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How Blockchain Technology And Decentralization Will Revolutionize The Crowdfunding Industry

Before the blockchain and the crypto buzz started, crowdfunding portals were the most common example of decentralization in the financial markets. Those portals help investors or donors to discover interesting projects and to invest or donate money to those specific projects.

In the case of securities, the crowdfunding process is called crowdinvesting and it concerns the purchase of shares of the issuing entity, usually start ups in an innovative sector. In this case the crowdinvesting portal is not selling directly shares, but just connecting the investor with the issuer. Would the crowdinvesting platform want to directly issue securities, it would require a regulatory authorisation as a security broker or issuing house.

The procedure for selling securities through a crowdinvesting platform is therefore complicated since it requires the platform to collect the money (but without owning the securities) and to transfer the money to the issuer. It also requires the platform and the issuer to take care of the registering process of the investor as shareholder and the transfer of the shares to the investor.

How blockchain can revolutionize this procedure

Thanks to the features of cryptocurrencies and atomic swaps, decentralized exchanges are already today offering to their users a peer to peer exchange of two digital assets, without the need for a third party.

This technology was also used to launch ICOs. In fact, the only difference between an ICO and a crowdinvesting campaign is the fact that in the first case we use a token which is not a security, while in the second a non-digital security. If we create a token representing a security, we can use the same procedures used for ICOs in order to improve the crowdinvesting processes.

This is already a big step forward compared to how crowdfunding platforms run today since by introducing decentralized processes, in any step of the procedure the asset will be held by a third party. The transfer of the security token and the payment token will be executed by a smart contract acting as an escrow and ensuring the smooth and automatic execution of the transaction, with great reduction in time and costs. This would be very helpful for all securities which are not representing shares (due to the fact that for shares there is the need of a shareholder register, see next paragraph).

Moreover, if the decentralized platform is only used to issue securities on the primary market, that is the first issuing to the public, there are no authorisation requirements, or a minimum if compared to those required by security brokers or issuing houses, due to the fact that the platform is not holding any security in custody, but only helping the issuer in the sale of the security.

Concerning shares, there is a remaining obstacle before creating a completely automatized transfer of equity. In order to combat money laundering, the Financial Action Task Force, an international organisation which drafts AML recommendations for the governments in order to create a level playing field, requires the identification of the shareholder, even in case of bearer shares. Therefore, by issuing digital shares, the issuer will have the ability to identify the investor.

This is not a big obstacle in the primary market, but since a digital asset can later be transferred to a third party without any intermediary executing a KYC, the AML requirement could create some obstacles. Those may be solved according to country specific legislation as well as technology. In Switzerland for example, bearer shareholders have a duty to communicate their data to the company, if they do not want to lose their rights when a company is divided. From a technology point of view, it is also possible to create tokens which require KYC before transferring.

The advantage of using a blockchain based token for issuing security is relevant also for another reason. In the normal crowdinvesting procedure, once the issuer has to pay a dividend, it will need the services of a bank which will execute the payment, an activity which is not executed without costs. By having a digital token the issuer can execute directly the payment in crypto (which can include also stable coins in order to avoid volatility), saving up on banking fees.

One of the first blockchain companies which is transferring its ICO experience to the crowdinvesting model is Eidoo. The well-known wallet provider, which has helped launch different ICOs in the past and has recently also launched its decentralized exchange, is rapidly moving into the crowdfunding industry and is planning to add to its application a section reserved for the issuing of security tokens on the primary market.

Once operative, the Eidoo app will allow the creation and issuance of security tokens, while the investors will be able to perform the KYC, purchase the security tokens and store them on the decentralized wallet. Every process will be done automatically, without any intermediary, with the involved parties always remaining in full control of the involved assets.

This is a new era in crowdfunding and will facilitate and democratize even more the collection of capital for startup companies.

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