Law, Trust, and the Development of Crowdfunding

Crowdfunding, also sometimes referred to as alternative finance, has been rapidly growing around the world. The average growth rate in global crowdfunding is over 200% per annum, one of the fastest rates of growth of any type of financial innovation documented in recent history. Despite this, there is no literature analyzing the determinants of growth of crowdfunding, the diversity of business models, or their evolution. My study analyzes the economic determinants of crowdfunding around the world. Drawing on a unique survey-based global database of the volume of crowdfunding, the paper documents the volume and determinants of crowdfunding in 152 countries across the world, covering a total of 1,362 platforms. The study covers four distinct types of crowd finance business models – debt platforms for debt lending, equity platforms that allow firms to raise financing from investors, reward-based platforms where funders promise backing in exchange for non-monetary rewards, and donation platforms.

I investigate three dimensions of crowdfunding. The first is the overall transaction volume and number of platform business models originating in different countries. Of the total global volume of crowdfunding ($139 billion in 2015), China, the US, and the UK form the three largest markets with around 74%, 20%, and 4%, respectively, of global volume. The same pattern holds when I examine the number of platforms. 41% of all crowdfunding platforms originate in developed countries, while 59% originate in emerging markets. However, the largest portion of the emerging market volume is in China, which accounts for 29% of all platforms globally. The remaining 124 emerging markets are tiny, accounting for only around 0.3% of global crowd financed volume.

The second dimension is the split between volumes on financial and non-financial return platforms. 98% of global crowdfunding platforms are debt or equity platforms that investors use to earn financial returns. The volume of financing obtained through reward- or donation-based platforms is comparatively minute at 2%. However, the relative proportions of financial and non-financial volumes vary considerably between regions. In developed markets, non-financial return-based platforms form a very small fraction of total volume while in contrast, in emerging markets, the corresponding volume is much larger.

The final dimension is the cross-country variation in the type of financing on financial-return platforms. Worldwide, debt-based platforms are dominant with 96% of global crowdfunding volume originating on these platforms. However, the overall number again conceals a great deal of cross-country variation. In developed markets, for example, debt markets account for 94% of total financial return transaction volume, in contrast to 82% in emerging markets.

These results suggest two major conclusions. First, a large body of theoretical and empirical literature suggests that the expansion of financial systems is important in affecting economic growth and poverty in developing countries. Several authors have suggested that crowdfunding is a form of innovation that is likely to have the same impact on market expansion and economic development as mobile phone penetration or microcredit. However, the evidence shows that crowdfunding is largely a developed market phenomenon.

Second, the law and finance literature has argued that the extent to which a country’s laws protect investor rights, and the extent to which those laws are enforced, fundamentally determines how corporate finance and corporate governance evolves in that country. However, both the financial policies studied in the prior literature and the legal regimes have co-evolved over long periods. Hence, while the prior literature documents correlations between legal regimes and forms of financing, it is difficult to convincingly argue that the legal regime causes forms of corporate finance and governance to evolve. Crowdfunding is a new form of financial innovation that has rapidly increased in popularity in a very short period over which the legal systems have not adapted to these financing types. Hence, it is easier to attribute a causal effect to legal regimes in determining the volume and types of crowdfunding. However, I find no relationship between the type of legal regime in a country and crowdfunding volume.

Instead, I find that a country’s control of corruption and quality of regulation are significant factors in the volume of crowd financing being carried out. Crowdsourcing volume declines when it is easier to do business in a country – suggesting that crowd financing volumes are tied directly to high costs or other obstacles in pursuing traditional channels.

Raghavendra Rau is the Sir Evelyn de Rothschild Professor of Finance at the University of Cambridge.