Wednesday, April 24, 2013

Crowdsourcing and Crowdfunding: What the handling of the aftermath of Boston Marathon's bombing, North Korea, the Statue of Liberty, and Nigerian email scams have in common.

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The decision by the FBI to invoke assistance from the public in sifting through the volume of images, photos and videos in search of the Boston Marathon bombing suspects was the most recent and visible example of crowdsourcing. More specifically, it was a Macro-tasking type of crowdsourcing, where a large task is presented to the public and each individual has the freedom to work on the solution as they see fit. Other types of crowd sourcing include Micro-tasking, Contests, and Crowdfunding.
In Micro-tasking, a large project is broken down into tiny tasks completed independently by a number of individuals. Amazon's Mechanical Turk or North Korean Mass Games are prime example of this type of crowdsourcing.

In Contests, a crowd is invited to work on a task but only winning or chosen entries receive compensation. On one end of the spectrum are sites for light-weight contests, like designing a logo, picking a tag line or a business name, such as SquadHelp or crowdSPRING. On the other side are heavy-duty sites like InnoCentive where solvers compete on challenges like Improved Asymmetric Synthesis of a 3,4-trans-substituted Piperidine or NASA's challenge for a Simple Microgravity Laundry System.

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Crowdfunding is one of the forms of crowdsourcing in which the crowd is invited to contribute monetarily towards an individual, goal, project, idea, etc. According to Nesta, the UK's innovation foundation, there were over 450 crowdfunding sites in 2012 with another 250 sites planned to go live in 2013.

At a high level, the business model for these sites is similar. The party seeking the financial contribution makes a pitch on the website describing how much they need, how the funding will be used, and what, if any, incentives they promise to the contributors. The potential backers sift through these pitches and individually or as a team decide to fund them or not. The crowdfunding site itself serves as an intermediary that facilitates the exchange of information and the transfer of funds for successfully funded ventures.

Obviously there are differences, driven by the type of contribution, incentives, motivation of funders, etc. Based on these differences, crowdfunding may be classified in the following four categories:
  • Donation. In this type of crowdfunding, the funders simply donate the money to support an individual or cause, without expecting anything in return. Perhaps the oldest example of crowdfunding belongs to this category. In late 19th century, France donated the Status of Liberty to the United States. Specifically, the donation meant that the French would cover the cost of building the statue and shipping it to New York. The Americans were responsible for preparing the site where it would stand and erecting the status there. A commission headed by Joseph Pulitzer was put together to raise the $300,000 estimated for the project. However by the time the statue was ready in France, they realized the commission had raised only $200,000. Pulitzer, through his network of newspapers, issued an appeal to the American public to donate in order to make up the shortfall. Within five months, $100,000 were raised from small donations, illustrating the tremendous financial power of the crowd if its interests are aligned. A typical crowdfunding site in this category today is gofundme. Within nine days of the Boston Marathon bombing, the site had raised $2,093,716 by 34,026 for its victims with an average donation of $61.50 per donor.
  • Reward. In this type of crowdfunding, the backers are promised a reward or incentive if the idea or project they are supporting comes to fruition. Perhaps the best known example in this category is KickStarter, where as of September 2012 over 65,000 projects had been submitted for funding and almost 44% of them were successful in raising a total of $300 million. KickStarter has an all-or-nothing model, in which projects are funded only if they raise all the money requested by the deadline specified. Other sites like IndieGoGo  transfer the money to the requestor as it is pledged irrespective of whether the target is met or not.
  • Lending. In this type of crowdfunding, the backers lend the money, typically in small chunks, to receivers who pay it back with interest over a predetermined amount of time. The interest rate typically is tied to the borrower's credit history. One of the most popular personal lending sites is Lending Club, which since its inception in May 2007 has handled over 1 million loan requests, approving 12% of them for a total loans amount of over $1.65 billion and almost $142 million in interest paid to investors. (Source: Lending Club, accessed on April 24, 2013.) While potentially these lending sites can be used by entrepreneurs and small business owners, in reality most of the loans (almost 80% of them in the case of Lending Club) go to consumers for debt consolidation and to pay credit cards with higher interest. An interesting twist on the concept is People Capital, which offers loans to college-bound students based not on their credit score, which most of them have not established yet, but based on their future promise. Yet another twist to the model are micro-financing and social landing sites, like the non-profit Kiva, where loans are used to fight poverty and support social causes in emerging markets.
  • Equity. In this type of crowdfunding, entrepreneurs and small business owners are matched with investors to raise money for their business as an alternative to seeking angel investments of venture capital backing. Because the transactions here qualify as equity purchases, they are subject to legislation and regulatory controls, which often is an impediment to the growth of these platforms. This is perhaps the reason why the leading sites in this category are European based, including Symbid, and crowdcube. The passing of the Jumpstart Our Business (JOBS) Act in the United States on April 2012 is intended to encourage funding of U.S. small business by easing various securities regulations, so we should expect Equity crowdsourcing platform targeting U.S. business pretty soon.
  • Scams. Like any other human endeavor, crowdfunding can be used for illegitimate or dishonest purposes as well. I am not talking about abuses of the platforms described above but schemes intended from the ground up to defraud people of their money. Examples are numerous here, including Nigerian emails, Ponzi schemes, fake donation sites that pop up after each tragedy, to name a few.
In conclusion, crowdfunding, as a model of capital distribution, is not new. But the convergence of mobile, cloud and social networking technologies has turned this model into a serious alternative to traditional banking, investment, VC and charity models.

I hope this overview is useful to you in understanding the space. If you have time, follow some of the links I have embedded and get involved. Support a project or idea you find worthy of your backing. if you happen to become inspired and come up with your own project, don't forget to send me the link so I can support and promote you.