As the face of banking changes, post-GFC and Libor scandal(s), alternatives to the traditional banking and investment models have emerged. From bitcoin to Kickstarter, there are now more ways to make your money work harder without having to rely on the banking system, ill-equipped national legislation or expensive intermediaries.
Scuffed reputations of institutions like Barclays and RBS, the collapse of financial services houses like Lehman Bros., and governments unable to respond fast enough to prevent the collapse of national banks or currencies have created a new type of investor who does not believe that putting their money in a bank or investment management firm is the best way to grow their capital.
Regulators require banks to ring-fence retail banking in order to prevent the kind of bailouts required in 2008, highlighting both the change in attitude and the inadequacy of existing legislation. People who in the past, may have just put their money into a high street bank’s investment program are more aware of the inadequacies and undesirable elements of the traditional models. Coupled with increasingly instant access to information across multiple channels in many other sectors, younger investors dubbed ‘millennials’, are dissatisfied with their options.
‘Distrustful’ investors expect to be able to manage their interactions without resorting to a fee-charging intermediary with exclusive knowledge and access to facilities they cannot use themselves. They are also open to use their money to do something unusual, with overt ethical values or just outside of the traditional system. As a result, there are several alternative investment models emerging worth evaluation from the traditional banking sector.
Crowdfunding sites like Kickstarter, Crowdfunder and FundRazr are a response to the changes in attitude and advances in technology; Kickstarter opened to UK investors in 2012. In this short time, interest in crowdfunding as an industry has grown exponentially: in the three years from 2011-13 crowdfunding more than tripled from $1.5 billion to $5.1 billion.
There have been several products that have broken free of the crowdfunding community and made it to mainstream production. The Veronica Mars movie was crowdfunded in 2013, and Weissenhaus, a real estate project to build a five-star-superior resort by the Baltic Sea, achieved more than double its target and has been completed with investors via Companisto, which specialises in high-quality projects. Many more projects have been successful within the ‘tech’ community, including video games, development platforms, and wearables. Pebble Technology – one of the first smartwatches designed independently from a mobile technology vendor to make it to market – made more than 100 times its initial investment requirement. The Pebble remains the fifth most successful crowdfunded product of all time, despite not really becoming well-known outside of the developer community.
Whilst accounts on crowdfunding sites are available on demand, it seems that the majority of investors are from within the tech community. A technical understanding of the projects most likely to be successful and the types of return available still limit the popularity of crowdfunding sites to those who have a particular interest in the technology world, or who are risky investors. The most frequent ‘reward’ for investment in a successful project is a v1 product or access to the resulting platform. This may be the most limiting factor for crowdfunding, as most investors are still seeking a financial return.
If investors want increased financial return rather than a ‘reward’ in the form of a v1 product or access to a service, then crowd ownership may be their preferred form of investment in crowdfunded projects. Equity-based funding is available through platforms such as Crowdcube, Housecrowd or Seedrs.
As with most crowdfunding platforms that release equity back to investors, there are complexities around securities legislation in different jurisdictions. The model allows private equity to be traded in a public forum without most of the state’s usual checks, balances, and taxation. The potential investor is less protected against risk and fraudulent activity. Investors with high levels of knowledge, interests in particular sectors (like crowd ownership of real estate) and a high tolerance of risk are attracted to this model.
Ethical crowd lending
Crowdlending is a form of equity crowdfunding that bypasses the traditional financial services model, including a lot of the restrictive regulation designed for lending between institutions and businesses.
Loans can be financed by peer-to-peer lending, or crowd lending, the difference being that P2P is usually between two individuals, on terms agreed by the parties, and crowdlending is between multiple lenders and a single party, in the form of a company or individual, usually for a business venture.
“The peer-to-peer and crowdfunding market is experiencing significant growth in both the UK and the US and in 2012 $2.7bn was raised globally from crowdfunding and peer-to-peer lending”, according to the CBI. Despite the legal limitations to this type of lending, it seems that reputational damage to established and traditional lending models has left those with the option open to such alternative options.
Lending small amounts of money to those with no traditional access to credit has also become increasingly popular, despite the dangers inherent in both providing the loans and taking them. There is a side-benefit to this type of investing about which millennials-as-investors feel good.
This year, 5 billion people will have access to a smartphone; but only around 10% of them have a bank account. This fact alone demonstrates how powerful the capability of breaking away from traditional models of investing and transacting in general, will make investors.
The ability to exchange small amounts of money without the need for banks, low/no fees and instant access is beginning to transform business in the third world as well the first. It creates possibility to do business for demographic groups who could only dream of transacting in this space just two or three years prior. If the anecdotal fact that mobile phones save more lives than penicillin holds any water, there is potential for this development in payments to fundamentally alter the balance of power in business.
Material assets (bought/ sourced online)
Luxury and rare items have always presented investment opportunities, but with the advent of online auction sites, investing in cars, perfume, stamps, wine, coins and the like is available to a wider audience. Investment in these items is based on sector knowledge, and most collectors are not limited to web-sourced goods. However, as the ability to gather information collides with the availability of items online, some amateur collectors have made discoveries that have allowed them to see the kind of return otherwise unavailable to them. The level of research required to make significant gains is probably not dissimilar to managing traditional investments independently. Exchange platforms such as liv-ex are developing alongside online auctions to provide a pricing barometer.
Cryptocurrencies started life in the deep web as ways of transacting to buy and sell illegal or borderline legal goods or services, or to transfer them outside of the state currency system. Since they’ve been liberated from their shady beginnings, the opportunities to bypass the dominance of physical currencies has become increasingly popular. Like any currency, cryptocurrencies can be volatile, especially in their infancy. Yet to break into the mainstream, they are becoming of interest to traditional banks for several reasons.
The opportunity to make money from cryptocurrencies is based upon the same factors as physical currencies. Bitcoin is the best known and most widespread, and has earned investors extremely high returns from speculation. For example, Bitcoin “gained over 300% from 2011 to 2012 and between August 2013 and August 2014 had increased in value around 400%”. Bitcoin’s value dropped in September 2014, with commentators noting that it’s growth has still been exceptional.
Cryptocurrencies themselves present interesting issues and limitations, but increasingly, it is the technology behind them rather than the currency itself is attracting increasing focus.
Opportunities to invest under these newer models allow investors with a specific requirement for ethical investing to move away from institutions with whom they no longer feel comfortable. This is key to some investors; especially those who do not remember a time when financial services institutions were not mired in corruption, poor performance and questionable associations.
Amongst the highest performing ethical investments are those that target green–energy such as Trillion Fund and Abundance. They give investors assurance about the relationships with the environment, local people and communities, and sources of finance.
Investing outside of the traditional model
The main reason to stay within the traditional model is the weight of responsibility. There is a legitimate fear of losing money when you are self-managing your investment. In the past, investing has been sold as a specialist skill, requiring many years of knowledge and experience in order to assure good decisions and smart investments are made. Independence and attitude to risk has shifted significantly, especially in the post-GFC environment. More investors expect access not only to reports, but the ability to manage investments themselves. Only a few of the larger institutions have started to provide adequate platforms for self-management, and alternative providers are growing faster than the established players. The ground is shifting significantly, and if they are to survive, traditional institutions need to move fast to catch up, let alone stay dominant.
Risk and morality
Investors interested in avoiding the traditional routes are often doing so because they are angry at the system, where there is plenty of legislation and accountability. However, their experience tells them that this did not prevent fraudulent activity nor protect investors. Their perception of risk is altered to that of previous generations by this and the options made available by internet connectivity.
Millenials especially are used to platforms where the ethics are grounded in the community values rather than legislation. This has been part of online commerce sites such as eBay and Gumtree for many years, and has translated into investment models. Traders in both models build good reputations for trustworthiness despite low levels of enforcement and recourse to chastisement from the model, based on mutual benefit and community feedback. The types of people who want to transact in these forums abide by communitarian principles. The principles of honesty and mutual assistance espoused in these interactions are core values reflected across the web; for example in the open source development community.
Many of the concepts in this article are bound by these principles, which are closely protected by those who develop or support new investment models. For example, every bitcoin transaction is recorded in a public ledger, where the transacting parties are recorded, the value and direction of the transaction. This is far more transparent and accountable than many business transactions in the traditional banking sector.
The whole ecosystem around investment online is changing. The millennials who do not want to use the ‘usual’ system are emerging as powerful voices in the personal investment market.
In the face of emerging opportunities from fintech startups, the role of banks, financial institutions, infrastructure services, and legislation require revision and design innovation in order to meet the needs of investors who expect to have their standards in other sectors, like communication, to be met and exceeded. Currently embryonic, many of these new services are increasing in popularity and will need management and development. Financial institutions need to be aware that not only niche players will be attracted by the ability to make money faster.
The response to the GFC should not be overzealous regulation and stagnation, but innovation. Over-large institutions are already being encouraged to split themselves into more manageable and accountable businesses. Via technological and design innovation, away from the financial institutions, investors are being lured by more focused and agile opportunities. The traditional sector needs to embrace the opportunities emerging from this market in order to retain their position and reputation.