If Crowdfunding is the New Day Trading, Look Out

http://blogs.hbr.org/2013/09/if-crowdfunding-is-the-new-day-trading-look-out/

by smit • 13 years ago

46 32 13 years ago

blogs.hbr.org

brey• 13 years ago

If you don't know who the sucker at the table is, it's you.

JonSkeptic• 13 years ago

Exactly. Crowd funding is an ideal source of capital for con artists.

"We are a team of Nigerian Bankers, and with your donations we will raise enough money to give you double what you contribute!"

"We are a team of scientists who have discovered this one wierd trick that the medical community doesn't want you know about. If we meet out goals, you can receive the new wonder pill that adds 3 inches to your penis!"

The future's gonna be interesting...

ISL• 13 years ago

It'll be much like the past.

dvanduzer3• 13 years ago

Gambling is a zero sum game. Global economic growth (in theory) isn't.

showerst• 13 years ago

I disagree that just because most people who day trade lose money, that wider access to the markets is a bad idea.

I'd rather have the option to enter a market when the odds are against me than not have that option at all.

wfrick• 13 years ago

Related to this, I do think the question of what should or shouldn't be legal is a bit of a separate question. Of which this data is only one part. (to be transparent, I'm the author of the post)

badman_ting• 13 years ago

Well, I'm not sure if the author is saying that the access period is a bad idea, or that availing oneself of it is a bad idea.

I would certainly agree with the latter. As for the former, we already have a lot of ways for people to throw their money away, so why not one more. Literal actual gambling is legal in many places, perhaps even most, so I don't think I could argue against this form of gambling being available too.

fiatmoney• 13 years ago

I see an interesting parallel of "crowdfunding" to MOOCs. The original (private capital / high-prestige colleges - or their synthesis in Harvard, a hedge fund with a university attached for tax purposes) is a clubby self-dealing arrangement designed to preserve a certain level of oligopoly profits. The cheap substitute gets held up as a way for the average person to buy into that system, when it's really a way to dump an inferior product on the public with the same brand and none of the private advantages that make it worthwhile in the first place.

ig14• 13 years ago

That's a straw man arguments, I don't think anyones claiming that doing courses on Coursera is the equivalent to a Stanford degree. Certainly the universities aren't.

shubb• 13 years ago

But they are charging plenty of money for University of Phoenix Online courses.

The statistics, that a disproportionate number of graduates from Phoenix and places like that are unable to make student loan payments, tell you that they are not returning on investment for those students.

If you are poor, and study very hard, it is possible to win a scholarship at a reputable college, and achieve social mobility that way. Pretending that people who have not worked hard enough to win a scholarship can become middle class by taking out a loan is a dupe. They would do better to join the army for that purpose.

ig14• 13 years ago

Crowdfunded equity investments should be treated as gambling, don't do it unless you're willing to lose money.

Over half of traditional angel investments don't return the investors money and 90% of the returns come from 10% of the companies. These are traditional angels who are well connected, do due diligence, etc.

With crowd-funding from the start you face an adverse selection problem, a lot of the "best" looking startups are going to take money from well respected angels and are going to fill up their seed rounds long before they need to turn to crowd-funding. So with crowd-funding you're left trying to find the good companies (which there are significantly less) which aren't obviously good from a surface analysis.

So rather than 10% of the companies returning 90% of the returns with crowd-funding it might be closer to 5% or 1% of companies (only time will tell us the exact numbers).

jonnathanson2• 13 years ago

Exactly, and it is really hard for me to see a scenario in which this whole thing ends well. It's basically inviting a huge pool of suckers to the table, gambling on terms set by the dealers, with payouts engineered and controlled by the dealers.

Just about the only way for this to work, without causing a ridiculous speculative bubble, would be to force increased transparency of the financial documents of private companies (thus blurring the lines between private and public, which is opening a can of worms in its own right).

Success in angel investing is predicated on two things: 1) access to the best deals on the best terms, and 2) enough capital to absorb losses in search of outsized hits. Retail investors have neither of these things going for them, so what they're doing amounts to little more than playing roulette.

ig14• 13 years ago

I still think it should be legal. After all you can take $10k and spend it at a Casino, there's no reason you shouldn't be able to gamble it on a company.

Although there are other reasons for investing other than financial returns, for example you believe in the mission of the company or you want to be a customer of the business.

jseliger• 13 years ago

Crowdfunded equity investments should be treated as gambling, don't do it unless you're willing to lose money.

Definitely.

I wonder about the extent to which crowdfunding is optimal for situations like startups versus the extent to which it is optimal in other fields, like real estate development (http://www.slate.com/articles/business/moneybox/2013/06/fund...).

Still, based on my reading of A Random Walk Down Wallstreet and The Millionaire Next Door, most people doing retail investing do not beat the market.

The good news in the case of crowdfunded equity investments, however, is that even if 90% fail, that last 10% may pay for some really cool stuff that wouldn't exist without the crowdfunding, in much the way that Amazon is enabling lots of people to publish shitty ebooks but it also enabling a small number of important books that wouldn't have gotten traction in the conventional system to get traction.

breckinloggins• 13 years ago

The nice thing about Crowdfunding is that, like traditional trading, motivations vary.

For example, I recently backed the Infrared Human Vision study on Microryza [1] simply because it sounded like cool research. I backed the Ubuntu Edge even though I knew it would most likely fail to reach its funding goals because I wanted to send a message that there's a market for a "pocket to desktop" convergence device. I sent a few dollars to Oculus on Kickstarter because I wanted to see that become reality.

I'm not naive... I know that as this gets bigger there is going to be room for technical trading, abuse, and an emergence of some myopic thinking similar to the "quarter-by-quarter" tunnel vision that plagues public companies on Wall Street. But the thing I like the most about crowdfunding is that it takes this long-standing idea of "principled investing" and really lets you put your money where your mouth is.

[1] https://www.microryza.com/projects/can-we-biologically-exten...

arbuge• 13 years ago

> The nice thing about Crowdfunding is that, like traditional trading, motivations vary.

Most certainly they do but I'm guessing that a large chunk of the crowd will be going into this thinking it's a surefire way to make money.

dvanduzer3• 13 years ago

I've been advocating Crowdfunding for years, but specifically with the assumption that it would be a mechanism to help the middle class diversify their investment portfolios.

The questionable wisdom of this assumption has been pointed out to me several times. So just now, I looked up the stock market crash of 1929, and it tells me that only 16% of U.S. households were invested in the stock market at the time. The bigger problem (ostensibly) was that commercial banks were too heavily leveraged in the market.

So we get Glass-Steagall and the Securities Act of 1933 out of all that. The "separate commercial and investment banking" clauses come out of the former. The "accredited investor" clauses that prevent true crowdfunding come out of the latter.

In 1990-something, Clinton weakens Glass-Steagall. In 2012, Obama signs the JOBS act, which weakens some "accredited investor" parts of the SEC.

So now, in retrospect, are we more worried about a weak Glass-Steagall after 2010?

Or are we more worried about policy that would have only protected 16% of households in 1929, and since then, has excluded ~99% of Americans from early stage investment?

edit: a $1,000 investment at Google's IPO would be worth $10k today. however, a $100 investment early in Google's history would also be worth $10k today.

pcowans• 13 years ago

From the article: "To be clear, Malik isn’t talking about Kickstarter where funders make a donation that acts like a pre-order. He’s talking about the public buying stock in private companies, something that may soon be legal thanks to the JOBS Act..."

wmf• 13 years ago

I think breckinloggins's point was that people may be willing to make equity investments for reasons other than profit.

(Now I'm wondering whether startups will be allowed to offer rewards in exchange for funding, leading to more "X is not a store" backlash.)

presidentender• 13 years ago

I'm worried that crowdfunding will lead to serious malinvestment, with large numbers of naive investors throwing money at a thousand Fakeblocks and Colors.

sharemywin• 13 years ago

Non-acredited investors are only allowed to invest 5% of their income. If grandma aint't got no income she ain't losin' alot of money. As long as all transaction go through marketlaces and the marketplaces are forced to validate the limits. Then no one is losing their life savings. Personally, The better option is to force the state lottos to inact the 5% limit and worry about the crowdfunding.

ChuckMcM• 13 years ago

Wow, this editorial exactly parallels my concern. Basically people chasing outsized returns getting fleeced by the bottom of the barrel type pump-n-dump types.

Here is my thesis, there exists a significant number of people who attempt to exploit people's desire four outsized returns using illegal "pump and dump" schemes where they pump up the value of a penny stock and them dump their shares to the unwitting victims. This is illegal and they get hunted down and sometimes caught. Now we'll have a "perfectly legal"[1] way for these same folks to create the illusion of an outsized opportunity. And that will create dark versions of wefunder type companies which are focused not on enabling the next generation of entrepreneurs but instead in fleecing the next generation of technology "investors".

[1] "Perfectly Legal" - code for a way to take money from someone where they cannot get it back, and yet had they known all of the facts would never have handed it over in the first place.

chamblin• 13 years ago

This disdain for "common" investment is over the top.

A much bigger concern than the potential for poor decisions by individuals is the creation of financial instruments that are, by government fiat, only available to an elite group of institutional investors and the otherwise-wealthy.

cowsandmilk2• 13 years ago

This disdain for "common" investment is over the top.

Completely agree. After pointing out that the institutional investors are clueless and lose to the market, he then says that only the little guys should stay out of the startup space. Honestly, many of the reliable indicators for Venture Capital are available to the public (eg past success). No reason to keep the little guy out.

cowsandmilk2• 13 years ago

Expanding a bit, HBR argues:

pouring more capital into VC has historically led to lower returns

Why this is unexpected is beyond me. More money should mean more competition. He's essentially arguing that we should allow VCs to keep exclusivity on the market because historically their returns have gone down as exclusivity has decreased.

There may be argument that the startup market may have more scams than the public markets and so on, but the author at HBR is not arguing that. He's arguing that a natural function of opening up a market is a bad thing because it provides less returns to the existing players.

bayesianhorse• 13 years ago

What they are describing doesn't sound like crowd-funding at all. It looks more like advertized private equity with dramatically lowered quality standards.

It does not sound as if "accredited investors" would necessarily include a lot of people, especially when people know that the risk is worse than in the usual stocks.

abalone• 13 years ago

I'm a little surprised at HBS, this is not a very well thought out commentary.

People like to say startup investments are "like betting" and it's true to a certain degree -- it's very risky and odds are against you. But what separates it from more popular forms of betting (casinos, lotteries) is...

You have to hold on to your investment for many years.

The timeframe on returns is a huge difference between day trading and early stage investments. Day trading was a very close approximation of off-track betting. It had similar psychological dynamics driving it. You win some, you lose some, you keep coming back for more, you think you can beat the odds tomorrow if you just get some money together.

Those addictive dynamics don't play as well over a timeframe of 5-10 years. It's like buying a lottery ticket for 2020. Not as addictive.

I'm not saying there are no downsides to unsophisticated investing. Just that day trading is a poor comparison.

If Crowdfunding is the New Day Trading, Look Out

Related Stories