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What is Crowdfunding and How Does it Work?

Crowdfunding has been around for several years and continues to make waves on the internet. The general definition of crowdfunding is to allow individuals, organizations, and businesses to raise funds by attracting people who will invest in the product or idea to get a profit — many who lack the capital to start a business look to crowdfunding as an alternative solution instead of going to traditional funding sources like banks.

US Equity Crowdfunding Market | Toptal

Different means of crowdfunding operate through a specific method of allowing people to invest in a product or idea.

  1. Reward-based crowdfunding. An interested party gives money outright to get a reward in exchange for the money given to support a project.
  2. Loan-based crowdfunding. Another term for this crowdfunding type is peer-to-peer lending, where you let an individual or business borrow money at a specific interest rate.
  3. Investment-based crowdfunding. A group of individuals invests money to receive shares or stakes.
  4. Donation-based crowdfunding. Just as the name suggests, you donate to a charitable institution or an individual with a corresponding promise in return for your donation.

There are regulating bodies that monitor crowdfunding sites, depending on the country they operate from. If you want to ensure you are joining a legitimate crowdfunding platform, check if it is registered with a regulating body.

How does crowdfunding work?

Crowdfunding sites typically include a landing page with an overview of products and projects you can invest in. Most crowdfunding sites require some form of registration if you plan on financing or have a project you would like to pitch and get support for. Users who are looking for a product to invest in can view details about a project upon registration. Some of the information you’ll find includes:

  • How much money the project owner expects to raise?
  • Percentage of funds raised in comparison with the goal.
  • The number of people who invested in the project.
  • How long the project is open for investment?
  • What’s in store for investors and supporters?

Projects can only proceed if the goal amount is raised. Otherwise, the project folds, and the site typically has a cooling-off period in case investors change their minds.

Are there risks involved with crowdfunding?

With any investment comes a certain amount of risk, and crowdfunding is no exception. Some of the possible risks with crowdfunding include:

  • The business or idea you put your money into goes under, and you lose your money.
  • There is no guarantee that you will get the return you are hoping for.
  • If you receive shares for your investment, you may have difficulty finding buyers or selling your stocks when the time comes.
  • There is always a possibility that the crowdfunding site also fails and closes down.

If you want to minimize the risk of investing in a crowdfunding platform, you need to make sure that you are putting in money that you are willing to lose. You also need to take the necessary precautions to double-check if the platform is authorized.


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