BLOCKCHAIN IN EQUITY CROWDFUNDING

Authors:
1. Prateek Kumar Gupta
Netaji Subhas University of Technology,
Dwarka, New Delhi, India
Email – prateek.g2906@gmail.com
Ph. No. - 9029857759

2. John P Kuriyen
Netaji Subhas University of Technology,
Dwarka, New Delhi, India
Email – johnpk7111@gmail.com
Ph. No. - 9956744355

3. Dr. Renu Ghosh

Assistant professor
Department of Management Studies, Netaji Subhas University of Technology,
Dwarka, New Delhi, India
Email – renu.ghosh@nsut.ac.in
Ph. No. - 9953227203
 Blockchain in Equity Crowdfunding

Prateek Kumar Gupta1, John Kuriyen2 & Dr. Renu Ghosh3

ABSTRACT

Blockchain is the leading technology of this century, which can help us achieve total
decentralization over day-to-day processes, including banking and election voting. With this
paper, we've applied the concept of blockchain to equity crowdfunding and explained the
significant advantages. Equity crowdfunding is one of the most effective ways for modern-
day start-up founders to raise money without accessing the venture capital ecosystem and at
the same time it gives an opportunity to retail investors to diversify their investment portfolio.
However, in this case, the biggest challenge is establishing the element of trust. Blockchain
could make the process decentralized and fraud-proof because of its essential characteristics,
including collective validation and strong data encryption. Manipulation of data and
corporate governance are areas that the application of blockchain can improve. In this paper
we’ve reviewed the ongoing attempts in the domain and tried to bridge the existing gaps with
the help of the mentioned technology.

1
Netaji Subhas University of Technology
2
Netaji Subhas University of Technology
3
Assistant Professor, Department of Management Studies, Netaji Subhas University of Technology
 Blockchain in Equity Crowdfunding

Prateek Kumar Gupta, John Kuriyen & Dr. Renu Ghosh

1. INTRODUCTION

In the 21st century, humans have realized the cons associated with centralized processes and
intermediary forces. Top-level financial institutions and supporting firms can get away with
frauds on a big scale, with no negative implications from the government. The financial crisis
of 2008 has proven the need for decentralization in modern finance (Varma, 2019).
Blockchain was conceptualized back in the 90s. However, we learned about its capability as a
decentralization tool after the inception of bitcoins in 2009. Blockchain is a distributed
network across all the nodes in the network, thus decentralizing the entire system in which it
is incorporated. Blockchain has a lot of potential applications in fields ranging from
entrepreneurial finance to election voting. This paper aims to explore one such application of
blockchain in start-up funding. 

Undoubtedly, money is one of the most critical aspects facilitating the existence of any start-
up. We've witnessed the boom in entrepreneurship worldwide especially in India, within the
past few years. Budding entrepreneurs generally require initial capital to grow their venture,
post their bootstrapped phase and this is where generally Angel Investor, Venture Capital
firms, Private Equity firms and Crowdfunder’s come in. Young entrepreneurs often find it
difficult to raise fund for their venture via traditional methods (Bernardino & Santos, 2020),
i.e., Venture Capitalists or Angel Investors. VC firms provide an opportunity for start-ups to
grow and expand their business by financing their operations and providing them with the
required capital and not only they provide monetary help but also technical and managerial
expertise, along with networking opportunities within the industry. VC firms raise their funds
through insurance companies, pension funds, endowments, and HNIs. Even though angel
investors play an essential role in the funding space, VCs dominate it. Toxic hegemony
developed by VC firms in the start-up industry has led to multiple problems for founders and
smaller investors, which we have tried to address in this paper.
When the world was suffering from the calamity of the financial crisis after Lehman Brothers
filed for bankruptcy in 2008, shortly after that, in 2009, an unidentified person named Satoshi
Nakamoto introduced the world to bitcoin, whose underlying technology is based on
blockchain (Xu, Chen, & Kou, 2019). There is a need for technology like blockchain because
people are losing trust from intermediary forces. The website often collects the digital
footprints left by a user on the website in the form of data later to sell it to other businesses or
used by themselves to manipulate the user to their advantage. Blockchain technology erodes
the possibility of using the data in such unethical manners.

Blockchain is a revolutionary technology called a distributed ledger, if described briefly.

Blockchain is a chain of several blocks in which each block stores three elements’ Data i,
Hashii, and Previous hashiii. 

In a decentralized network, where there is no central authority to verify the authenticity of

every activity in the system, the consensus mechanism comes into the picture. Therefore, the
participants in the network come together to validate the status of the ledger in the
blockchain. For example, in the case of the blockchain of bitcoin, the consensus mechanism
used is called ' Proof of Work,' and in the case of Ethereum, ' Proof of Stake ' is used.

2. PROBLEM STATEMENT

Early-age start-ups require mentorship and networking opportunities. However, this does not
mean it's necessary to dilute a considerable portion of the equity. VC firms often take undue
advantage of start-ups and their founders to give up a massive chunk of their equity by
pitching expertise and networks as an incentive. This leads to meddling by VC firms in the
company's daily operations. Many times, VCs try to alter the boardroom dynamics and gain
massive control over start-ups and their founders, especially in India, where many promising
start-ups face the same problems because of non-founder Chief Experience Officer. Constant
interference by these institutional investors might even go against the vision and ethos of the
company, which could lead to diminished growth or extreme failure.

Moreover, the presence of big VC firms in the funding space has deprived retail investors of
the opportunity to invest in promising, high-growth start-ups before they go for an IPO. Many
small-scale investors with relevant knowledge and zeal for the start-up space often miss out
on investment opportunities for budding companies due to a lack of knowledge, network,
and, most importantly, a solid platform (Bernardino & Santos, 2020). This is where the
concept of crowdfunding comes in. Crowdfunding can be broadly divided into four
categories: donations, rewards-based lending, and equity crowdfunding (Vulkan, Åstebro, &
Sierra, 2015). In this paper, we are going to mainly focus on equity crowdfunding.

Equity crowdfunding is a method of raising small amount of capital from a large number of
individuals used by start-ups and early-stage companies to fund their venture ( Hsueh, Lin,
Shyu, & Li, 2016). Essentially, equity crowdfunding offers the company's securities to a
number of potential investors in exchange for financing. Each investor is entitled to a stake in
the company proportional to their investment. Equity crowdfunding has become a better
alternative for founders who don't require expertise nowadays. One of the most popular
methods of raising fund for a venture by using blockchain based crowdfunding is by issuing
Initial Coin Offering (ICOs) ( Fisch, Meoli, & Vismara, 2020). Instead of a VC firm funding
your capital requirements, you can now have a slew of retail investors investing in your
company from different geographical locations and from all walks of life. With equity
crowdfunding, founders won't be liable to big VC players to make relevant decisions for the
company, possibly resulting in minimal intervention from stakeholders, thus ensuring that the
vision and ethos of the company aren't hampered. 

Investing in a start-up or in a non-listed company isn’t a very conventional target for

investment for retail investors because of multiple reasons, the likes of which are, lack of
information and network, low risk appetite as often start-ups are epitome of high risk – high
return asset class. The only exposure for a retail investor to invest in a start-up is when they
invest in a venture owned by their friends or families. But, investing in start-ups provide a
good investment portfolio diversification option ( Peterson, 2018). Thus, equity
crowdfunding caters to those retail investors who wants to invest in new ventures as they see
it as a good investment portfolio diversification option but at the same time can’t invest large
sum of money to buy considerable equity in it.

However, equity crowdfunding has a lot of problems associated with it. Most of these
problems are related to low liquidity and fraud management. With blockchain, it opposes
these problems. We've deduced our findings and results of implementing blockchain on
equity crowdfunding through this paper.
 2. DISCUSSION

Unlike centralized systems, blockchain stores the input data in the distributed ledger, which is
basically a chain of linearly connected blocks designed to store data in an encrypted form.
The data is stored on a decentralized server, accessible by every node in the system. As
quoted by Investopedia, "Blockchain does not store any of its information in a central
location. Instead, the Blockchain is copied and spread across a network of computers.
Whenever a new block is added to the Blockchain, every computer on the network updates its
Blockchain to reflect the change." Generally, the dynamics between an investor and the
company are maintained by an intermediary force, like SEC, SEBI, etc. However,
crowdfunding mainly involves raising money, even before the company is registered
(Reichenbach & Walther, 2021). Even though there are specific regulations in this process, no
third party can have absolute control over crowdfunding. This leads to massive trust issues
within the community of investors, which inhibits them from taking part in crowdfunding.
This is where Blockchain comes in.

Blockchain, a decentralized data storage solution, can bridge the trust gap between investors
and start-ups by acting as the required intermediary force. Because of its decentralized nature,
parties on both sides cannot alter the data (e.g., financials, audit reports, product details, etc.)
fed into the blocks without reaching a common consensus. Such a robust system ensures the
element of trust between the two parties. Every block on the Blockchain contains a hash,
which validates the existence of the further and previous blocks. Any change caused in the
hash would lead to total alteration in the blockchain system and ultimately be stopped by the
Blockchain itself. Also, the data stored inside the Blockchain is encrypted using a robust
encryption algorithm called SHA-256. This is done to ensure that no one outside the system
can crack into the confidential information present within the Blockchain. With Blockchain,
data is equally accessible by all nodes on the system. It spreads the data across an array of
computers. Hence, no new block can be added to the chain without all the nodes reaching a
common consensus and accepting the change. This ensures that information entered on the
Blockchain is equally accessible to all stakeholders, including investors and founders of the
company. 

As we've discussed earlier, Blockchain is genuinely democratic to its core. Since the
information is copied and spread across multiple computers, each node has independent
access to available data. Because of this, it is impossible to alter the data stored on the
Blockchain without all the nodes coming to a consensus and accepting the change. This
prevents all forms of data manipulation and fraud, as the data cannot be forged without the
investors knowing about it. This further elevates the established trust between all the
stakeholders.

Strategic decisions for the organization are made, with the majority support of the
stakeholders. Another advantage of equity crowdfunding is that cartelization within the board
is extremely difficult because most shareholders might not know each other. However,
consulting the investors before deciding is extremely important as it goes with ethics. Here,
blockchain can be used to record the vote of each shareholder. Since the data is accessible by
all network nodes, it is impossible to manipulate the data. Hence, the complete process of
corporate governance is truly decentralized and democratic with the application of
blockchain.

3. CONCLUSION

This research paper is an attempt from our side to democratize the funding space. The current
mechanism provides an undue advantage to Venture Capitalists and other institutional
investors. Instead of being equal shareholders in the system, big investors have a more critical
say than the founders. Even though expertise and mentorship are essential, giving up a
considerable stake in your company for the same isn't. Over the past few years, we have
witnessed multiple start-ups going out of business because of no vision, or long-term goals,
orchestrated mainly by non-founder CEOs. Hence, equity crowdfunding is a more attractive
option for many start-up founders seeking to raise capital. However, even though regulated,
equity crowdfunding is mainly outside the bounds of the government. There is no
intermediary force that could establish trust between both parties. This is where blockchain
comes in, acting as a decentralized intermediary between the founders and investors, giving
them equal access to encrypted, non-crackable information and making the transactions much
more convenient, thus increasing liquidity. In this paper, we've explained the advantages of
integrating blockchain into equity crowdfunding and tried our best to take a positive step
towards the whole problem.
References:
Fisch, C., Meoli, M., & Vismara, S. (2020). Does blockchain technology democratize

entrepreneurial finance? An empirical comparison. Economics of Innovation and New

Technology. doi:10.1080/10438599.2020.1843991

Hsueh, R.-T., Lin, K.-C., Shyu, J., & Li, K.-P. (2016). Equity crowdfunding: A new social

innovation-a regulatory cross-nation study. PICMET (pp. 1346-1350). Honolulu: IEEE.

doi:10.1109/PICMET.2016.7806539

Peterson, C. (2018). Can investing in startups be the best way to diversify your portfolio?

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i
Annexure A
Data - Considering the example of the blockchain system of bitcoin, every block stores a few
transactions, validated by a process called proof of work. After every transaction of the block is
validated, the block is added to the blockchain.
ii
Hash - It can be considered a unique id or fingerprint of the block. Suppose someone tries to alter
data stored in the block, the hash changes. This unique property of blockchain ensures that the data
stored in the block cannot be fudged. The hash function used in bitcoin is 'SHA-256.'
iii
Previous Hash - The third and last element in a block denotes the previous block's hash to which it
is chained. So, as we know, if someone tries to fudge data in a block, its hash changes. Therefore, to
escape, they have to change the hash of all the succeeding blocks, which can be considered a nearly
impossible task since there'll be many blocks succeeding to that one, and meanwhile, new blocks
are being added to the blockchain.