How Crowdfunding Can Prevent the Next GFC

It has been ten years since the 2008 recession hit the world market. The USA and Europe were worst affected as Wall Street crashed. With the collapse of the Lehman Brothers, the world was plunged into a completely different system of economy.

The 2008 recession was precipitated by banks who provided too many loans to people which they were unable to recover. They found out more and more complicated derivatives which resulted in a financial meltdown. Since then, regulatory bodies have made sure to reign in the banks. As a result, raising capital for small and medium sized businesses have become difficult.

Small and medium sized businesses are not given loans for various reasons. They are too small, too new and sometimes even misunderstood when they are a startup in Silicon Valley. Most startups run on fintech, computer generated algorithms and governments and banks do not have a clue about what these companies are dabbling in. As a result, these startups find themselves unable to raise the required capital.

After the recession however, there has been a stress on alternative ways of raising money. Since banks are not the best options to get loans from, many startups have resorted to crowdfunding. Crowdfunding in India and everywhere else has grown massively since the 2008 meltdown.

These crowdfunding platforms have raised more than $2.7 billion in capital in 2012. They are expected to raise about $90-96 billion by 2025. Equity crowdfunding is one area of the crowdfunding market which shows a lot of promise. Although equity crowdfunding is on hold in India and only accredited investors can invest in the USA, equity crowdfunding shows great promise.

There are certain things about equity crowdfunding that makes one hopeful that it might be able to prevent a global meltdown:

  1. It reduces the influence of mediators: The site where the crowdfunding pitch is made takes a part of the investment. However, this is nothing compared to the money establishments on Wall Street made during their heyday. One of the prime causes for the 2008 meltdown was lax lending particularly led on by the housing bubble.
  2. When customers defaulted on their loans, housing prices started falling resulting in panic until the entire housing industry collapsed and with it the major investment banks which sold bonds which could not be recovered. The shadow banking system too is considered responsible for precipitating this crisis. With the removal of middlemen and direct lending and investing, it can be hoped that small businesses at least will not have to bear the brunt when the next recession comes.
  3. While bigger companies are usually not thought of as raising money for through crowdfunding, they can do the same. As crowdfunding is becoming more popular, a lot of investors are shifting their assets to the equity crowdfunding market.
  4. Since many investors like to invest in bigger companies for the security it brings, it is expected that large companies too will take to crowdfunding at some point. When this happens, middlemen and other investment banks will lose a lot of business. This may or may not be a good thing.
  5. If the crowdfunding sector is well regulated, it is unlikely that crowdfunding will bring any damage to the economy. It is likely to benefit the economy more than harm it. It can create new business and jobs thereby creating a boom. However, if it is not well-regulated the mistakes made during the early to mid-2000s can be made again.

Fundraising in India is not enough to make or break a Global Financial Crisis. However, a sector can be a starting point for a larger meltdown. This is why emergent sectors like crowdfunding need to be well-regulated so that the benefits out of them can be maximized and harm minimized.

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