Crowdfunding Is a Truly Disruptive Innovation

A blog about business and economics.
May 29 2013 2:00 PM

"Crowdfunding" Is a Real Disruptive Innovation—for Better or for Worse

fundrise
I now own a small share of this shell.

Image from Fundrise.com

The (absurdly named) JOBS (aka Jumpstart Our Business Startups) Act hasn't really been phased in yet, but when it is it's going to become a lot easier for vendors of exotic financial products to market themselves loudly and publicly. In principle, for example, you might see a hedge fund buying ads on Fox News to try to get money from the people who are currently targeted by all these "buy gold" ads. But Mariah Summers writes that there's little evidence hedge funds actually want to do this. So does that mean the JOBS Act is going to be a big bust that changes nothing?

The hedge funds that exist today have a perfectly good business model. Despite (or perhaps because of) the fact that the returns to hedge fund investors aren't very good, the people who run hedge funds are making plenty of money. And they make it in part through the allure of privacy, prestige, and exclusivity. Mass marketing would be somewhat costly, not very useful, and arguably counterproductive. These are investment tools for the in-crowd, not for the chumps buying gold coins off cable.

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But that doesn't mean nobody is going to crowdfund. It just means the crowdfunding will be done by whole new operations. Fundrise, for example, is a company whose idea is to sell small (as small as $100) shares in urban infill real estate projects to the public. They've been doing this thus far through a rather laborious regulatory process and are very much looking forward to the promulgation of laxer rules that will let them publicize their offerings in a simpler and more effective way. And the whole point here is to do projects that the large pools of money don't want to do. Initially, at least, you wouldn't be competing with those big funds. But like anything disruptive, if it works it will grow in scale and sophistication over time to the point at which almost nothing is financed by heavily intermediated fee-laden large pools of capital.

But note that while Fundrise is aimed squarely at everything I think is awesome (and, indeed, I bought a few shares in this project) even though the Web makes crowdfunding feasible, it really does nothing to dispel the worries that prompted the regulations the JOBS Act is repealing. There are already a lot of bad investment vehicles out there and a lot of small investors making terrible decisions with their money. Opening up the doors to more marketing of a wider array of financial products is likely to lead to a lot of people making a lot of really bad investment decisions. At which point the question becomes what does it crowd out? When I invested with Fundrise, I made sure to take the money out of the "consumption" side of my household ledger—make a risky and totally unproven real estate investment rather than buying a new suit. Insofar as crowdfunding crowds out more-or-less frivolous expenditures—at a minimum, "investing" might be more fun than playing the slots—this will be unmitigated change for the better. But sooner or later someone's going to end up swindling someone out of their life savings and there's going to be a big backlash.

All in all, I think we've rarely seen so much promise and so much peril all rolled into one underdiscussed piece of legislation.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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