In July of 2014, Facebook acquired virtual reality headset company Oculus Rift for around $2 billion. One of the most successful crowdfunded companies of all time, Oculus raised nearly $2.4 billion on the popular crowdfunding platform, Kickstarter.
Sounds like a great success story in crowdfunding, but here’s the catch: Kickstarter investors saw barely a dime from the lucrative buyout.
That’s because traditional crowdfunding platforms like Kickstarter are middlemen, set up to reward Kickstarter participants with things like tiered promotional items, and in the case of Oculus, early access to or discounts on the product. As it stands now, crowdfunding a startup gets platform investors just about anything except an actual piece of the company.
But that’s all set to change this year. The federal Jumpstart Our Business Startups (JOBS) Act has provisions set to kick in that will allow crowdfunded startups to issue equity directly to their investors. Financial technology companies are ready to move quickly, seeking to leverage digital currencies and innovations like bitcoin and the blockchain to create completely digital stock offerings for investors. Simply put, they want to cut out intermediaries like Kickstarter to provide investor with direct access and greater returns.
Here’s a look at what some of the early leaders in the space are doing, and how digital currency could be a major game changer to equity crowdfunding in 2016 and beyond.
True Equity Crowdfunding is On The Way
While the regulatory framework for equity crowdfunding in the United States has only recently been codified, it will set the table for existing platforms like Seedrs and Crowdcube to enter the marketplace. Both companies have been operating in the United Kingdom for several years, as UK regulators have made it a point to work with fintech companies early on and implement favorable frameworks for their development.
Seedrs goes far beyond the Kickstarter model, allowing different shareholder equity models such as “funds” of startups (investors receive stock in a basket of startups, similar to a mutual fund) and convertible notes. With Crowdcube, investors can choose to fund businesses with a choice of equity or debt. Neither of these companies are issuing equity in digital currency (yet), but the synergies are becoming apparent as bitcoin-related startups like Bitreserve are using these platforms to raise money for their businesses.
Digital Equity Can Be Issued with the Counterparty Protocol
Also known as cryptocurrency, digital money like bitcoin is completely virtual and has a cap on the total amount that can be in circulation at any given time. Users can hold their bitcoin, exchange it into fiat currency or spend it on goods or services from retailers that accept bitcoin. Major retailers like Amazon, CVS and Target are among those that now accept bitcoin as payment. All transactions are secure and verifiable through a public digital ledger known as the blockchain, which presents several unique opportunities in terms of equity crowdfunding.
This is largely due in part to what’s known as the blockchain’s Counterparty Protocol, an API that allows assets like equity shares and dividends to be created and exchanged using bitcoin or other digital currency. Fueled by the open source Counterparty Foundation, startups can create their own digital tokens representing various assets (such as shares of stock) and issue those assets directly to their crowdfunding shareholders’ bitcoin wallets. Although any startup can complete this process independently, there is a high amount of trust involved in these transactions, with a certain amount of risk on both sides of the equation. Startups like Tokenly are emerging to bridge the gap to make these counterparty equity transaction more secure, easy and transparent.
Improved Investor Certainty and Participation on the Blockchain
Digital currency innovation has become increasingly ambitious over the last few years. Ethereum, in particular, has created its own bitcoin derivative called Ether. The express purpose of Ether is not to supplant bitcoin as a digital currency, but to create a better way for the creation and exchange of tokens like crowdfunded equity shares. Because Ethereum is capable of creating an entire Democratic Autonomous Organization (DAO) on the blockchain, startups can basically automate the financial administration of their company, including equity shareholder participation. When a company needs to take a vote from shareholders, for example, the entire process can be completed within Ethereum by identifying shareholders via their unique shareholder token and thereby allowing votes to be cast digitally on the blockchain.
The result is that when companies choose to crowdfund on Ethereum, they can issue equity shares in the form of tokens with pre-set rules and goals regarding when and how much investors will receive returns based on their initial investment. Digix, a startup that backs shares of gold with cryptocurrency, was recently one of the first companies to crowdsale their tokens on Ethereum’s DAO. In just under 12 hours Digix reached its crowdfunding goal of $5.5 million, with investors receiving a token tied to a specific amount of physical gold. The exact same process can be applied to equity crowdfunding of all shapes and sizes, giving investors a verified share of the company along with certainty (based on public DAO rules) as to when they’ll see a return.
So what does it all mean for the future of equity crowdfunding? The point is that, while traditional crowdfunding might be fun and rewarding in an intrinsic sense, there are severe limitations on the extrinsic financial rewards investors can receive. With innovations like counterparty equity and DAOs on the blockchain, fintech innovators are already on the move to ensure investors get more from their crowdfunding efforts than just a free t-shirt.