Therefore, from the perspective of growth-oriented companies, funding opportunities that are complementary or alternative to bank financing, such as risk and equity finance (i.e. bond markets, crowdfunding, venture capital) have increased their importance. Equity crowdfunding is especially important to finance the growth of technology-intensive businesses and innovative companies in general. This is even more relevant when a company is looking for new markets or planning to develop new products. Palmer has concluded in his study that the price of the (crowd) funding (i.e. associated costs) is not the main reason why some companies decide to use crowdfunding instead of traditional sources of finance. The main reason for companies to avoid bank-based financing is, according to Palmer, to avoid the heavy bureaucracy involved in dealing with banks in the first place (Palmer 2016).

The prevailing (zero or even negative interest) market conditions have also forced investors to look into new channels for investments providing high yields with higher risks, which have not been available from traditional sources of finance, such as banks balance sheet financing or capital markets in general. Both loan and investment-based crowdfunding include many opportunities for investors looking for investments with different return-to-risk ratios. From the investors' perspective, crowdfunding also offers a new way to diversify investments and seek higher than average profits with a higher risk profile compared to more general investment products available in the market. However, the several hundred years old banking institution is unlikely to vanish any time soon. On the contrary, there is strong indication that some leading business banks have established successful partnerships with crowdfunding platforms and other fintech companies (Nordea 2018; BBVA 2019; Deloitte 2019).

## **What Next?**

The Fourth Industrial Revolution is underway. According to Statista—a German online portal for statistics, which makes data collected by market and opinion research institutes and data derived from the economic sector and official statistics available—there were about 26 billion devices connected to the internet around the world in 2019. The total installed base of internet connected devices is projected to amount to 75.44 billion worldwide by 2025, a fivefold increase in ten years. The internet of things, enabled by the already ubiquitous internet technology, seems to be the next major step in delivering internet's promise of making the world a connected place (Statista 2019). Currently it seems that artificial intelligence, machine learning, and the internet of things will have the most effect on the financial sector (Deloitte 2019). Digitalization is currently shaping the financial market sector with a force that has not been experienced in this scale before (Chambers and Dimson 2016). The disruption we are currently witnessing means a development during which many existing policies might be abandoned, and new ones adopted within a relatively short term. This has become even more evident after the outbreak of COVID-19 virus and how it has forced governments, institutions and companies to adopt to new and digitalized ways of working.

The financial market has, throughout its history, experienced tremendous economic and functional breakthroughs and changes, but basic operating models have remained largely unchanged, unlike, for example in industrial and service sectors (Atack and Neal 2009; Chambers and Dimson 2016). However, digitalization and technological advancement have significantly changed people's behaviour since the beginning of the twenty-first century. The virtual world has entered into all aspects of human life, and modern devices (such as tablets, mobile phones, smart watches, etc.) and applications (such as Facebook, Instagram, WhatsApp, WeChat, Skype, different e-mail applications, etc.) allow people to be continuously reached and contacted. This has given people many new opportunities to improve their living conditions and use of time, but, at the same time, mixed and overlapped time between work and leisure. In parallel, social interaction is increasingly moving into the internet and its complex social media networks (Joinson et al. 2009; Kallio and Vuola 2018).

Not surprisingly, in the same context, people's expectations towards (financial) service providers have changed. This naturally influences financial markets, which are not a separate fort from the rest of society. People's expectations as consumers require ongoing development work from the financial markets so that financial market participants are better equipped to meet people's ever-growing expectations. Nascent technology creates numerous new business opportunities in all business sectors.6 In the financial markets of the near future, it is likely that besides existing incumbent market operators, such as banks, also big technology companies like Amazon, Facebook (especially with its proposed cryptocurrency project Libra), Apple, Google, Tencent, or Alibaba, who are already integrating payment services on a large scale to their own services, will take a big share of the markets (Deloitte 2019).

Advances in technology seem to ensure that internet, and other sharing networks, will become more significant and take a larger part of our living environment, which will also inevitably change the financial markets as well, while enabling new service concepts and forms of financing (Morel et al. 2018). This poses challenges for current financial market participants, especially for banks (Deloitte 2019) but also creates a correspondingly high potential to newcomers (disruptors), investors, and companies seeking finance. Lawmakers and market supervisors are facing challenging times, though it is essential to keep in mind that the biggest and often most amazing things happen in a period of big breakthroughs or changes that can at this stage only be expected to accelerate through technological development. With these developments, the role of central banks may be changing rapidly. For instance, ECB is examining whether to develop a digital currency as an alternative to cash (Financial Times 2019). To further support and derive from the project, a body of six central banks (the Bank of England, Bank of Canada, BOE, the Bank of Japan, the European Central Bank, the Riksbank, and the Swiss National Bank, along with the Bank for International Settlements) have been set in order to "share experience as they assess the potential cases for central bank digital currency in their home jurisdictions" (Bloomberg 2020).

Fintech refers to those technological innovations in the field of financial services that may lead to new business models, applications, processes, or products and have a significant ancillary effect on financial markets and institutions in the way financial services are provided. The history of the financial market is full of financial innovations, but the importance of these innovations has grown and market transformation accelerated by technological advances (European Commission 2018a). Accordingly, the market is, at an accelerating pace, deploying various fintech solutions that leverage digital identification, mobile applications, cloud services, big data analysis, artificial intelligence, blockchain, and distributed ledger technologies. New technologies are changing the financial industry and the way consumers and businesses buy services. This creates opportunities for fintech-based solutions that improve access to finance and financial inclusion of digitally networked consumers (PWC 2017).

Today, crowdfunding is used to finance business growth at an accelerated pace. Until recently, it has generally been considered to be appropriate during the seed and growth stages for start-ups and especially small businesses (Spacetec 2014) involving financing from non-professional investors often reaching sums between ten thousand euros to a few million euros. In the financial markets, crowdfunding is typically seen as a high-risk mezzanine as well as debt or equity financing. However, the paradigm might be shifting. The crowdfunding market has already seen institutional interest, which may further accelerate growth of this form of financing (Ziegler et al. 2019). This trend is partly supported by regulation making crowdfunding part of regulated financial markets, as well as governments' continuous will to impose ever-stricter regulation to existing financial market players.

There may well be an underlying risk that the crowds will be pushed back in the most successful platforms, which are able to show long-term track record especially in debt crowdfunding. If this happens, the credit rating models of platforms would have been battle-tested by the nonprofessional crowds, but eventually the professional investors will come and harvest the fruit. In addition, deepening deflation in the financial markets seems to push more and more institutional investors to alternative finance in order to pursue profits, which are less available from traditional sources. However, recent research has shown that institutionalization across all crowdfunding model types has actually decreased between 2016 and 2017. This includes funding from pension funds, mutual funds, asset management firms, and banks (Ziegler et al. 2019).

## **Conclusion**

The size of the crowdfunding market, and hence the importance of this form of financing, has grown rapidly (European Commission 2016) and continues to grow based on recent studies (Ziegler et al. 2019). Crowdfunding transactions taking place digitally on different technological platforms via the internet is a concrete demonstration of how digitalization and business models applying new technological solutions can influence access to finance. Subsequently, such solutions also channel and allocate the limited resources of society to benefit a larger pool of companies, investors, and consumers, and hence supporting the society as a whole.

Nevertheless, crowdfunding is not immune to risks, immorality, opportunism, and moral hazard, which have been witnessed in the financial sector from the start. Here, although the systemic risk may be quite low for the economy as a whole, it is for the benefit of all stakeholders in crowdfunding that some level of governmental control is being exercised. So far, it may be fair to argue that there are no crowdfunding platforms that are "too big to fail". The business model of crowdfunding involves the ability to seek instant profits from and at the expense of investors, for example, by loosening the service platform's customer selection. Here, it may be argued that less-informed investors may take risks which better informed investors may not. This risk is highlighted by a fact that crowdfunding platform operators are often start-ups themselves struggling with adequate cash flows and may be pressed to onboard campaigns and investors less selectively. This argument defends reasonable minimum capital requirements.

In the end, the markets naturally repair themselves when investors start to avoid those crowdfunding platforms, which price the risks of their projects and operations poorly or indifferently. For a young and developing industry, the market-based correction mechanism may not necessarily be sufficient, because the industry's overall reputation can significantly weaken already from one bigger moral gambling case. This is true especially in the current situation where advanced self-regulation of the industry has not yet formed, but competition on market shares and customers has constantly been growing and tightening. The biggest risk for crowdfunding industry and its long-term success would seem to be the industry itself if it does not take these signs of danger seriously enough.

The history of the financial markets is full of innovations, starting from the invention of money and using it as a medium of exchange, the exit from the gold-denominated currency system, and all the way to the increasing popularity of online payment systems. Crowdfunding as a form of financing is part of this series of innovations in the general history of financial markets. Crowdfunding has in quite short period acquired a small but significant position in the international financial markets making it important and accessible funding channel especially for start-ups and SMEs. It can also be stated that crowdfunding has democratized the process of commercialization and financing by making investing in start-ups more widespread and easier to access for all people, instead of being accessible to only high-net-worth individuals, business angels, or venture funds (Ziegler et al. 2019). This has also given new opportunities for companies seeking financing and diversified the functioning of existing financial markets.

The evolution of financial markets or corporate finance naturally will not end in crowdfunding. For example, blockchain technology can, if sufficiently advanced, enable completely new business models that can challenge, when scaled adequately enough, traditional corporate finance as well as crowdfunding as we know it today. Blockchain technology, like other fintech innovations, can have a significant impact on the development of financial markets in the future (Deloitte 2019). This also relates to cyber security and data privacy in general, which are issues that need to be addressed globally in order to capitalize on the benefits of digitalization not just for the good of financial markets, but for the society as a whole (European Commission 2018a). The big challenge for the regulators in this rapidly changing financial environment is to maintain an attitude of "mend it, don't end it".

In the future, it is necessary for researchers to further study the historical evolution and development of crowdfunding markets in the wider context of financial markets. The relevance of crowdfunding as a new form of financing to market participants (i.e. investors, companies, and established operators like banks) would be worthwhile researching. This is especially true in the current exceptional financial market environment, which is characterized by zero or even negative interest rates, as well as continuous liquidity injections by central banks and governmentled projects or initiatives (especially in Europe), such as the European Fund for Strategic Investments and its local counterparts. An alternative historical approach may be comparisons between the development of crowdfunding and other innovations in financial markets, highlighting common and different drivers and barriers to such developments, and the actors behind them. There is also a need for more (historical) study on both the positive and negative implications of financial innovations (including crowdfunding), the determinants of risk taking by institutional and individual investors, the governance problems (including conflict of interest between different stakeholders), and the causes of volatility in financial markets in relation to emergence of fintech. All these issues have practical implications to the success and implementation speed of new financial innovations to practice and everyday service offering and use by individual banks, companies, and households.

Also increasing regulatory burden, which has mostly fallen on the shoulders of established financial institutions like banks, might distort the functioning of financial markets even further and create more concerns among investors and in the public, which can have unprecedented effects to the financial markets of today. Big shifts in current paradigm in the financial markets can make crowdfunding more attractive to institutional investors in the future. The relationship between institutional investors and crowdfunding platforms is a particularly interesting research opportunity, as it may have profound effects on industry development, and the extent to which it will remain loyal to its grass-root ideals.

Further, more research is needed on the effects on and implications of the crowdfunding industry on systemic risk especially if the growth of the industry continues as strong as it has to date. It will also be interesting to follow how quickly and agile crowdfunding platforms will adapt innovations of fintech (blockchain, AI, cloud computing, etc.) into their everyday operations compared to, for example, banks, as well as what effects will that have on the future position and service portfolios of platforms and banks respectively. In growing markets, there also seems to be an increasing pressure for consolidation of the crowdfunding platforms as well as expansion of their current product lines and ability to adapt to new and more scalable business models (e.g. setting up alternative investment funds in order to ensure steadier cash flow as well as expanding from solely lending-based crowdfunding to cover other crowdfunding forms). In addition, it is interesting to study the increasing syndication and cooperation activities between traditional banks and crowdfunding platforms.

In conclusion, we are living in interesting times of constantly evolving financial markets. In order to be able to predict future trends and directions, we must understand the past and derive from the teachings of history; and in this particular case-financial history. In order to understand history, it is essential not to highlight only similarities between historical episodes such as the Great Depression of 1929 and the subprime crisis of 2007 but also differences.7 Such an approach shows us that history does not always have such a conclusive predictive power than we would probably like it to have (Chambers and Dimson 2016). However, history has always provided invaluable guidance to those willing to learn from events, and especially mistakes, of the past. At the finalizing phase of this chapter we are witnessing an outbreak of COVID-19 virus that hammers the global economy at forces rarely seen before. The outcomes of such crises are hard to predict. We might be entering into a beginning of a new era of disintegration in EU and rising levels of nationalisation. On the other hand, the solidarity may even strenghten among EU states, and the level of global co-operation and transparency might increase and improve.

From practical standpoint, it is useful to contextualize crowdfunding—a modern and digitalized form of financing—as part of financial markets, its rules, and mechanics. In order to achieve such a goal, it is essential to understand fluctuations between economic cycles driven by historical, economic, and political processes. Crowdfunding and fintech in general will definitely offer many interesting research topics for researchers in the financial markets for years to come.

## **Notes**

#### **10 History of Crowdfunding in the Context of Ever-Changing…**

### **References**

**Open Access** This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/ by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence and indicate if changes were made.

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# **11**

# **The FinTech Industry: Crowdfunding in Context**

**Paul Griffiths**

## **Introduction**

The last three decades of the twentieth century witnessed the adoption of information and communications technology (ICT) by business corporations at an increasing rate and banks were leaders and trendsetters in this process. However, this leadership role of banking in the development of corporate ICT was lost in the second half of the first decade of this millennium. This chapter intends to shed light on the process that led to this. In so doing, it addresses the questions: Why did FinTech emerge as an industrial sector, independent of banking?

The author is strongly connected to the world of ICT transformation and of banking as an information intensive industry. He entered the business world as a young graduate during the mainframe-based, bespoke systems age; he then oriented his career towards management consulting, where he carried out and led technology-enabled business transformation

P. Griffiths (\*)

EM Normandie Business School, Métis Lab, Oxford, UK e-mail<EMAIL_ADDRESS>
projects in the enterprise resource planning (ERP) era and the customer relationship management (CRM) and e-commerce solutions era; he replaced legacy core-banking systems by more modern client-server platform ones. On the academic side, he went back to university and enrolled on a doctoral programme that he researched into strategy-technology alignment in banks from which he graduated in 2005. He then became a full time academic and for the last three years has been researching the industrial organization of the FinTech sector. So, it is from this broad background that bridges across the practitioner and academic worlds in banking and technology that he sets out to address the above questions.

The rest of this chapter is organized in the following way. Section "Twentieth Century: ICT Emerging and Evolution" will give an overview, based on the author's professional experience, of the evolution of ICT in the last three decades of the twentieth century. From the specific perspective of banks, it will show that the financial sector in general, and banking in particular, was a driver of the ICT evolution during that period, until the mid-2000s. Section "Advent of the Tipping Point: Why Did Banks Lose Control?" will, based on current literature, identify three root-causes for banks to have lost control over the ICT agenda in the financial sector. In having lost control of the evolution of ICT, Section "A New Industrial Sector: The Emerging of FinTech" will give a framework to understand how the FinTech sector is structured based on a classification of the players according to the functional services they offer and the types of technology they apply. It will emphasize the role of crowdfunding in this landscape. Section "Discussion" will offer a discussion on the findings, and Section "Conclusions" will draw some conclusions.

## **Twentieth Century: ICT Emerging and Evolution**

The last three decades of the twentieth century witnessed the adoption of information and communications technology (ICT) by business corporations at an increasing rate. During the 1970s and 1980s it was large systems developed and running on mainframe computers, with bespoke applications of narrow functional scope and weak integration with other functional applications. ICT was essentially about number-crunching large volumes of flat files, initially fed in by perforated cards and later in the period by magnetic tapes and discs. It was a domain restricted to the largest corporations, prominent amongst them the big banks, government institutions and universities. Systems were all corporate and managed by large IT departments with battalions of in-house programmers, analysts and systems engineers complemented by professional staff belonging to the large systems companies (that later called themselves 'integrators') such as IBM, Honeywell-Bull, ICL, Unysis. The technology platforms on which these corporate applications were developed were proprietary, with no convertibility from one vendor's platform to another vendor's: Client lock-in was the name of the game.

Democratization of ICT and its access to the smaller corporations and companies came in the mid-to-late 1980s and early 1990s with the advent of the mini-computer, the table-top personal computer, local area networks, handheld devices and, very importantly, the relational database. Democratization turned into revolution with the access to, and popularization of, the Internet.

The until then reigning mainframe computer and its centralized architecture ceded part of its domain to the distributed client-server architecture. The mainframe did not completely go away as those organizations who had them tended to keep the mainframe as database server due to its low cost per transaction for large volumes of transactions.

In parallel with client-server a significant change in the 1990s was the advent of the enterprise resource planning (ERP) systems with a new key player that with time became the dominant player in the corporate applications world, breaking the until then hegemony of the Anglo-Saxon companies: SAP from Waldorf, Germany. Being the four founders of SAP ex-IBM engineers, the first versions of their ERP ran on mainframes, but they really took off with their first client-server version that they called R/3. There were competing providers such as Oracle (with its Financials), JDEdwards, and PeopleSoft. This wave responded to a significant change in philosophy and the name of the game now had two dimensions: (a) it was all about packaged solutions, that is solutions that did not need code developed from scratch for each corporation, but that would be standard with the possibility of configuring parameters for limited adaptation to each company; and (b) integration was dominant over best-of-breed solutions, that is that now it was more important to have integration across functional applications than to have the best individual and isolated application.

Integrated packaged solutions brought with them another significant change: the concept of 'leading practices' in business processes. While the bespoke systems of the mainframe era were modelled in line with the processes of each company, in the ERP era the company would adapt its processes to the leading practices in-built in the solution. The implications of this is that the implementation of an ERP system would lead to significant changes in processes that, in turn, radically changed people's jobs. Thus, change management became an important component of implementation projects, with a focus on stakeholder management and training of people in entire processes, not just their specific task in a large process as was the case before.

Another change that came with the ERP wave is how projects were organized. The configuration of a systems project team was no longer a team of highly technical analysts and programmers, but people who were versed in business processes. The bulk of the work was not in coding but in parameter configuration and change management activities. So, the project teams were integrated mainly by non-technical systems people. ERP projects were not referred to as systems or technology projects anymore, but as business transformation projects enabled by technology.

Ripples of ERP in 1991–1993 became waves in 1994–1998 and turned into tsunamis approaching 2000 and the generalized policy of implementing 'vanilla' ERPs to sort the Y2K problem (this term was coined by Gartner Group and refers to the fact that the early mainframe systems had only two-digits for the year in dates, so it was suspected that they would all fail with the advent of the new millennium). With the advent and establishment of ERPs, came the reduction in the size of the IT departments in corporations. In effect, what adopting and implementing ERP meant was that the development of new functionalities to adapt to changes in the legal and tax environment, or to the need for new functionalities, was outsourced to the ERP vendors.

Of course, ERP were not the panacea that appears at first sight. Significant amount of coding to ensure integration with legacy systems or vertical industry-specific applications were still necessary. Although 'big bang' projects were highly promoted, common sense and risk management led to many projects being piloted and phased in, which meant that temporary interfaces had to be developed. And although the ERP vendors did produce their solutions with specific flavours for different industries, this was still not enough and corporations demanded having some of their vertical functionality developed outside of the ERP. For example, SAP achieved a highly competent footprint in the consumer packaged goods (CPG) and in the utilities industries, but never managed to produce convincing solutions for the core-banking functionalities despite having invested heavily in its solution for that sector. In other words, coding and development effort for integration did not entirely go away.

After the ERP binge running up to Y2K came the hangover in the form of a relative slowdown in the ERP market, but that did not stop the corporate-systems business as a whole. At around the time that ERP slowed down e-commerce and client relationship management (CRM) solutions emerged with force. E-commerce was the hottest product but it was severely impacted by 9/11 and the implosion of dot.com, recovering afterwards but growing at a more moderate pace.

With the slowdown of the ERP market and of the global economy after 9/11, came a consolidation within the corporate ICT solutions industry. SAP expanded its functionality into CRM, e-commerce and business intelligence through internal developments but later broke this tradition by entering the acquisitions path. Oracle, on the other hand, acquired PeopleSoft, Siebel (the leading CRM provider), JDEdwards, and many others, with significant pains in converting all these independent applications into a coherent, seamless offering to its clients. Oracle also moved into the hardware space by acquiring SUN Microsystems and SAP moved into Oracle's traditional realm, the database layer, through acquisition, too. Oracle articulated the concept of 'stack', from hardware to enterprise application, through operating systems, databases, integration layers and others. Oracle publicized itself as being able to offer the whole stack or just some of the layers.

The strong narrative of ERP vendors in terms of the importance of integration started weakening with the advent of intelligent middleware communications platforms that made unnecessary the dreaded point-topoint, or one-to-one, interface development. The nightmarish spaghettistyle interfaces that haunted CIOs and kept them awake at night, could now be substituted by simpler to understand middleware layers into which applications could easily be plugged in. Another highly significant concept that was materializing and coming of age at the turn of the century was the API (application programming interface—term that was coined decades before by Cotton and Greatorex 1968), a set of subroutine definitions, communications protocols and tools for building software. As will be seen in Section "Discussion", APIs would play an important role in the FinTech world.

The prior paragraphs give an overview of how corporate ICT in general developed from the 1970s to the early 2000s. The effect on business transformation of the adoption of ICT was highly significant, but nowhere more than in banking. Banking is an information-intensive industry, by which it is meant that differentiation comes exclusively from their intellectual capital and information or, in other words, their people, processes, relationships, and technology (Clayton and Waldron 2003; Griffiths 2003, 2005; McKeen and Smith 1996; OECD 2003, pp. 65–66).1

Driven by this dependence on information, banks played very much of a leading role in adoption and development of ICT, and the trajectory they followed differed from the mainstream CPG, retail, industrial products, and utilities corporations. Banks were clearly ahead of the pack in the early phase of that period, that of the bespoke systems running on mainframe computers. They were so heavily vested in those technologies and had such high numbers of transactions compared to the other industries, that they could not make the business case for moving to clientserver. This, together with the fact that banking processes and applications had become highly sophisticated and business critical at an extreme, disincentivized the ERP vendors to develop vertical solutions for banking in the early days of ERP. Eventually SAP did propose a banking-solution, but its adoption was disappointingly slow and hardly ever with an endto-end footprint but limited to fragmented pieces of the business. Essentially, the largest banks are trapped, to this day, in their legacy systems.

Indeed, banks have adopted standard packaged solutions in many parts of their business, particularly the highly technical middle office, but the back office remains on the legacy systems. That is not to say that there have not been any client-server solutions for banks, but the more successful ones have been developed by specialized companies and not the leading ERP vendors. For example, Citi co-developed a client-server core banking system with a company called i-Flex in India, to implement in its smaller operations around the world (it later divested from i-Flex and a few years later i-Flex was absorbed by Oracle). So, essentially, banks did not participate in the ERP part of the prior narrative.

Notwithstanding their attachment to the legacy mainframe systems, banks did make some memorable breakthroughs, of which the ATM is a notable example. The generalization of ATMs in the 1980s enabled banks to give 24 × 7 service and significantly lower their banking transaction costs. This led the self-service kiosk technology that is still in the process of being adopted by other corporations in most other industries and government.

The ATM was followed by the waves of phone banking, home banking, and Internet banking. They all had in common pushing their clients out of the branch office and lowering further the costs of banking transactions and brought with them the need for omni-channel, that is the need to show the same face to the client independently of what channel the client chose to interact with her bank. So, the big banks that had departed from mainstream in the ERP age, took leadership again in the CRM phase. With this came the transformation of the banking branch office, that until the 1990s was a mini-bank in its own right with all functionalities in the branch. From the turn of the century banks took all the back-office and middle-office functionalities (e.g., bookkeeping and accounting, credit scoring, loan origination) from the branch to the head office, and most of the transactional activity out of the branch to remote channels. The branch office became far smaller and focused on valueadded client services.

This narrative brings us to the mid-2000s when a tipping-point with several fronts was reached in the ICT world as will be developed in later sections. As has briefly been outlined in this section, ICT in business and government went from a rarity in the 1970s to complete infiltration and dissemination in the early 2000s. What this story is telling us is that during this period of study the world, or at least what we generally refer to as the Western world, almost unperceptively migrated from an industrial economy of predominantly tangible assets, to a knowledge one where intangible ones overwhelmingly predominate over the tangible. This is a new era where the application of ICT radically changed, and where banks lost their grip on its development.

The importance that ICT took on in the business world in general, but especially so in such an information-intensive sector as is banking, makes the research question stated in Section "Introduction" of the utmost relevance both to the practitioner and to the academic world. The process through which this happened is described in the next section.

## **Advent of the Tipping Point: Why Did Banks Lose Control?**

## **Overview**

A thorough review of the literature on the emerging of the FinTech sector was carried out—the emphasis was put on academic papers from 2012 onwards, as it is thought that before then would be too close to the events for clarity and that it has been found by Zavolokina et al. (2016, p. 9, fig. 1) that article publication numbers started growing that year. Based on that search this section identifies three root-causes that, although unrelated to each other, happened to coincide in time and lead banks to have lost control over the ICT agenda in the financial sector. The narrative in Section "Twentieth Century: ICT Emerging and Evolution" brings us to the mid-2000s and it announces that around that time several major events happened in the banking, the ICT world and society in general that led to the emerging of a new industrial sector that we nowadays call FinTech as a contraction of financial technology. The Basel Committee on Banking Supervision (BCBS) defines FinTech quite broadly as

*[t]echnologically enabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services*. (Claessens et al. 2018; Palazzeschi 2018)

So for BCBS FinTech is a form of innovation, but a very broad one at that, as it includes business models, applications, processes, or products. Dorfleitner et al. (2017) while admitting that there is no universally accepted definition of FinTech, take a more cautious approach and refrain from proposing a definition based on that while accepting that most companies in the FinTech sector share certain features, there are always enough exceptions to render them inadequate for producing a general definition. They opt to give a summary description of the different service domains of FinTechs, that they group in four: (a) financing, (b) asset management, (c) payments (in which they include cryptocurrencies), and (d) other FinTechs. The latter includes a hotchpotch of things such as insurance; search engines and comparison sites; technology, IT and infrastructure; plus 'other FinTechs'. Both approaches have limitation: BCBS stay at a conceptual level, and Dorfleitner et al. (2017) are far too broad and encompassing, which unsurprisingly gives place to so many exceptions.

In this chapter we will overcome those problems and propose and adopt a definition. We will overcome the BCBS limitation by defining FinTech as a company/organization, and we will narrow the service offering domain. We will limit the services to banking services, that is services where the core competence is managing credit risk, market risk, or banking operational risk. So, by FinTech in this chapter we understand *not the technology itself, but a digital technology-enabled entrepreneurial initiative that offers services to clients that would traditionally be considered within the domain of banks; or that are an innovative service in the natural business domain of banks; or that help banks develop their back-office processes.*

So, returning to the research question—*Why did FinTech emerge as an industrial sector, independent of banking?*—and to focus the mind we will address it by responding to four subquestions:

Arner et al. (2017) divide the co-evolution of finance and technology into three stages, namely:

As is mostly the case, there is not a single cause for the advent of the tipping point that moved the evolution of finance and technology into the *diverging era*. This research identifies three unrelated causes that happened in the 2007–2008 point in time; it is quite probable that none of these causes alone would have caused such a disruption, but their coincidence in time enabled them to feed into each other and cause havoc in the banking industry. The first is the global financial crisis known as the Great Recession that is generally accepted as having been caused by the banking system and its greed in the mortgage segment. The second is several nearly simultaneous major breakthroughs in the technology sector that led to a drastic drop in entry barriers to the banking services sector. And finally, significant social changes with the coming of age of the millennial generation and their growing role in the business world and in relationship to banking. The rest of this section will flesh out these three causes.

#### **The Effect of the Great Recession**

The 2007–2008 recession put banks in the US, the UK, and several countries on the European continent at the brink of collapse leading to systemic failure which, in turn, led banking authorities in those markets to bail them out with public funds. Subsequent investigation into the events detected that banks accelerated their growth by taking on excessive risk that they partially transferred to other organizations through financial engineering devises concocted by their investment banking arms. In conjunction with this, the population became extremely critical of banks and there was general distrust in these institutions. These three factors led national authorities to react, and in many cases over-react, with the result of far more stringent banking regulations that caused great regulatory challenges to the banks (European Central Bank 2016; Haddad and Hornuf 2019; Kotarba 2016). These more stringent regulations worked in two directions (see Fig. 11.1).

The first was in the sense of demanding banks to significantly increase their regulatory capital so that never again would they need to be rescued with public money. Because as a result of the crisis capital was costly to acquire by banks, they reacted by reducing the denominator of the capital adequacy ratio, that is by reducing their exposure to risk. They did this by pruning those clients of higher-risk profile, and by letting go the less

**Fig. 11.1** The effect of the 2007–2008 crisis

profitable operations (e.g., certain products and geographic markets). The resulting reduction in scale in turn led them to embark on cost reduction initiatives (European Central Bank 2016; Kotarba 2016).

The other way in which more stringent regulations worked was related to client data. On the one hand the authorities put emphasis on client data security, and on the other hand bank regulators demanded that client data be made available to third-party providers in order to break the oligopoly of incumbent banks and increase competition in banking service (European Commission 2014, 2015; Tammas-Hastings 2017).

### **The Effect of Major Technological Breakthroughs**

At the time the banks focused all their senses inside to cope with the regulatory changes that came because of the crisis, three key technology phenomena were happening. The first is incremental and refers to the continuing of Moore's law that translated into lower prices and thus giving more and more people access to devices (Lundstrom 2003; Waldrop 2016).

The second was the swift coming of age of Cloud computing with a change in mind-frame in the business community in the sense that moving from on-premise applications to cloud ones did not bring extra risks in terms of data security, and that adopting an on-demand model for technology appropriation had significant operational and balance sheet advantages (Ambrust et al. 2010; Rimal et al. 2009).

The third phenomenon was surely disruptive and is the advent of the first i-Phone and from there all the forms of smartphones that came after it. Moreover, the smartphone had the effect of enabling the development of social networks and, thus, the side effect of the advent of the data tsunami usually understated as Big Data (Barkhuus and Polichar 2011; Lee and Shin 2018; Smolan and Erwitt 2012).

 The effects on these two groups initially developed quite independently of each other, but as will be seen opportunities for cross-fertilization emerged in later stages (EY 2018, p. 28; Gai et al. 2018; Lee and Shin 2018).

Looking at the FinTech sector first, it is found that the conjunction of the three technological phenomena had the effect of both lowering entry barriers for small new players to offer components of financial services and giving many more people access to devices and thus become potential clients for these new entrants to the financial services market offering. As opposed to entrepreneurial technology-based start-ups in other sectors, in general these new players in the FinTech sector did not have cash to burn at outrageous rates, so they developed two characteristics. On the one hand they are limited in the scope of their service, and on the other they take incremental opportunities in relatively mature markets that offer them quick cash-flow. These two characteristics translate into them focusing on niche but profitable parts of the incumbent banks' business, causing strong reaction from the banks who denounce them as avoiding regulations to take the icing of their cake (Lacasse et al. 2016).

The conjunction of taking the more profitable pieces of the banks' business and being able to serve many more people who were then possessing digital devices, converted into great opportunities for the emerging FinTechs. But their increasing visibility and the protests of the incumbent bankers led banking regulators to observe this new sector and extend at least part of the regulations to them.

From the perspective of incumbent banks, these three technological phenomena and their derivations (i.e., social networks and Big Data) had a significant impact on their own operations. Bank clients were demanding new channels such as mobile and generating massive data flows that offered significant potential if properly exploited. However, they also posed unsurmountable challenges in terms of cybersecurity, of data analytics issues and of data visualization complexities to incumbent banks that were constrained by their legacy systems as described above. This led the banks to start seeing FinTechs as potential enablers for their own processes in this new era of financial services (EY 2018; Gai et al. 2018).

Particularly on continental Europe where FinTechs were being funded more by banks than venture capital (Lee and Shin 2018), risk management challenges emerged quickly and were addressed by regulators which erected barriers for FinTechs to operate as independent client-facing service providers, but opened opportunities in the banks that were funding them. So, in general, the antagonistic atmosphere between incumbent

**Fig. 11.2** The effect of major technological breakthroughs on FinTech and banks

banks and FinTechs that prevailed in the early post-2008 years gave way to a more collaborative spirit between both sectors. This effect of the technological breakthroughs is depicted graphically in Fig. 11.2.

#### **The Effect of Social Changes**

At the time of the financial crisis and the advent of the technological phenomena described above, the business world was going through major social transformations in terms of power as depicted by Naim (2013), of the changes in mindset that came with Generation Y taking a growing role in the workforce and of the advent of social entrepreneurs and entrepreneurship.

The Generation Y are avid adopters of mobile banking as long as it is easy to use and it poses no excessive risks in terms of data security. Both these conditions were hard to meet for incumbent bankers due to their legacy platforms, but straight forward for the FinTechs. On the other hand, due to the capital constraints mentioned above banks put effort into developing CRM processes and solutions that enabled them to strengthen their relationship with their 'valued' (i.e., the older more affluent) customers, and let go their less profitable and higher risk ones, as the Generation Y were seen to be. This opened a segment of great potential to the FinTechs (Boonsiritomachai and Pitchayadejanant 2017; Lee and Shin 2018).

In parallel with the above and especially in the Anglo-Saxon world, there emerged a new breed of what were to be called social entrepreneurs whose projects did not pursue a predominantly financial objective and thus were unfit to be assessed in terms of the banks' traditional credit scoring criteria. This new breed of entrepreneurs resort to alternative finance sources such as crowdfunding so became another market opportunity for FinTechs (Kotarba 2016).

On continental Europe it was found that while people do not trust banks much more than in the Anglo-Saxon world, they have less incentive to leave their banks and trust FinTechs even less than banks. So that becomes a barrier for FinTechs on the continent.

The effects of social changes are depicted and summarized in Fig. 11.3. As a result of these three external forces (i.e., the Great Recession and subsequent regulatory changes, the technology breakthroughs, and the social changes) acting nearly simultaneously, banks lost control of the

**Fig. 11.3** Effects of social changes on banks and FinTech

evolution of ICT and left the door wide open for technology entrepreneurs to set up independently and eat away at the icing of their cake. The next section gives an overview of the industrial organization of this new sector.

## **A New Industrial Sector: The Emerging of FinTech**

As mentioned above the FinTech sector is quite different from other technology-driven entrepreneurial or start-up sectors in the sense that it did not access massive funding and therefore its companies had to be focused in terms of service scope, and it did not produce great new markets but rather served extant markets that were until then poorly or underserved by banks. While, due to the latter, initially the relationship between traditional banks and FinTechs was notoriously antagonistic, with the passage of time banks realized that their constraints from legacy systems would obstruct them entering the digital era, so started to see FinTechs as possible collaborators to help overcome those barriers. This is particularly so in the data-oriented, security and privacy, and compliance spaces (Duan and Da 2012; Gai et al. 2018; Roumani et al. 2016).

Growth of the FinTech sector in terms of investment is literally exponential, going from \$1.8 billion in 2010 to \$19 billion in 2015 according to some sources (Citi 2016 cited by Leong et al. 2017) or from \$1.5 billion in 2010 to \$22 billion in 2015 according to others (Shuttlewood et al. 2016) and there are indications of steep growth in 2016 (Lee and Shin 2018). Within this context, seven banking-service areas emerge as the domains where FinTechs carry out their offering. These are: alternative finance, transactions, investment markets, banking back office, financial inclusion, cryptocurrencies, and business partner integration.

*Alternative finance* refers to services that supersede the traditional lending function of banks. They include personal finance, consumer finance, small and medium enterprise lending, and prominent in this category is *crowdfunding* in its four formats: reward-based, donation-based, equity-based and loan-based. Examples of reward-based crowdfunding companies include Kickstarter, Indiegogo, CrowdFunder, and RocketHub; of donation-based are GoFundMe, GiveForward, and FirstGiving; of equity-based crowdfunding companies are AngelList, Early Shares, and Crowdcube; finally, of loanbased crowdfunding companies are Funding Circle and Cumplo (Lee and Shin 2018; Shneor and Munim 2019 citing Ziegler et al. 2018).

*Transactions* refers to one of the most active areas of FinTech as are payments and remittances. These two areas were traditionally controlled by banks but are now giving way—in the case of payments by offering layers of service overlaying those of traditional banks and biting away at parts of the fees that banks charge in this space. In the case of remittances, it is about offering channels that circumvent bank services and fees altogether (Lee and Shin 2018).

*Investment markets* include services such as equity financing, retail investment, institutional investment, fund management and crowdfunding as an opportunity for investing (Lee and Shin 2018; Shneor and Munim 2019).

*Banking back office* is about FinTechs supplying banks agile services such as banking infrastructure, financial security services, identity verification, compliance, business tools, financial research, and energy efficiency in regard to achieving green finance. Prominent amongst these are RegTech, a flavour of FinTech aimed at helping banks comply with the demands of regulators and assist banking supervisors in keeping track of the banks under their watch (Gai et al. 2018; Puschmann 2017; Tammas-Hastings 2017).

*Financial inclusion* means reaching out to the unbanked and offering financial services at an extremely low cost and fill a gap that banks have never tackled, with well thought through and low-cost service offerings; micro-finance is prominent amongst this category (Lacasse et al. 2016).

*Cryptocurrencies* emerged as an initiative to circumvent banks altogether in the payments space but have not materialized as such; up to now they have served more as investment than payment instruments, and with doubtful outcomes at that. However, the distributed ledger technology that underlies them could be of application in many other areas such as trading and 'smart contracts' (Chen 2018; Hawlitschek et al. 2018).

*Business partner integration* is about FinTech offering services that bridge across the traditional offerings of banks and of other sectors with large business-to-consumer operations, such as telecommunications, retailers and airlines (Kumar et al. 2006; Rosingh et al. 2001; Schmitt and Gautam 2016).

To deliver these services FinTechs will apply one or multiple emerging technologies such as the DANCE acronym (Data, Algorithm, Networks, Cloud, Exponential) proposed by McAfee and Brynjolfsson (2017) and others including mobile, distributed ledgers, bioinformatics and behavioural biometrics, robots, all-in-one smartcards, and others.

It is helpful to understand the industry to present this in the form of a double entry table and map the FinTech companies onto the cells of this matrix (see Table 11.1).

The rest of the chapters in this book will develop the contents that will fit into the columns under alternative finance and investment markets of this framework. Those are the two service domains in the FinTech I/O framework where crowdfunding plays a key role. In the first case in its funding role, and in the second in its investment opportunities role. Just as an example of how this works, Table 11.2 reproduces the contents of one cell in this framework: The cell corresponding to Alternative Finance as a service domain, and data analytics and the exploiting of Big Data as a predominant enabling technology for those services.

It should be noted that in the Table 11.2 there are the four kinds of crowdfunding companies described above, but there are also other companies such as Touch Bank, which is a retail bank, or Retail Capital, which lends through partnership with banks, and do not conform to the crowdfunding principles but nevertheless are FinTechs in the alternative finance space.

With all this information in mind, the next section will extract some insights into how the FinTech sector emerged and evolved, and it will address the research question.

## **Discussion**

Many interesting insights emerge from this analysis of the FinTech sector, of which four will be mentioned in this section. The first is that technological breakthroughs are all important but are only a necessary but not a sufficient condition for the advent of FinTech. Cultural-based influences

**Table 11.1** The FinTech I/O framework

**Table 11.2** Sample from the repository of FinTechs

**Table 11.2** (continued)

have also been essential and probably the most important was the Millennium generation taking their place in the labour and consumer markets. The incumbent bankers disregarded them to focus on more affluent baby-boomers, particularly in asset management services. What the banks did not anticipate is that Millennials are not individually affluent yet but that they are on the way to being the largest demographic group and as a group they hold over \$1 trillion in wealth (Pitchbook).2 This group is not interested in investing in active management funds and having costly financial advisors; they want passive management funds that can be monitored through their mobile phone. What is even of more impact is that the older generations learn to trust technologies that are embraced by the Millennials, so disregarding this generation exposes them to losing their senior relations.

A second insight is that according to some sources of the seven service categories of FinTechs, the most highly funded (Venture Scanner 2019) are lending to consumers and to businesses, (meaning small- and medium-sized enterprises, SMEs). Most of this is based on the peer-topeer business model thus constructing links between borrowers and investors. Some of the FinTechs in this space are co-lending with banks and loan criteria vary across companies, but most want to avoid the classic credit scoring criterion in favour of seeking the highest potential borrowers and the most interesting personal projects. Based on keeping a low operating cost, these FinTechs can offer lower rates to borrowers and higher returns to lenders or investors. This insight is saying that crowdfunding is in a highly relevant position within FinTechs.

The third insight, as anticipated, is that banks have departed from their original antagonistic view of FinTechs to start finding potential in them as start-up venture opportunities and, more importantly, as resources for internal projects to make their operation more responsive, secure, compliant and efficient (EY 2018; Lee and Shin 2018). Typically, they look at FinTechs to help them reduce operational costs, provide more personalized services through data, and respond to customer behaviour changes. As a result of this, FinTechs have extended their role from retail customer facing to the back office or middle office of banks. Although it is mentioned above that alternative lending is the most funded domain, this can be contested based on the massive resources that are increasingly going into security and privacy initiatives (Gai et al. (2018), citing Gartner, says that the cybersecurity market reached \$75 billion in 2015 and is projected to reach \$170 billion by 2020; a significant share of this will go to financial services).

Finally, it has been said that in the UK, following the 2007–2008 financial crisis and the tarnished image with which established banks came out of it, the regulators proactively promoted FinTechs in the hope that challenger banks would emerge from them.  What is even more disappointing is that some of these challenger banks have had to have their business models closely scrutinized by the banking supervisors under suspicion of adopting aggressive lending practices and even manipulating of balance sheets to avoid increased demand for fresh regulatory capital (FT 2019). It is hoped that the implementation of open banking supported by regulations such as Payment Services Directive 2 (PSD2) will enable FinTechs and the most agile and forward-looking mainstream banks to offer more API-enabled services and thus change the oligopolistic structure of the banking business. Traditional banks will not go away but they will most likely become a component of a more fragmented industry in the form of a network of hyperspecialists (Malone et al. 2011).

This evolution of the evolving relationship of banks and FinTechs is summarized in Fig. 11.4.

**Fig. 11.4** Evolution of the relationship between banks and FinTechs

So, returning to the research question, *Why did FinTechs emerge as an industrial sector, independent of banking?* A combination of factors happening nearly simultaneously led banks to get distracted from the transformations that were happening around them. Just as the banks were looking inside their own organization to deal with the severe regulatory changes being imposed upon them as a result of the Great Recession, bankers did not perceive the importance that new technologies such as the smartphone were having, nor did they understand the cultural changes that were starting to happen with the coming of age of Gen-Y.

The effect of the smartphone and thus accessibility to devices of a mass market of relatively low income individuals, combined with the lowering of barriers to entry into the banking business of agile entrepreneurs that came with the maturing of cloud computing, enabled FinTech companies to roar into activity.

What encouraged entrepreneurs to move into the multiple banking services domains was the fact that they could detect a great number of underserved banking customers, with a young mindset, to whom they could approach with a narrow service offering driven by technology. That the offering was narrow meant that investment in developing application was relatively low; and the fact that the market was already there meant that cash flow would start coming in quickly. The combination of these two factors meant that the amount of working capital required was relatively low.

The fact that the FinTech companies developed relatively focused service offerings within a far reaching service industry as is banking, and that their services are enabled by a large spectrum of technologies that either emerged or matured in the second half of the last decade when this sector was emerging, has led the FinTech sector to encompass a large number of companies with quite different configurations. The framework presented in Table 11.1 as a double-entry table, with seven service-offering domains in one dimension, and over ten technology categories in the other, helps to understand how the sector is organized and where each company plays.

## **Conclusions**

In summary this research has found that, distracted by the 2007–2008 crisis and its immediate regulatory changes, the banking industry lost sight of the technological breakthroughs and social changes that were happening around it. As a result, after decades of having been a driver and leader for technological change, the industry left windows wide open for nimble companies based on ground-breaking technologies to emerge and 'eat its lunch'.

It is extraordinary that in such a closely regulated industry as banking, these FinTech entrepreneurs could have found gaps in regulations to eat away at some of the most profitable icing on the banking industry's cake. It is also extraordinary that in such a short period of time FinTechs could open into so many different business domains, enabled by the emerging of such an unprecedented number of different game-changing technologies.

The FinTechs managed this feat with little capital in comparison with the deep pockets of the institutions they were outpacing. They achieved this precisely by focusing on niches where the market was already there and waiting for a solution. So, in a way, it was more a pull by social changes than a push by the FinTechs (this is quite different from other areas of technology-based entrepreneurship where the pioneers created a market). However, FinTechs should not become complacent as regulation is creeping in. Approximately one-third of the FinTech business in the Eurozone is not regulated, but going forward, FinTechs should count on the fact that banking regulations will move further into their space.

Crowdfunding and other forms of alternative finance occupy a position of relevance within the FinTech sector and together have the greatest fraction of investment as compared to the other six business domains included in the FinTech industrial organization framework. Clearly banks have great difficulty in financing the SME segment, where its traditional credit scoring techniques are not appropriate. There is, thus, a promising opportunity for crowdfunding to grow in this space.

Banks have found it hard to keep up as selecting a new technology that will drive its processes is no minor decision for a bank and in times when so many technologies are emerging, it is hard to predict which will be the winning ones. This is not a level field: Clearly banks as incumbents have far more to lose than FinTechs so the question we need to ask ourselves is this: Do extant strategy-technology alignment models apply to banks in times of so much disruption? Banks need to address this issue.

This review of the FinTech sector as a framework to give context to the theme of crowdfunding that is the focus of the rest of this book, is necessarily generic and bridges across the different markets. But clearly the process of emerging of the FinTech sector and the evolution of its relationship to banks, as synthesized in the process described in Fig. 11.4, will change from market to market. As a result of the stage of economic development, the regulatory environment, the quality of the technological infrastructure, the different attitudes towards the financial sector, and many others, the FinTech sector has evolved differently in each market. There is scope to do comparative analyses of this evolution between markets and thus arrive at a more granular knowledge on its evolution.

Finally, another question for future research is why, despite the advent of the FinTech sector with all its diverse set of players, has the market structure in terms of market control by a small number of traditional players, remained essentially unchanged. Will open banking be the answer to this problem?

## **Notes**

## **References**

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# **Part III**

**Crowdfunding in Geographic Context**

# **12**

# **Crowdfunding in China: Turmoil of Global Leadership**

**Liang Zhao and Yuanqing Li**

## **Introduction**

Crowdfunding is the practice of funding a project or venture by raising small amounts of money from the public via the Internet. Since the establishment of the first crowdfunding platform ("Demohour") in China in 2011, crowdfunding has gained substantial popularity in the country. However, the growth of crowdfunding in China is still at early stage compared to other markets and overall market potential.

The development of crowdfunding in China can be divided into three stages. First, a "Rudimentary stage" (2011–2013), when the number of platforms and the scale of fundraising was small, and the number of

L. Zhao (\*)

School of Business and Law, University of Agder, Kristiansand, Norway e-mail<EMAIL_ADDRESS>
Y. Li

Brennan School of Business, Dominican University, River Forest, IL, USA e-mail<EMAIL_ADDRESS>
crowdfunding platforms grew slowly. Second, a "Hyper-growth stage" (2014–2015), when the number of platforms and the scale of fundraising began to increase rapidly, and when the scale of transactions expanded rapidly. And, most recently, a third "Cautious development stage" (2016– present), where due to the stricter supervision of alternative finance, the number of platforms has decreased and so did the volumes of funds raised. Most of the crowdfunding platforms were waiting for the official regulatory policy before restarting/expanding their business. Accordingly, the growth rate of the crowdfunding industry has been slowed down.

Based on past developments, the Chinese crowdfunding market has carried out some favourable explorations in crowdfunding practice. Specifically, crowdfunding project initiators have found out the power of social network interaction in boosting crowdfunding success. Some integrated crowdfunding platforms have been transferred into vertical platforms in order to strengthen competitive advantages. For example, some comprehensive crowdfunding platforms have transformed into specialized crowdfunding platforms. And, furthermore, Chinese crowdfunding practitioners have started to explore ways to educate the public and potential investors.

In term of market size and market balance, despite being the largest in the world (Ziegler et al. 2019), the Chinese crowdfunding industry exhibits slower growth rates. The slower growth rate is mainly subject to the following problems: Firstly, the policy and legal environment of crowdfunding in China are still immature and under development, and there are still some frictions between the crowdfunding innovation and profit models and the current laws and regulations (e.g. Lin 2017; You 2017). Secondly, the Chinese-style crowdfunding credit system lacks a degree of credibility. Thirdly, intellectual property in crowdfunding projects is insufficiently protected. Lastly, Chinese society in general has limited understanding of crowdfunding and there are many misunderstandings about its use and associated risks and benefits. Accordingly, if the above problems can be solved, the Chinese crowdfunding industry is expected to achieve and regain rapid development in a standardized, regulated, and healthy way.

The purpose of the current chapter is thus to review the landscape of the crowdfunding industry in China, with a focus on providing meaningful insights from this unique and important market. We first provide extensive descriptions of different crowdfunding models in China. Based on that, we then generate context insights in different models respectively. Next, the current regulations of different crowdfunding models in China is presented and discussed. Then, through an extensive literature review, main crowdfunding research related to the Chinese market are exhibited and summarized. Finally, this chapter highlights the implications for practice and research, as well as mentioning potential future research directions.

### **Volumes by Models and Context Insights**

As crowdfunding has different operating models, it is necessary to take all the main crowdfunding models into consideration in order to properly capture the comprehensive crowdfunding landscape in China. In this section, we report data and analysis for the four main crowdfunding models (reward-based, equity-based, loan-based, and donation-based) in China and then provide special insights of each model respectively.

#### **Reward-Based Crowdfunding**

Reward-based crowdfunding is identified as individuals contributing comparatively small amounts of money to crowdfunding projects in return for different kinds of non-monetary reward (e.g. physical products, services), while accepting a certain degree of risk of non-delivery on campaign promises (Shneor and Munim 2019). Reward-based crowdfunding is the best-known crowdfunding model in China.

According to the China Crowdfunding Industry Development Research (Yuan and Chen 2018), there were 90 operating reward-based crowdfunding platforms in mainland China. Geographically, these reward-based crowdfunding platforms are operating in 20 provinciallevel administrative regions across the country. Most of the platforms are established in the coastal areas which have better financial conditions and entrepreneurial culture. Compared to the coastal areas, only a few platforms are established in the northeast, northwest, and southwest of China. Specifically, there are 26 reward-based crowdfunding platforms in Beijing followed by Guangdong (12), Zhejiang (11), Jiangsu (7), Shandong (7), and Shanghai (6). The platforms in the coastal area capture 77% of all reward-based crowdfunding platforms in mainland China.

In 2017, 18,209 reward-based crowdfunding projects were successfully online. Among the online projects, 13,927 projects got successfully funded by the end of their fundraising periods. The success rate is 76.48%. The sum of the fundraising targets of all successful projects is RMB 2.09 billion (approx. USD 0.3 billion). Eventually, the successful projects have raised RMB 9.743 billion (approx. USD 1.38 billion) in total, which is approximately 4.5 times higher than the expected funding amount. The total backer number of successful projects is approximately 23 million (Yuan and Chen 2018).

Among the successful projects, 4144 projects got funded in the range of RMB 50,000–100,000 (approx. USD 7106–14,211) followed by RMB 10,000–50,000 (approx. USD 1421–7106) (3967 projects), RMB 1000–10,000 (approx. USD 142–1421) (2600 projects) and less than RMB 1000 (approx. USD 142) (647 projects). The projects within the top four fundraising ranges are 11,358 which account for 81.57% of all the successful projects. There were only 208 projects that were successfully funded with an amount of more than RMB 1 million (approx. USD 0.14 million).

Reward-based crowdfunding projects in mainland China can be classified into seven main categories: technology, film, and television, agriculture, tourism, music, publishing and games. Technology, agriculture, and music are the top three categories for reward-based crowdfunding in China by number of campaigns. Technology ranked first with 3558 online projects, followed by agriculture with 3351 online projects, and music ranked third with 806 online projects. Projects from the top three categories account for 42% of the total number of online projects.

### **Insights on Reward-Based Crowdfunding**

As the best-known crowdfunding model, reward-based crowdfunding in China has some unique characteristics. First, Chinese reward-based crowdfunding supporters are more "realistic" compared with the supporter in other mature crowdfunding markets (e.g. the U.S. crowdfunding market). Most of the Chinese backers invest their money in the projects in order to buy future products. Besides that, they tend to be less interested in participating in co-creation processes (Yuan and Chen 2018). In this sense, they behave more like consumers than like supporters. Accordingly, reward-based crowdfunding can be considered as equal to pure product pre-selling in China.

In addition, reward-based crowdfunding has been used as an online marketing/market testing channel by Chinese e-commerce giants (e.g. Alibaba, JD). These corporations' participation in crowdfunding is not for fundraising but for launching their own products, increasing product awareness, and finding potential consumers.

Lastly, different from other reward-based crowdfunding markets, no commission fees are charged by most Chinese reward-based crowdfunding platforms. Instead, platforms get their income and profits from online marketing and advertising services.

#### **Equity-Based Crowdfunding**

In terms of equity-based crowdfunding, individuals invest money in purchasing offerings of private company securities with an expectation of receiving monetary rewards in the future. Equity-based crowdfunding is a game of capital markets. Therefore, it is subjected to financial regulations (Ahlers et al. 2015).

By the end of 2017, there were 89 equity-based crowdfunding platforms operating in mainland China. Geographically, among the 34 provincial-level administrative regions, equity-based crowdfunding platforms only cover 13 regions. Like the distribution of reward-based crowdfunding, most equity-based platforms are located in economically developed areas, while few platforms are established in the northeast, northwest, and southwest part of China. Specifically, 29 equity-based crowdfunding platforms are based in Beijing followed by Guangdong (24), Shanghai (15), Zhejiang (8), and Sichuan (4). The platforms in the above area capture 90% of all equity-based crowdfunding platforms in mainland China.

According to the China Crowdfunding Industry Development Research (Yuan and Chen 2018), 1053 equity-based crowdfunding projects were successfully online in 2017. Among the online projects, 745 projects got successfully funded by the end of their fundraising periods. The success rate is 70.75%. The successful projects have raised RMB 3.361 billion (approx. USD 0.48 billion) in total. In terms of categories, equity-based crowdfunding projects in mainland China can be classified into eight main categories: technology, physical stores, film and television, agriculture, tourism, music, publishing, and games. Projects from the eight main categories account for 77% of the total number of online projects. Among the eight categories, physical store, technology, and film and television are the top three categories by the number of projects. The physical store ranked top with 562 online projects, followed by technology with 137 online projects and film and television ranked third with 85 online projects.

In 2017, the total number of successful projects' backers was 41,900. Most of the successful projects are with a small number of investors. Specifically, 63% of all the successful projects had less than 60 investors. 93% of all the successful projects had less than 160 investors. Relatively few projects had many investors. Here, only 44 projects had more than 160 investors, which account for 7% of all the successful projects. In terms of total fundraising amount, 42% of all the successful projects had a total fundraising amount of less than RMB 1 million (approx. USD 0.14 million); 91% of all the successful projects had a total fundraising amount of less than RMB 10 million (approx. USD 1.4 million), while only 69 projects have successfully raised more than RMB 10 million (approx. USD 1.4 million) through equity crowdfunding, which account for 9% of all successful projects.

## **Insights on Equity-Based Crowdfunding**

Equity-based crowdfunding has not yet been legalized in China. Equitybased crowdfunding in China refers to "Internet non-public equity financing". As public offering in China is under extremely strong supervision by the government, equity-based crowdfunding in China can only be executed in the form of private offering (Hu and Yang 2014). As a private offering, "equity-based crowdfunding" in China is strictly controlled and supervised by the China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC), and the People's Bank of China (Huang et.al. 2018).

The development of equity-based crowdfunding in China suffers from perceived uncertainty, void of legalization, and strict investor threshold. Therefore, in terms of investor numbers, equity-based crowdfunding is the least popular crowdfunding model when compared to the other models (reward-based, loan-based, and donation-based).

#### **Loan-Based Crowdfunding**

Loan-based crowdfunding is also known as online Peer to Peer (P2P) lending. P2P lending is the practice of lending money to individuals or businesses through online platforms while matching lenders with borrowers, which is repaid with interest added (Mamonov and Malaga 2018). For lenders, loan-based crowdfunding platforms usually offer better interest rates than standard commercial banks.

According to an annual P2P lending report (WDZJ 2018), by the end of 2017, there were 1931 P2P lending platforms operating in mainland China. Geographically, 410 P2P lending platforms were based in Guangdong followed by Beijing (376), Shanghai (261), and Zhejiang (233). The P2P lending platforms in the top four areas capture 66% of all P2P platforms in mainland China. The total volume of transactions of P2P lending in mainland China has reached RMB 2805 billion (approx. USD 400.33 billion) in 2017 with an overall profit ratio of 9.45%. The number of investors and borrowers in the P2P industry in 2017 were approximately 17 million and 23 million respectively. The average lending period was 9.16 months in 2017.

The loan balance (e.g. remaining amount to be paid) of P2P loans is also increasing. By the end of 2017, the overall loan balance of the P2P lending industry in mainland China has reached RMB 1225 billion (approx. USD 160.56 billion). Geographically, Beijing, Shanghai, and Guangdong ranked the top three regions in terms of loan balance with the total volume of RMB 439 billion (approx. USD 62.39 billion), RMB 325 billion (approx. USD 46.19 billion), and RMB 227 billion (approx. USD 32.26 billion) respectively. The top three regions accounted for 81% of the total loan balance volume in 2017. Zhejiang, Jiangsu, and Sichuan ranked third to sixth with the loan balances of RMB 106 billion (approx. USD 15.06 billion), RMB 38 billion (approx. USD 5.4 billion), and RMB 13 billion (approx. USD 1.85 billion) respectively (WDZJ 2018).

In China, loan-based crowdfunding is the only model which has institutional participation. Institutional investors engage and collaborate with P2P lending platforms. By the end of 2017, 212 P2P lending platforms received investment from state-owned companies. 153 P2P lending platforms received investments from venture capital. 126 P2P platforms received investment from publicly listed companies and 15 P2P lending platforms received funds from banks (WDZJ 2018).

## **Insights on Loan-Based Crowdfunding**

Loan-based crowdfunding (online P2P lending) in China has its unique characteristics. First, providing supply chain financial service through loan-based crowdfunding has been a new trend in the loan-based crowdfunding market of China. The Supply chain financial service connects various parties (buyer, seller, and financing institution) in a transaction organically to lower financing costs and improve business efficiency. There were 118 online P2P lending platforms providing supply chain financial services in 2017 (WDZJ 2018).

Second, mergers and acquisitions among platforms are popular in the loan-based crowdfunding market of China. It makes the market more and more concentrated. For large platforms, the concentration process can further consolidate the platforms' business capabilities and increase their competitiveness. For small and medium-sized platforms, the market concentration strategy gives them a way to survive under conditions of fierce competition.

Last, to expand influence, some Chinese P2P lending platforms (e.g. China Rapid Finance, Hexindai, PPdai) choose to get on overseas listings in the U.S. Some mature Chinese P2P lending platforms (e.g. Dianrong, Lufax) have opened overseas branches to offer P2P lending services in southeast Asia to increase scale and profits.

#### **Donation-Based Crowdfunding**

Donation-based crowdfunding is usually used for funding social causes, NGOs, and charity projects. Through donation-based crowdfunding, individuals donate money to support social causes, charitable projects, or persons with no expectation of receiving tangible rewards in return, while enjoying intangible benefits such as the feeling of self-fulfilment and mental satisfaction.

Specifically, there were 12 donation-based crowdfunding platforms operating in mainland China by the end of 2017 and 9513 donationbased projects were successfully launched on these platforms. Different from other crowdfunding models, donation-based crowdfunding in China follows the "keep it all" principle. This means that there will be no unsuccessful projects (unless no funds are raised at all). Here, fundraisers set funding goals and keep the entire amount raised regardless of whether they meet their goals or not (Tomczak and Brem 2013). In 2017, total fundraising target was expected to be about RMB 1.90 billion (approx. USD 0.27 billion) and the actual total fundraising amount was about RMB 401 million (approx. USD 56.99 million). Among all related projects, 6467 have raised less than RMB 10,000 (approx. USD 1421) and 1711 projects have raised amounts in the range of RMB 10,000–50,000 (approx. USD 1421–7105). In other words, 86% of all the donationbased projects (8178) have raised less than RMB 50,000 (approx. USD 7105) and only 1335 projects got funded with more than RMB 50,000 (approx. USD 7105) (Yuan and Chen 2018).

In 2017, the total backer number of all the projects was 15.98 million. Specifically, 3839 projects had between 100 and 500 supporters, 1689 projects had between 50 and 100 supporters, and 1538 projects had less than 50 supporters. Overall 74% of all the donation-based projects (7066) had less than 500 supporters (Yuan and Chen 2018).

## **Insights on Donation-Based Crowdfunding**

Donation-based crowdfunding industry in China is still in its initial stage of development. Specifically, in terms of platform numbers, there were only 12 donation-based crowdfunding platforms in mainland China, which is substantially a lower number of platforms when compared with the total number of platforms operating in all crowdfunding models. In 2017, the total fundraising amount of donation-based crowdfunding in China was RMB 401 million (approx. USD 56.99 million). This sum was far from enough to mitigate the huge supply gap of public welfare (Yuan and Chen 2018).

In addition, donation-based crowdfunding platforms in China are not charitable organizations but private-owned companies. Therefore, they need to pay their own daily expenses by charging commission fees or advertising fees. Because of the charity nature of donation-based crowdfunding, whether charging fees can be applied as the revenue source of donation-based crowdfunding in China is questionable.

Lastly, donation-based crowdfunding in China is usually used to solve individual cases/help individuals rather than to organizational initiatives. This means that offering help to needed groups through donation-based crowdfunding is still under exploration and development in China.

Regardless of crowdfunding model operated, as elsewhere, platforms are subjected to differing regulatory requirements. In the following section we explore the current state of crowdfunding regulation in China.

## **Current Regulation**

Because of the lack of specific regulations for supervising crowdfunding, the Chinese crowdfunding market has grown rapidly since its emergence in 2011. However, perceived substantial risks challenge all crowdfunding participants (investors, project initiators, and crowdfunding platforms) in China (Zhu and Hu 2019). To promote a more secure environment for developing the crowdfunding industry, the Chinese crowdfunding market supervision is based on two core principles: separate supervision and information disclosure.

In term of separate supervision, the equity-based crowdfunding is mainly regulated by the China Securities Regulation Commission (CSRC). The loan-based crowdfunding must be carried out under the supervision of the China Banking and Insurance Regulatory Commission (CBRC) and the People's Bank of China. In opposite, the donation-based crowdfunding and the reward-based crowdfunding are not included in the financial supervision system because they are not providing financial products and services. In addition, the Ministry of Industry and Information Technology (MIIT), the National Development and Reform Commission (NDRC), and other related ministries and commissions are required to participate in the supervision of cybersecurity and credit information system (Yuan and Chen 2018).

The crowdfunding platform is the main body for crowdfunding practices. The supervision of crowdfunding platforms is based on information disclosure. Since the crowdfunding platform is an intermediary between investors and project initiators it is required to establish a systematic and institutionalized information disclosure system in order to mitigate information asymmetry between these parties. Based on the two core principles, the central government of China has issued a series of policy announcements to regulate the operations of different crowdfunding models.

#### **Reward-Based Crowdfunding Regulation in China**

Reward-based crowdfunding is considered as product pre-selling in China. Under this viewpoint, the supporters of reward-based crowdfunding are the "consumers" and the project developers of reward-based crowdfunding are the "sellers". The reward-based crowdfunding platform acts like an online trading intermediary. The regulation of reward-based crowdfunding should be the same as the ones used to supervise online B2C marketplaces. In general, it is subject to the supervision of the "State Administration for Industry and Commerce of the People's Republic of China". The "Law of the People's Republic of China on the Protection of Consumer Rights and Interests" and the "Administrative Measures for Online Trading" are applied to the regulating process of reward-based crowdfunding.

Specifically, as "consumers", the rights of reward-based crowdfunding supporters are under the protection of the "Law of the People's Republic of China on the Protection of Consumer Rights and Interests" and the "Administrative Measures for Online Trading". As "sellers", project developers should take related legal obligations. As "online trading intermediaries", crowdfunding platforms should take legal responsibilities related to the infringement of consumer rights caused by the products or services provided on the platforms. In addition, the "State Administration for Industry and Commerce of the People's Republic of China" may impose administrative penalties in cases of misconduct by platforms.

However, reward-based crowdfunding cannot be equally treated as general online consumption according to the concept at its core, as backers also accept a certain degree of risk of non-delivery on campaign promises (Shneor and Munim 2019). This leads some to suggest that it should be regarded as investing behaviour rather than pure consumption. Therefore, supervision may also be different. The backers of crowdfunding projects should have self-awareness of the risks and share the risks with project developers in order to achieve their mutual ambitions in a relatively high information asymmetry environment. If crowdfunding participants' rights and interests are infringed, they should be able to take legal action to defend their rights. Therefore, reward-based crowdfunding platforms should only serve as information intermediaries and not as credit intermediaries, and under such conditions they will also not assume any responsibility.

To sum up, based on different understandings of reward-based crowdfunding, there is still controversy on how to protect the rights and interests of reward-based crowdfunding participants in China.

### **Equity-Based Crowdfunding Regulation in China**

Among the four models of crowdfunding, the regulation of equity crowdfunding is the most complicated. Due to current legislation void, genuine equity crowdfunding has not been officially accepted and carried out in China. The Chinese government has announced a series of legal provisions to manage the equity crowdfunding market in a quasi-regulated manner. The legislation remains unfinished and the ongoing legislation progress is as follows:

## **Loan-Based Crowdfunding Regulation in China**

China has the world's largest P2P lending market. However, this immature market is still suffering from some inherent risks such as the lack of credit and risk controls, the lack of industry standards, and regulation challenges.

At the national regulatory level, China Banking Regulatory Commission (CBRC), and other related departments have officially established a "1 + 3 supervision system" to monitor, manage, and mitigate inherent risks in Chinese P2P market (Huang 2018). Specifically, the "1 + 3 supervision system" refers to "one method plus three guidelines" which is mainly composed of the following regulatory documents:

Besides, the National Internet Finance Association (NIFA) has also issued several rules and standards on the information disclosures and selfregulation of Chinese P2P market in 2016.

At the local regulatory level, being supplements, some developed regions (e.g. Beijing, Shanghai) have begun to develop self-regulatory frameworks and associations by taking regional variations into consideration. Self-regulation is effective in reducing the regulatory burden and cost, eliminating the information asymmetry between the market and the regulatory authority and improving market standardization.

#### **Donation-Based Crowdfunding Regulation in China**

In China, public fundraising for charitable purposes is mainly related to the "Charity Law of the People's Republic of China". According to this law, there are clear regulations on charitable organizations using the Internet and other platforms to conduct public fundraising. Organizations or individuals that do not have the qualification for public fundraising may not use public fundraising.

Most donation-based crowdfunding projects in China are created by individuals who are facing difficulties. These troubled individuals use crowdfunding as the channel to seek help from the greater society.  Therefore, donation-based crowdfunding in China is not charitable fundraising but social assistance and may not apply to the "Charity Law of the People's Republic of China".

On July 20, 2017, the Ministry of Civil Affairs announced the "Basic Specifications for the Internet-based Public Fundraising Platform for Charity Organizations" and the "Basic Management Regulations for the Internet-based Public Fundraising Platform for Charity Organizations" to manage donation-based crowdfunding market. Donation-based crowdfunding is officially distinguished from charity fundraising.

According to the specifications and regulations, project developers should take full responsibilities of the authenticity of the provided information. Donation-based crowdfunding platform should strengthen project information review and disclosure, inform potential donors on the potential risks of the projects, and clarify the traceability of responsibility. In addition, donation-based crowdfunding platforms should disclose platform operation information to the public at least every six months.

## **Review of Key Research Done in China**

Though the first Chinese crowdfunding platform "Demohour" went online in 2011, most Chinese crowdfunding platforms were launched after 2014 (Yuan and Chen 2018). Since then, the crowdfunding concept has been recognized in China in both research and practice with researchers starting to investigate this phenomenon within the Chinese market. In order to summarize the findings of such research, we conducted a literature review. Generally, we found out that the crowdfunding research focused on the Chinese market is still limited in scope compared to the ones based on Western market data. Specifically, our main findings are summarized as follows:

First, most of the existing Chinese crowdfunding studies are focused on investigating the success factors of crowdfunding. These mostly rely on the signalling theory and Elaboration Likelihood Model (e.g. Zheng et al. 2016; Bi et al. 2017), which were frequently adopted as the main theoretical foundations. Based on the data collected from the key players of Chinese crowdfunding market (e.g. JD Crowdfunding; Demohour; Zhongchou), Chinese crowdfunding literature reveals that social capital (Shahab et al. 2019; Kang et al. 2017; Chen et al. 2018), trust and commitment (Zheng et al. 2016; Zhao et al. 2017; Liang et al. 2019), campaign characteristics (Du and Wang 2016; Du et al. 2019; Zhao and Vinig 2017), campaign quality (Xu et al. 2016; Yuan et al. 2016; Shahab et al. 2019; Chen et al. 2018; Zhang et al. 2017; Bi et al. 2017), as well as backer and initiator interaction (Wang et al. 2018; Xie et al. 2019) are positively associated with crowdfunding success in China.

Second, many studies explore the current status of crowdfunding in China compared to the one in other countries. In general, the degree of development of crowdfunding markets in developed countries is higher than that of developing countries (Rau 2018). However, as an emerging market, the volume of the Chinese crowdfunding market grows rapidly and has become the largest crowdfunding market in the world (Ziegler et al. 2018). Compared with the Western crowdfunding markets, the Chinese crowdfunding market has its unique characteristics. Specifically, in terms of reward-based crowdfunding, the Chinese contributors are more realistic compared to the ones in Western markets. Specifically, their motivations to contribute are mainly generated by receiving the rewards but not by helping to further develop the business ideas (Yuan and Chen 2018). In addition, the Chinese crowdfunding market is controlled by several key players (Yuan and Chen 2018). The performance of the key players (e.g. Taobao Crowdfunding, JD Crowdfunding) counts for most of the market share in China (Huang et al. 2018). As a latecomer of the crowdfunding market, the legal framework related to the regulation of the Chinese crowdfunding market is immature which hinders its further development (Yuan and Chen 2018). Specifically, this immature legal framework has brought problems such as fraud, illegal fundraising, and money laundering (Huang et al. 2018). As a result, the growth rate of the Chinese crowdfunding market has been slowed down as legal frameworks are being revisited (Chirisa and Mukarwi 2018).

Third, crowdfunding has proved to be a feasible tool in supporting creative industries and sustainable projects in China (Sun and Meng 2015). Two-thirds of the reward-based crowdfunding projects in the Chinese market are related to creative industries such as film, music, publication, animation, design, and games (Sun and Meng 2015). Besides, crowdfunding is also used to support sustainable campaigns in China (Lam and Law 2016). The success of sustainable crowdfunding projects is closely associated with public opinion and brand effect in the Chinse market (Chen et al. 2018).

## **Implications for Research and Practice**

### **Theoretical Implications**

Based on the review of the key Chinese crowdfunding literature, we found that existing research has provided valuable insights for understanding the Chinese crowdfunding market. However, the limitations of the current literature indicate several future research directions as well.

First, most of the existing Chinese crowdfunding literature are replicative studies. These replicate previous crowdfunding studies by using the Chinese data in order to test the validation of previous findings in non-Chinese crowdfunding market (e.g. Zheng et al. 2017). Future research could generate more special outputs by taking unique Chinese cultural factors and market characteristics into consideration. For instance, "Guanxi" is a special element of Chinese culture, which has been embedded in the daily practices of the Chinese business community (Chung and Hamilton 2001). It should be beneficial to enrich the Chinese crowdfunding literature by investigating the impact of "Guanxi" on Chinese crowdfunding practices (Zhao and Vinig 2019). Besides, the Chinese crowdfunding market has strong connections to several Chinese Internet giants (e.g. Alibaba, JD, and Tencent) (Yang and Zhang 2016). It would be interesting to explore the influences of these Internet giants on the formation and development of the Chinese crowdfunding market, and their relations with crowdfunding platforms.

Second, in terms of research perspectives, most of the existing literature aims to explore the success factors of crowdfunding in the Chinese market by analysing real market data from the platforms. The signalling theory and Elaboration Likelihood Model are mostly adopted by Chinese crowdfunding literature (e.g. Zheng et al. 2016; Bi et al. 2017). Besides, the total amount of research related to equity crowdfunding and loanbased crowdfunding is smaller compared to the research associated with reward-based and donation-based crowdfunding. To generate more meaningful insights, future research could try to analyse the Chinese crowdfunding market from other perspectives by applying alternative theoretical frames (Huang et al. 2018). In addition, more research on equity-based crowdfunding and loan-based crowdfunding should be generated.

#### **Practical Implications**

This chapter also provides several practical implications for Chinese crowdfunding practitioners, contributors, and regulators.

First, Chinese investors tend to rely on personal relationships to help make investment decisions as the Chinese business is relation-based. The personal relationship is used as substitutes for formal institutional support (Xin and Pearce 1996). In terms of the Chinese crowdfunding market, project initiators' social capital levels should be closely associated with crowdfunding success (Shahab et al. 2019). Therefore, Chinese crowdfunding practitioners should pay attention to their social capital accumulation by interacting with potential contributors to create personal trust and take full advantage of the power of social capital to promote projects within their target audiences.

Second, Chinese crowdfunding contributors are more pragmatic compared to the ones in the Western markets (Yuan and Chen 2018). Specifically, they contribute for getting the rewards, rather than being parts of the process of the project "co-creation" (Yuan and Chen 2018). Therefore, it is beneficial for Chinese crowdfunding campaign initiators to pay more attention to the design and delivery of the crowdfunding rewards. For instance, compared with the other campaigns, the campaigns with clear descriptions, well-designed reward prototypes, and determined delivery time are expected to have higher probabilities to get successful fundraising.

Third, it is of great importance for the regulators to strengthen the regulative framework to guarantee the healthy development of the equity-based and loan-based crowdfunding models in China. The regulative framework should be designed within the existing Chinese legislation system and cultural background (Hu and Yang 2014). Under the established framework, specific principles and regulations need to be promulgated to provide adequate supervision of the whole crowdfunding market and offer timely information disclosures to market participants. In addition, the development of Chinese loan-based crowdfunding market has been greatly impeded by fraud caused by the lack of nationwide credit rating systems (Wei 2015). Therefore, a comprehensive credit rating system should be established to support the development of the Chinese loan-based crowdfunding market.

Lastly, for promoting crowdfunding industry in China, it is also important to create a close integration between social media sites, digital payment systems, and crowdfunding platforms to create a seamless, convenient, and efficient process for information sharing and transactions.

## **Conclusion**

In conclusion, given the uniqueness of culture, regulation, and social systems in China, the concept of Chinese crowdfunding could be considered as a combination of Chinese unique characteristics and general crowdfunding principles (Funk 2019). In this chapter, we introduce and discuss the crowdfunding phenomena in China concretely from the perspectives of different stakeholders (platforms, fundraisers, funders, and regulators) and crowdfunding models (reward-based, equity-based, loanbased, and donation-based). Generally, the Chinese crowdfunding market has developed rapidly and has become the world's largest crowdfunding market (Ziegler et al. 2018). However, we also find out that there are some problems in the Chinese crowdfunding market, such as underdeveloped regulatory system and personal credit system (Chirisa and Mukarwi 2018). These problems will limit the further development of the Chinese crowdfunding market. To solve these problems, specific solutions have been proposed in this chapter. Practically, this chapter can be used as prescriptive guidelines for Chinese crowdfunding stakeholders to enhance and improve market performance. In addition, we also point out some meaningful research topics for researchers to explore the Chinese crowdfunding phenomena further.

### **References**

**Open Access** This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/ by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence and indicate if changes were made.

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# **13**

# **Crowdfunding Prospects in New Emerging Markets: The Cases of India and Bangladesh**

**Krishnamurthy Suresh, Stine Øyna, and Ziaul Haque Munim**

## **Introduction**

In 2013, the World Bank published a report on crowdfunding's potential in emerging markets, which estimated a market opportunity for South Asia alone of close to USD 5 billion (The World Bank 2013). The South Asia region consists of predominantly collectivist societies (Hofstede Insights 2019)—India, Bangladesh, Sri Lanka, Pakistan, Bhutan, and Nepal—where helping others through donations is an integral part of

Indian Institute of Management Bangalore (IIM B), Bangalore, India

S. Øyna

School of Business and Law, University of Agder, Kristiansand, Norway e-mail<EMAIL_ADDRESS>
Z. H. Munim Faculty of Technology, Natural Sciences and Maritime Sciences, University of South-Eastern Norway, Horten, Norway e-mail<EMAIL_ADDRESS>
K. Suresh (\*)

prevailing religious obligations and societal norms. Thus, these countries share certain cultural and religious traits that are highly consistent with the principles of crowdfunding. Yet, by 2017, the alternative finance activity in the region amounted to no more than USD 269 million, 96% of which was related to the Indian market (see Table 13.1), indicating a vast untapped potential in the Asian economies.

In the current chapter, we explore the history, ongoing activity, and future prospects of crowdfunding in new emerging markets. Specifically, we look into the cases of India and Bangladesh. Both countries represent interesting crowdfunding markets due to the cultural inclinations described above, combined with their large populations (1.3 billion people in India and 165 million in Bangladesh) and number of people living in extreme poverty (15% of the population in Bangladesh and 21% in India) (The World Bank 2019). India is, by far, the leading market of alternative finance in the South Asia region, and thus provides an interesting case to explore. The alternative finance market in Bangladesh, on the other hand, is still in its infant stage and thus far less developed. Comparing and contrasting the state and types of crowdfunding in these two markets thus allow us to reach new insights.

The remainder of this chapter consists of sections focusing on India and Bangladesh, respectively. Both sections cover the history, including cultural roots of crowdfunding in the given market, prevailing models and platforms, regulatory issues, and future prospects. Given the relatively more developed state of crowdfunding in India versus Bangladesh, the section on India is naturally more comprehensive. The chapter concludes with a few summarizing remarks on the state of crowdfunding in new emerging markets.

**Table 13.1** Alternative finance volume in South Asian countries

aZiegler et al. (2018)

bThe World Bank database

## **Crowdfunding in South Asia**

Research on crowdfunding in South Asia is still somewhat limited, although a few contributions do exist. Crowdfunding studies in the Indian context examine regulatory issues (Marakkath and Attuel-mendes 2015), business model transformation (Srivastava 2016; Chirputkar et al. 2015; Gupta and Bose 2019), risk factors (Leela 2016), crowdfunding intention (Baber 2019a), and drivers of growth (Pa 2018). Similarly, studies in the Bangladeshi context examine crowdfunding business model (Adhikary and Kutsuna 2016), awareness and drivers of crowdfunding (Adhikary et al. 2018), and the drivers of crowdfunding intention (Hasan et al. 2018; Munim et al. 2020). In sum, these studies build knowledge relating to crowdfunding on the individual (backer), firm, and societal levels.

Until 2014, a few crowdfunding platforms were operational in India, and people believed that family or friends or venture capital firms would determine crowdfunding campaign success (Srivastava 2016). A majority of the early platforms were associated with creative industries like filmmaking, publishing, and design (ibid.). On the contrary, in 2019, the existing Bangladesh crowdfunding platforms are not fully functional but are more dedicated to raising funds for medical treatment or equity (Munim et al. 2020). In both the Indian and Bangladeshi context, the main drivers of crowdfunding are increased demand for alternative finance due to improved socio-economic status, significant increase of internet users, complexity of documentation, and requirement for tangible securities for credit applications in traditional financial institutions such as banks (Srivastava 2016; Adhikary et al. 2018; Marakkath and Attuel-mendes 2015).

In terms of factors influencing crowdfunding intention, findings are similar in the Indian and Bangladeshi contexts. For instance, technological awareness and experience of traditional financial market have a positive influence on a backer's crowdfunding intention (Baber 2019b; Hasan et al. 2018). Meanwhile, in societies like India and Bangladesh which can be "characterized by a low degree of thin trust between strangers, people are less willing to contribute to/invest in fundraising efforts by a stranger" (Kshetri 2015, p. 106). Therefore, the campaign owner being friends and family is positively associated with a backer's crowdfunding intention in the Indian context (Baber 2019a). However, the quality of the campaign and media coverage is more important in the Bangladesh context (Munim et al. 2020).

## **Crowdfunding in India**

## **History**

Crowdfunding or crowdsourcing, in various forms and under various names, has existed in India since ancient times. For instance, 'Chanda' involves people collecting small sums of money from large crowds to finance religious, cultural, and other events like festival celebrations in the local community. Another example of a historic crowdfunding campaign happened in 1962, during the war with China. The then Indian Prime Minister, Jawaharlal Nehru, appealed to the citizens of the country to contribute to the defence fund. Thousands of people, especially women, donated not only money but also their jewellery. The campaign was said to have collected over USD 220,000 in cash and much more in gold. Later, in 1976, a group of 500,000 milk farmers from the Indian state Gujarat contributed to fund the movie 'Manthan,' which was estimated around INR 1.1 million (USD 1 ≈ INR 70). After the inception of modern-day (internet-based) crowdfunding, the Indian online crowdfunding started its operations in 2012 with the launch of Wishberry, Ketto, and Milaap (Impact Guru 2017).

## **Prevailing Models and Platforms**

The four prevailing models of crowdfunding—reward, equity, lending, and donation—are all represented in the case of India, and Fig. 13.1 presents their levels. Loan-based crowdfunding is responsible for the majority of the activity. Since 2016, equity and donation-based crowdfunding have reached similar levels. The volume of reward-based crowdfunding, however, remains low. The different types of crowdfunding in the Indian context are discussed below.

**Fig. 13.1** Indian crowdfunding market volumes by model (2013–2017). (∗Based on figures from Ziegler et al. [2018])

#### **Donation-Based Crowdfunding**

Philanthropy—including charity and donations—is an integral part of the Indian culture and tradition, visible through its mention in the first Indian scripture—known as Vedas (Bhasin 2019). In India, the word 'donation' or 'giving' has different nomenclature based on religion. The Hindus term it as *daana* (giving) and *dakshina* (alms), Buddhists call it as *Bhiksha* (alms), while it is *zakat* (prescribed offerings) and *sadaqah* in Islam (Viswanath and Dadrawala 2004). As per classical Hinduism, it is considered as the *duty* of an individual to help those who are in need (Bornstein 2009). Donations are usually made for social, religious, cultural, as well as political causes. Earlier, donation was an individual activity. However, the establishment of socio-religious institutions during the nineteenth century gave birth to scientific or institutional philanthropy, which is later dominated by NGOs, trusts, and foundations.

Donation-based crowdfunding is the second-largest model by volume after P2P lending in India. Around USD 21 million were raised in 2017 (see Fig. 13.1), and, as of May 2019, there are more than 25 donation-based (Table 13.2) crowdfunding platforms operating. Campaigns on these platforms allow both individuals and NGOs to raise money in support of various causes under categories such as health, education, community development, and others.

**Table 13.2** List of popular donation and reward-based crowdfunding platforms in India

aFees excluding processing charges, GST, and payment gateway charges. Data compiled from platform websites (as of May 21, 2019)

#### **13 Crowdfunding Prospects in New Emerging Markets…**

A popular form of donation-based crowdfunding in India is nonmonetary donations, where backers donate products, meals, or medicine to people in need. Donatekart is one such platform that enables backers to donate various products to the NGOs which they wish to support. Another platform, Give India, enables backers to support the delivery of midday meals to poor children across the country through one of their initiatives—*Mission 10 Million Meals*. Finally, in the last two to three years, *medical crowdfunding* has taken off in India, where platforms like Milaap, Ketto, and ImpactGuru assist common people in raising money for expensive medical treatments. Given the population and poverty levels of the country, these forms of non-financial return crowdfunding have the potential to make a substantial socio-economic impact.

#### **Reward-Based Crowdfunding**

In the case of reward-based crowdfunding, backers receive a non-financial reward in return for the money contributed: as of May 2019, about nine to ten reward-based platforms were operating in India (including reward + donation, see Table 13.2), the most prominent ones being Wishberry and Fueladream. Noteworthy, some of the campaigns on Fueladream are run by students raising funds for social causes. For example, one such campaign ran by students, aimed at raising funds to help with the education of children from underprivileged homes, has been funded 534 times (Goal: INR 1,080,000). Also, platforms like Desired Wings and Rug Beneath My Feet are exclusive women-centric platforms. As per Ziegler et al. (2018), around USD 5.3 million has been raised by these platforms over the years from 2013 to 2017 (see Fig. 13.1) of which 40% of the fundraising was for business purposes.

#### **Equity-Based Crowdfunding**

India has developed into a start-up hub with the third-largest start-up ecosystem in the world, home to more than 20,000 start-ups (KPMG 2018), more than 63 million micro, small, and medium enterprises (MSMEs) (Government of India 2017) and more than 210 active incubators/accelerators (NASSCOM 2018). Traditionally, start-ups are being funded through angel investors, private equity, or loan arrangements with banks and other financial institutions. However, since the global financial crisis of 2008, financing through traditional means became even more challenging, resulting in a credit gap where nearly 50 million MSMEs have an unmet debt demand of USD 198 billion (PWC 2018). In line with the rapid growth in the number of established start-ups, alternative means of financing these enterprises evolved.

Under equity crowdfunding, the equity shares of the company are issued to the investors in consideration for their investment. There are around 15 such platforms operating in India (as of May 2019), LetsVenture being the most prominent one (see Table 13.3). The platform has more than 4400 angel investors and has funded over 172 deals. By 2016, around 200 companies had been crowdfunded by equity-based platforms, and the total amount raised was over INR 3.5 billion. The average ticket size for small working capital was between INR 5 million and INR 60 million, while average fund-raised ticket size was between INR 30 and 40 million (Menon 2016). However, the regulatory challenges for equity crowdfunding have curbed the growth prospects of the industry. As per Ziegler et al. (2018), around USD 60 million has been raised by these platforms over the years, from 2013 to 2017 (see Fig. 13.1).

**Table 13.3** List of popular equity crowdfunding platforms in India

Commission information of most of the equity crowdfunding platforms is not publicly available

#### **Lending-Based Crowdfunding (Peer-to-Peer Lending)**

Alternative lending is one of the fastest-growing segments in the Indian Fintech space, reflecting the unmet financial needs of Indian consumers and businesses. Over 40% of the population and around 90% of small businesses are not linked to formal financial institutions (EY 2017). Also, nearly 90% of the consumer market is unaddressed by the existing financiers due to insufficient credit scores (ibid.). The failure of banks and other financial institutions to meet the needs of these segments, especially after the global crisis, led to the rise of alternative lending in India. As of 2017, there were more than 225 alternative lending companies in India (ibid.).

Like other emerging economies, the country has multiple informal sources of financing for the unbanked population, like chit funds and microfinance. Chit funds are schemes that combine savings and credit (Kapoor et al. 2012). Chit funds could be registered or unregistered, organized by formal financial institutions or informal groups such as friends and relatives. In India, there are more than 10,000 registered chit funds and around 200,000 unregistered ones. The value of the unregistered chit fund industry is estimated to almost 100 times the registered value, which is about INR 300 billion (Acharya 2013).

In India, though still in a nascent stage, P2P is one of the fastestgrowing markets, with current market size of around INR 2 billion, including both consumer and business loans (Saleem 2018). The market is expected to reach over USD 5 billion by 2020 (Deloitte 2017). There are currently between 40 and 50 platforms operating under the P2P model, although only 11 are registered with the Reserve Bank of India, so far. The most prominent P2P platforms are Faircent, Finzy, Lendenclub, and Monexo. The interest rates on these platforms are generally categorized based on the riskiness of loans (i.e. low risk—ultra high risk, and 'unidentified'), range between 14 and 36% (over 40% for unidentified).

In addition to providing an attractive asset class for lenders, the P2P industry acts as an avenue for financial and credit inclusion through addressing underserved people and small businesses. Mostly, the borrowers of the industry are from tier-two and tier-three locations, who would

**Table 13.4** List of RBI registered peer-to-peer lending platforms in India

Interest rates are per annum (unless specified otherwise) and based on the riskiness of loans. Data compiled from list of NBFC-P2P companies registered with Reserve Bank of India as on March 27, 2019.

otherwise rely on money lenders for credit, paying exorbitant interest rates. Notably, participation from women (as fundraisers and investors) has been increasing in the recent past. From 2013 to 2017, P2P platforms in India included nearly USD 195 million in overall market volume, of which USD 33.19 million were for business purposes (see Fig. 13.1 and Table 13.4).

## **Regulations**

Regulations largely depend on the type of crowdfunding. Like most of the other countries, there are no bespoke regulations for donation and reward-based crowdfunding in India. Since there is no financial return involved in these models, they fall outside the purview of regulators like the securities market and the central bank. However, they come under the ambit of other regulations related to the payment of donations (e.g. Income Tax Act 1961) and campaign content (e.g. Information Technology Act 2000). Both individuals and organizations can run campaigns on these non-financial return crowdfunding platforms. However, only Indian nationals holding an Indian bank account can raise funds. For non-profit entities to receive contributions from abroad, an FCRA (Foreign Contribution Regulation Act) approval is mandatory. Yet with equity and lending-based crowdfunding, the situation is quite different.

All types of money lending are regulated by the central bank of India the Reserve Bank of India (RBI). Although P2P lending came to India in 2014, there was no specific regulation in place until the latter half of 2017 (Menon 2016). In 2017 RBI issued directions targeting 'Non-Banking Financial Companies' and specifically P2P lending platforms. These directions require all P2P lending platforms to obtain a certificate from RBI, while also limiting the financial services that such platforms can provide and the amount of money they can manage (e.g. maximum INR 5 million per lender and INR 50,000 to the same borrower). Additionally, the regulations do not open for the international flow of funds.

The securities market regulator, SEBI's *Consultation Paper on Crowdfunding in India* (2014), proposed a framework for raising of funds by start-ups and SMEs, through online crowdfunding platforms or websites. The proposed guidelines restrict both who are eligible to become equity crowdfunding platforms (e.g. recognized stock exchanges, SEBIregistered depositories, associations and networks of investors), who can receive funding through these platforms (i.e. early-stage start-ups/SMEs <4 years old) and how much a company can raise (i.e. <INR 100 million/12 months).

#### **Future Prospects**

Although the ideology of crowdfunding in India traces back to the Vedic period (1500–1100 BCE), online crowdfunding is still in a somewhat nascent stage. Compared to matured markets like China, USA, UK, and Europe, there is a big gap in terms of awareness, education, acceptance, and usage of crowdfunding. In the 2013–2017 period, the Indian crowdfunding volume reached USD 450 million, which is only a fraction of the potential indicated by the World Bank (The World Bank 2013). However, the industry has seen tremendous growth with a volume of USD 268 million in 2017 alone, and year-on-year growth of 116% (Ziegler et al. 2018).

The significant growth rate can be attributed to socio-economic inequality, financial exclusion, unmet financial demand (credit gap), along with various other factors. The growth of non-financial return or community-based crowdfunding is driven by an increase in charity and philanthropy among people in India, a rise in foreign donations, and support for new and innovative causes. Growth in peer-to-peer lending is related to the credit gap and unbanked population. Finally, growth in equity crowdfunding can be explained by a combination of factors, and partly by the exponential growth in start-ups and SMEs. Yet, there are also several factors hindering the further expansion of the crowdfunding market.

The lack of regulatory guidelines for crowdfunding in general and equity crowdfunding, in particular, is likely hindering the growth and prospects of the industry. The industry needs to be supported by concrete guidelines in order to secure the interests of both platforms and platform users, as well as the society in general. For this purpose, inferences could be drawn from the UK's FCA regulations for investment-based crowdfunding and JOBS Act from the USA. Considering a few companies have already been crowdfunded by equity-based platforms in India, the perspective of these key stakeholders could also be considered in framing the guidelines.

Although crowdfunding in India is already covering a wide array of sectors, there still exists a number of areas that could benefit from the concept. Examples include agriculture, legal, real estate, and politics. Even though real estate and political crowdfunding have taken off recently, lessons could be drawn from developed markets like the Middle East and the USA, for its future prospects. Having one of the largest agricultural markets in the world, India could most likely benefit from agricultural crowdfunding, which is quite popular and successful in Nigeria and other African countries.

## **Crowdfunding in Bangladesh**

#### **History**

Bangladesh, similar to India, has a long history of crowdfunding-like approaches to donation and collection of money. Bangladesh is home to Nobel laureate Dr Muhammad Yunus, known for initiating the concept of 'microfinance' which involves lending small amounts of money to a large number of people with the purpose of alleviating poverty (Kickul et al. 2012). Another example is the so-called Somity concept, which refers to an informal co-operative where a group of people (particularly women) save together a portion of their salary or a household income that is later invested in a business (Scheyvens 2002). Somity is identical to the 'Chit Fund' concept in the Indian context. Also, during the two Eid festivals, large sums of money are donated by Muslims in the country to people in need (the concepts of *zakat* and *sadaqah* as mentioned earlier). Today, there exist crowdfunding platforms relying on the concept of Muslim donations (e.g. www.launchgood.com).