Protec-
currently have limited or no options to tion Organization should contribute to
get financial return on their savings, not this work and share their financial con-
to mention current barriers to access sumer protection expertise, particularly
investment products. regarding consumer (digital) credit and
protection of fundraisers.
The crowdfunding industry will deliver
on its promise to promote financial inclu- We hope this paper provides a basis for
sion only when a sound and enabling le- further work, which should explore in
gal and regulatory framework is in place. more detail areas where crowdfunding
Policy makers need to find a way to reg- may be of the highest relevance to financial
ulate crowdfunding so that it can achieve inclusion. This paper provides background
its market-building potential, while ap- by defining crowdfunding, providing an
propriately managing the risks that come overview of its evolution and ecosystem,
with it. Platforms need to be subject to explaining in detail the basic categories
an appropriate regulatory regime that of crowdfunding, listing their key benefits
is adequately tailored to crowdfunding and associated risks, describing the most
and adequately protects both funders recent trends, and highlighting benefits of
and fundraisers. In the absence of such crowdfunding for broadening and deep-
a framework, there is a risk that crowd- ening of financial inclusion. Follow-up
funding may worsen consumer trust in work, for instance, could focus specifically
the very financial sector it was born to on the following issues:
“revolutionize.” The recent issues faced ■■ A more in-depth economic analysis of
by the industry (Ezubao in China, Lending
what the true competitive advantage
Club in the United States) call for more
of crowdfunding platforms is, how it
coordinated approaches toward regu-
plays out in different (economic and
lating and monitoring of crowdfunding.
regulatory) contexts, and what im-
Several countries have already adopted
plications it has on the potential of
a specific regulatory regime, but their
crowdfunding to serve excluded and
approaches vary widely (IOSCO 2015a).
underserved customers.
This paper addresses a broad audience ■■ The impact of crowdfunding on im-
because the topic requires engagement by proved access of unserved and un-
multiple stakeholders. Standard-setting derserved customers to credit and
bodies in their respective domains should other financial products.
continue or start looking into regulatory
and supervisory issues relevant to crowd- ■■ The potential of crowdfunding to sup-
funding: Financial Stability Board from plement or substitute underdevel-
the perspective of shadow banking, Basel oped market-based finance in EMDEs.
29
■■ The adequacy of the legal and regula- ■■ The risk or regulatory arbitrage,
tory framework to address the risks particularly in the light of the re-
faced by fundraisers and funders. cent trend of institutionalization and
hybridization.
■■ Minimum regulatory standards for
the industry and supervisory guid- ■■ The level of customer awareness
ance for the responsible supervisory concerning the risks and benefits of
authorities. crowdfunding.
30

1. Donation-Based Crowdfunding
Legend:
1. The campaign objective
2. The certification indicating that the fundraiser has been subject to due diligence by
the platform
3. Indication of the threshold, amount raised and time remaining
4. Payment methods available to donors
5. Information about the campaign, fundraiser and other disclosure
6. Indication of the threshold, amount raised and time remaining
Source: Kiva
31
2. Reward-Based Crowdfunding
Legend:
1. Three steps to set up a campaign
2. Key features of the campaign
3. Beneficiary’s profile
4. Information about the project
Source: IdeaMe
32
3. Debt Crowdfunding
Legend:
1. The funder’s main dashboard
2. The list of loan asks
3. The borrowers’ credit rating provided by the platform
4. Detail of the loan ask, including the downloadable fact sheet with more details
about the borrower
Source: Crowdo
33
4. Equity Crowdfunding
Legend:
1. The summary offer
2. The detailed information about the offer
3. Disclosure
Source: Seedrs
34

SERVING EMDES
BOX A2-1. Examples of Platforms Targeting EMDEs
Babyloan—a French platform aimed at small entrepreneurs without access to the

banking system and committed in the fight against poverty. It has recently part-
nered with Total to develop the first crowdfunding platform dedicated to access
to energy. The collaboration aims to support the creation of local microbusinesses
that will develop distribution networks to cover the last mile to reach isolated
communities in Africa, Asia, and Latin America.
Cheetah Fund—was a €400,000 fund that partnered with the 1 percent Club
Netherlands (a crowdfunding platform) aimed at supporting African start-ups to
kick-start or boost their projects. If borrowers managed to crowdfund at least
30 percent of their target amount via 1 percent Club within 30 days, the Cheetah
Fund then granted them the remaining amount.
Farmable.me—a Ghanaian crowdfunding platform that aims to provide money to

solve the country’s dependency on imported beef. By investing in a cow through
the Farmable website, online investors become “CowBackers,” and they are con-
nected to their own cow on a real farm in Ghana. Every cow costs US$500 and
is made up of “cowshares.” CowBackers can choose to fund a full cow or invite
friends and family to share a cow, also known as “CowSharing.”
Homestrings—a platform that allows overseas diaspora to invest in their home

countries in market projects, including commercial real estate, telecoms, and
SMEs. Homestrings recently started to offer development impact bonds, which
provide upfront funding for development programs by way of private investors,
who earn a return when specific preagreed outcomes are achieved.
Ketto—an Indian platform, where each borrower is assigned a manager who helps
the borrower raise money. Moreover, to facilitate investor donation, it partners
with a courier service to offer cash pick-up, tapping into India’s cash culture.
Kiva—a nonprofit platform for P2P lending to underbanked microentrepreneurs.

It operates in 80 countries with 300 “field partners,” mostly MFIs. Lenders choose
from borrowers’ online profiles and lend for zero financial return. The pooled funds
are disbursed to borrowers through local MFIs.
M-Changa—a Kenyan platform designed to resemble “Harambee,” a tradition of

funding friends’ and family members’ ventures to enhance this tradition by pro-
viding secure communication and record keeping capabilities for unprecedented
end-to-end transparency. M-Changa has integrated mobile money and credit card
payments, SMS, email, social networks, and geo location.
MYC4—a platform that allows investors to invest in SMEs in Africa. Once the
project is approved by MYC4’s local partners, prospective investors participate
in an online auction where they bid the amount they wish to lend and at what
interest rate. The investor offering the lowest interest rate ends up lending money
to the business when the auction is over.
35
Orange Collecte—a mobile crowdfunding platform in Côte d’Ivoire launched by

mobile network operator Orange. With this platform, private individuals and char-
ities can finance their personal (weddings, birthdays, etc.) and charitable projects
by making an appeal through their mobile network. Investors can then use their
Orange Money electronic wallet to donate money.
United Prosperity—a nonprofit platform operating in Sri Lanka that partners with
MFIs to offer funding solutions and reaches more unserved clients. The 0 percent
interest capital raised on the platform is used by borrowers as cash collateral at
local banks, and is not an actual loan, thus incentivizing banks to make loans to
MFIs. Between 2009 and 2013, the platform has facilitated more than US$280,000
in loans to 1,300 families (Aveni 2015).
Zidisha—a P2P lending platform, performing basic underwriting and sourcing

borrowers through volunteers. Typical loans are charged 0–15 percent of the prin-
cipal amount, but borrowers are able to decide specific conditions (such as loan
terms and repayment frequency).
36
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WORKING PAPER

ACRONYMS AND INITIALISMS.....................................................................vi

EXECUTIVE SUMMARY................................................................................ vii

SECTION 1. WHAT IS CROWDFUNDING?.................................................... 1

SECTION 2. MAIN CATEGORIES OF CROWDFUNDING............................... 5

SECTION 3. EVOLVING FRONTIERS........................................................... 21

SECTION 4. CROWDFUNDING AND FINANCIAL INCLUSION................... 24

SECTION 5. NEXT STEPS............................................................................ 29

ANNEX 1. EXAMPLES OF CROWDFUNDING PLATFORMS........................ 31

ANNEX 2. EXAMPLES OF CROWDFUNDING PLATFORMS

The authors would like to thank the International Organization of Securities

ACRONYMS AND INITIALISMS

BoP Base of the Pyramid

CGAP Consultative Group to Assist the Poor

EMDEs Emerging and Developing Economies

FCA Financial Conduct Authority (United Kingdom)

FinTech Financial Technology

FSP Financial Service Provider

IOSCO International Organization of Securities Commissions

IPO Initial Public Offering

MSME Micro, Small, Medium Enterprise/Entrepreneur

NGO Nongovernmental Organization

OECD Organization for Economic Co-operation and Development

SME Small- and Medium-Sized Enterprise

SSBs Standard-Setting Bodies

WBG World Bank Group

A down side of crowdfunding is that it has the potential to be harmful to customers

standard-setting bodies (SSBs), and development professionals. This paper is

Section 1 of this paper defines crowdfunding, provides an overview of its evolution,

SECTION 1. WHAT IS CROWDFUNDING?

BOX 1. Examples of the Areas Disrupted by FinTech (R)evolution

InsureTech. As with banking, technology facilitates

the Internet on so-called crowdfunding from funders to fundraisers through a

BOX 2. Examples of Crowdfunding Definitions

Global Standard-Setting Bodies and Financial Inclusion the Evolving

Crowd-funding: An Infant Industry Growing Fast (IOSCO 2014)

Crowdfunding in the EU Capital Markets Union (European Commission 2016)

Crowdfunding’s Potential for the Developing World (World Bank 2013)

individual or entity in need of funding to credit, especially for smaller

FIGURE 1. Crowdfunding around the World

SECTION 2. MAIN CATEGORIES OF CROWDFUNDING

BOX 3. Example of Charges

“All donations go through the GlobalGiving Foundation, a registered 501(c)3

There are two common subcatego- 2.1.2. Benefits and Risks5

of donations, basic accounting, advice, any transaction; this creates currency

BOX 4. Example of Charges

6 See, e.g., www.kickstarter.com/projects/1523379957/oculus-rift-step-into-the-game.

2.2.2. Benefits and Risks to trade in traditional markets (e.g.,

■■ Lack of due diligence. Relying on 2.2.3 Regulation

as lending-based crowdfunding, market- loans. There are different subcategories

to lend to individual fundraisers as lenders increasingly rely on a range of

FIGURE 2. Segregated Account Model

offered by intermediaries, such as ■■ Provides convenience. As men-

■■ Lack of transparency. When dis- focus on volume, rather than on the

16 See, e.g., OECD/G20 (2011).

Platforms have limited access to credit specifically prohibited (until recent-

2.4. Equity Crowdfunding online private placements, this region

FIGURE 4. Investor-led Model

and organizes investments and presents financial intermediaries and venture

FIGURE 5. Co-investment Model

22 See, e.g., www.statisticbrain.com/startup-failure-by-industry.

TABLE 1. Special Regime for Equity Crowdfunding

2.4.3. Regulation include Title III of the Jumpstart Our

ANNEX 2. EXAMPLES OF CROWDFUNDING PLATFORMS

ANNEX 2. EXAMPLES OF CROWDFUNDING PLATFORMS