Crowdfunding the Future

I’m very optimistic that computer technology will fundamentally change many aspects of modern society for the better. When it comes to real estate, tools such as Popularise already allow developers to solicit retail and other development concepts from the public. Taking that a bit further, a different tool, Fundrise, allows community members to invest small sums of equity into local development projects that they care about.

This bold new world of soliciting small investments online, or crowdfunding, seems to hold a lot of promise and is receiving substantial positive press. While I myself am eager for this trend to grow, I’m also somewhat afraid that crowdfunding’s reputation could take a blow as some investments inevitably fail to perform as predicted.

For example, look at this crowdfunded skyscraper project in Colombia. As impressive as it is that the internet has helped to organize 3,000 relatively small investors, what happens if the project faces problems during construction, doesn’t lease up, or fails to achieve its projected rents? Are these 3,000 investors adequately informed of the project’s risks, and how will they respond to losses if they are not?

While serving as a Peace Corps Volunteer in Albania, one of the first things I learned about was the country’s 1996-1997 Pyramid Scheme Crisis. Having lived in a command economy controlled by the country’s brutal and isolated communist regime for over four decades, the Albanian people were extremely unfamiliar with market institutions and modern capitalism. As a result, from 1991-1996, approximately 2/3 of the country’s population eventually invested large shares of their household wealth in a series of pyramid schemes that were unregulated and even promoted by their new government. When these schemes eventually failed, the country descended into anarchy, the government toppled, approximately 2,000 people died, and the country was set back decades as critical infrastructure was destroyed during persistent rioting.

Obviously, this Albanian example is an extreme one, but I think it’s effective at illustrating the risks that uneducated investors face with new investment opportunities. My fear is that the great potential of crowdfunding will be dampened by widespread media reports of a few examples of fraud that will almost inevitably occur at some point. While government regulation can certainly boost investor confidence and limit the potential of fraud, it’s possible that the same regulation could itself limit crowdfunding by making it overly burdensome to both investors and entrepreneurs. Balancing investor protection against transactional friction will be tricky for regulators–perhaps that is why the SEC missed its year-end deadline to create crowfunding regulations as obligated by the JOBS act.

While I hope that the right regulations will be developed soon, perhaps regulation alone isn’t the solution. Crowdfunding entrepreneurs and portals should proceed cautiously and transparently. To do this, investors should be given a platform to publicize the results of their investments and to rate the projects and developers that they invest in. In the end, the ideal solution to this technology-induced conundrum, ironically enough, might well be the effective utilization of more technology.

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