Capitalism is an economic system that has been adopted as the ultimate formula of success by the biggest economies in the world. One visible feature of a Capitalistic system is that it allows every business and individual to draw loans to start their project within a suitable time.
Hence Capitalism has given birth to commercial loaning that includes options like crowdfunding. With the blockchain changing every aspect of the financial ecosystem, it also means that blockchain enthusiasts have taken the central idea from traditional crowdfunding and upscaled it.
What is Crowdfunding?
When it comes to running a business, having sufficient funds can be a huge help. However, there are many businesses and business people who have the idea and expertise but lack the necessary capital to back their dreams. Under such circumstances, the startups can organize a crowdfunding event where they allow interested investors from related sectors to measure the feasibility of their business enterprise and support it financially.
The funds raised during a crowdfunding event are treated like a loan by the business and they are under a legal obligation to generate profits and return these funds to the loaners with an added interest and share of profit.
Five Types of Crowdfunding
Crowdfunding is not as simple and easy a financial option as it may seem at first glance. It is worth noting that the participants of crowdfunding have several legal obligations that are monitored by financial regulators of the region. Based on the nature of business and the classification of investors, there are several different types of Crowdfunding events. Some of the most common types of crowdfunding are listed as under:
Reward crowdfunding is the type of event where the investors put their money into a business idea or a startup as a donation. It means that they are not entitled to get back their investment amount however, they can gain some rewards issued by the receivers. In many cases, the perks or rewards of the donation can be an executive position in the company or something as small as the power to attend all their future events for free. In some cases, rewards can also be in the form of a free supply of products or services issued by the business. There are also some cases, where rewards are granted in the form of goodwill and recognition only.
Donations are the type of crowdfunding campaign that invites investors to submit money for a charity cause. Many non-profit organizations can organize such events to make sure that they can raise money for humanitarian causes. The philanthropists who are financially well-off can make sizeable donations at such events that are also sometimes counted as a tax write-off. The crowdfunding participants in this case usually do not receive any perks or benefits from their donations.
Debt is one of the oldest forms of loaning that becomes a crowdfunding event when a commercial enterprise asks for a loan from the public or commercial entities. In this type of crowdfunding, the contributors are entitled to receive their original investment back from the business after a predetermined period.
In addition, the contributors also get to receive an additional interest return from the businesses. The contributors in Debt crowdfunding are expecting the business that they are investing in to make a profit with their funds. Therefore, the investors in this case conduct in-depth research and evaluation of the business in question before committing their money.
Unlike stocks and securities, crowdfunding events do not grant ownership rights to their investors. However, some businesses can offer an ownership stack in the company by completing the necessary legislative documentation. It means that the investors in this type of crowdfunding event would be able to share the net profit of the startup based on their financial contributions. Crowdfunding can issue ownership right by granting donation privileges or rewards to their investors.
The invention of the internet has affected every aspect of human life. In the same manner, it has also shaped crowdfunding events. Since the start of the dot com era, several people have laid the foundation of online crowdfunding. The trend was started by The Million Dollar Homepage which was a website set up in 2005 by Alex Trew to support his future education. Today, there are several popular and dedicated crowdfunding platforms like GoFundMe, Kickstarter, LeadingClub, and Indiegogo among others.
What is Blockchain-based Crowdfunding?
A blockchain is a decentralized financial ledger that is used for issuing cryptocurrencies and keeps a federated record of financial transactions. Blockchain has also given birth to DeFi or decentralized Finance which is the reflection of all the traditional financial functions with the addition of blockchain innovations.
Blockchain enterprises have adopted the crowdfunding idea and upgraded it to the next level inviting more users from every part of the world to participate as investors and create financial gains. The DeFi or blockchain crowdfunding event has the same basic idea as traditional crowdfunding. However, this type of crowdfunding is done using the blockchain for keeping all the financial records and it is directed at tech companies or startups that are working with blockchain or DeFi-related projects.
Terms of Blockchain Crowdfunding
At first glance, it can seem like anyone with a business idea can go ahead and ask for investors to put their money into their dream projects. However, qualifying for financial assistance from investors who are looking to turn up a profit is everything but an easy task. Many professional investors are in the market looking for potential business ideas.
However, these investors want to make sure that their investment does not drown and therefore they conduct detailed research on the crowdfunding hosts and their business models. Here are some of the most basic requirements and terms for crowdfunding qualification:
- The blockchain project should have a solid technical background presence on paper and online.
- The creators of the blockchain should possess the qualification to lead a project and handle all the technical aspects of the DeFi network.
- The startup looking for investment should have a qualified founder or a group of founders with an original and unique concept.
- The blockchain enterprise should have the correct legal backing and documentation such as patents and regulatory compliance on their side.
- The investors are also looking for a feasible business plan that contains a realistic projection of important factors like risk management, expansion, business development, and a market survey among others.
- The investors only show interest in projects that offer blockchains that are ready for mainnet launch or already in operation.
- The blockchain should have a functional governance voting model that allows them to track the information about all the other investors related to the project.
- The blockchain governance model should also possess smart contracts that are set to issue proportionate profit shares to the investors and other stakeholders.
- Blockchain crowdfunding can only succeed when every milestone has been defined and reflected in the governance model, at least for the short term.
- Blockchain crowdfunding also can issue a dedicated portion of the whole investment based on the number of milestones achieved.
- Blockchain crowdfunding can also accept donations and equity funds at the same time depending on their investors.
- Blockchain crowdfunding also has the option to offer more than one event at a time depending on the number of dApps running on them.
- Blockchain crowdfunding also comes with an escrow wallet that only issues the next round of funds if all the investors vote in favor of it.
- Investors can also use cryptocurrencies to lend their financial aid to the projects that are using blockchain crowdfunding.
- DeFi platforms can explore the investors present on other DeFi protocols on the same blockchain or parachains to explore the option of becoming their potential investors.
Types of Blockchain Crowdfunding
Now that all the prerequisites of blockchain crowdfunding are clear and well-defined, it is time for the reader to learn about its various classifications and types. There are currently two basic types of blockchain crowdfunding. However, the developers are working on introducing new types of loaning methods into the space using blockchain technology.
Initial Coin Offerings
Initial Coin Offerings or ICOs are the types of crowdfunding events were the founders of a new DeFi project issue cryptocurrencies to their investors. In this model of funding, the DeFi project can invite investors from all parts of the world who can become a potential investment in the business.
In exchange for their financial investments, the investors can qualify for a reward of a certain number of cryptocurrencies that are related to the cryptocurrency project in question. However, ICO token issues do not grant ownership in the DeFi startup to their investors.
Investors can opt to transfer their investments in the form of cryptocurrencies or fiat. Smart Contracts play a central role in ICOs by issuing cryptocurrencies to the investors automatically following their investment ratio. The investors of ICOs are expecting to generate income by waiting for the distributed digital currencies to gain traction and experience price inflation. The distribution of cryptocurrencies during ICOs against funds is also known as token sales as the investors are essentially paying for acquiring a new token.
Initial Exchange Offerings
Cryptocurrencies are one of the primary byproducts of a blockchain. Cryptocurrency exchanges are another product of the blockchains that allow digital investors to purchase, sell, lend, borrow, and exchange different types of cryptocurrencies. Just like ICOs, IEOs or Initial Exchange Offerings are the type of cryptocurrency projects that are gaining traction among cryptocurrency investors on account of better security. On account of scams and the high price volatility of cryptocurrencies, ICOs are seen as a very risky investment option.
However, IEOs allow cryptocurrency investors to participate in the sales of a new token using their exchange platform. It means that IEOs is responsible for conducting financial research on account of the individual investors with limited resources of a particular DeFi or blockchain startup.
The cryptocurrency exchange is also responsible for conducting AML/ KYC for its investors. The better cyber security protocols, financial auditing, legal screening, and regulatory compliance check of a cryptocurrency exchange before listing any new cryptocurrency project grants better investment safety in comparison to ICOs.
Challenges in Blockchain Crowdfunding
Crowdfunding in blockchain has created many new solutions for the tech and DeFi businesses. However, it does not mean that the blockchain crowdfunding formula is perfect. On the contrary, blockchain crowdfunding events can face so many new challenges that require deliberation and solutions. The cryptocurrency investors who wish to make a profit by investing in a blockchain crowdfunding event must first learn about its challenges. Since learning about the problem is many times half the solution. Here are some of the most common challenges in blockchain crowdfunding:
Cryptocurrency scams are rife when it comes to DeFi crowdfunding events. Some of the most destructive and damaging cryptocurrency scams happened in the guise of an ICO. Satis Group claims that around 80% of all cryptocurrency ICOs were identified as scams.
Some of the biggest ICO scams are Pincoin and iFan, Plexcoin, Bitcard, Benebit, Bitconnect, and others. Estimates by Fortune Jack claim that ICOs have caused a loss of $687.4 million thus far. Due to the high frequency of ICO scams regulators and cryptocurrency investors have developed an untrusting stance on most blockchain crowdfunding projects.
A big downside of blockchain crowdfunding is that just about anyone with a little knowledge of computers can create a new token. The person who has created a new token does not have to be an expert programmer or possess any financial or investment knowledge. It means that anyone willing to dupe investors can organize an ICO with promises of fake returns and create the façade of a successful DeFi startup.
With the help of the internet, it is also possible for scammers to disappear without a trace of the funding. There are also many cases, where the investors are unable to get the real name of a new DeFi project and still proceed to invest in it. Just about anyone can organize a blockchain crowdfunding with no merit or credibility.
Even when the blockchain crowdfunding organizers are sincere and qualified, the protection of the investor’s interest is not an easy task. The cryptocurrency market is rife with competition and the market is subject to frequent ups and downs. It requires a lot of effort and dedication to making a new cryptocurrency project popular enough to get suitable investment interest.
On the other hand, the blockchain startup founders are unable to control factors like the unprecedented price volatility of cryptocurrencies. Cryptocurrency markets also depend heavily upon market speculation, it means that a little mishap is enough to shake the confidence of investors and drown the whole project in a matter of a few hours.
Unlike traditional enterprises, Blockchain crowdfunding events do not have the backing or supervision of any financial regulatory authority. It means that in the case of a scam, the investors might not have proper legal evidence or pretext to sue or investigate the project.
DeFi allows investors to commit their funds anonymously and the business startups can also keep their real identities private. Therefore, in case of a scam, hack, market crash, or poor management, the investors cannot track down the fund receivers or identify them.
The ICOs are considerably vulnerable to hack attacks on account of their lack of sufficient funding from the start. When a blockchain enterprise does not have enough resources, they are less likely to conduct a professional technical audit of their project or hire a dedicated team of cyber security personnel to safeguard their DeFi project. It means that the cryptocurrency project under question is still vulnerable to hack attacks and it now contains a considerable amount that has been committed by the investors making it a prime target for threat actors. Therefore, the investors need to consider the cyber security protocol before investing in the product.
Lack of Education
A considerable number of cryptocurrency investors fall for scams and unqualified blockchain crowdfunding events since they lack education. Despite being around for more than a decade, blockchain is not part of academic education in the public schooling system and other academic institutions.
Therefore, the technical and financial awareness around blockchain and ICOs are considerably lacking and limited. A person with limited or non-existent nature around cryptocurrencies is unable to reasonably project the financial success of a DeFi startup or identity a potential scam.
Blockchain crowdfunding allows investors to participate in some of the biggest cryptocurrency and DeFi projects in the world without any discrimination. However, investors must educate and research the DeFi enterprise before investing any money into it. Developers and programmers are trying to come up with alternatives such as IEOs to make blockchain crowdfunding a more secure and inclusive financial avenue.
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