It may not be apparent to those on main street, but the world of finance is undergoing a seismic shift, the likes of which hasn’t been seen since the advent of banking itself.
We’re still in the early days, but the trend is unmistakable; through new technology coupled with changes in regulation, we’re making the changes necessary to change the culture of investing and place the power of economic participation back into the hands of the people.
Banking as we know it has barely changed in over 600 years
Modern-day banking is still based on the system pioneered by the Medici Bank in medieval Florence in the late 14th century. To give you an idea of just how long ago this is, consider that Gutenburg was still decades away from developing his first printing press. Columbus was 100 years away from sailing to America. King Richard II reigned over Catholic England – Henry XIII would only form the Anglican Church over a century later.
Before banks, people would borrow and lend among themselves. Just think about how tough this must have been; If you wanted to grow beyond your own resources, you would have needed to personally find someone who was willing and able to lend to you. If you had surplus capital that you wanted to earn a return on, you would have needed to find somebody who wanted money, and was a reasonably good prospect to pay it back. And if they didn’t pay you back, there wasn’t much you could do about it other than threaten physical violence, which, given the lack of enforceable contracts, you’d have to carry out yourself.
Banking is so natural to us now that it’s all too easy to ignore what an incredible innovation this was at the time. When the first banks arrived on the scene, it was a godsend. Citizens at last had a place where borrowers and lenders could go, and conduct business without personally knowing one another.
At the risk of hugely oversimplifying the broad sweep of history, this more efficient allocation of capital that banks enabled was a big reason behind greater investment and economic growth, which lifted Europe out of the dark ages, unleashed the Renaissance, and saw the European continent gain geopolitical pre-eminence over the rest of the world for the next 500 years.
The side-effect was it made the bankers that now controlled these flows of capital incredibly powerful. This, as we all know, has been a recurring problem in the years since. Go to the downtown area of any major city. Look at the tallest buildings, and the names that adorn them. What do you see? Banks. Investment houses. Insurance companies. The reason they can occupy the most expensive real-estate in the world is because of the unique place they’ve carved out for themselves – taking a cut of practically every transaction that takes place between us.
Yes, in the intervening centuries there have been some minor innovations, but the basic architecture remains the same. The culture of investing, as it stands, assumes that financial middlemen belong in the system in between fund-raisers and investors as an essential feature of a functioning economy.
But the current system isn’t working
The 2013 Yougov-Cambridge report Public Trust In Banking found that only 4% of Britons surveyed think bankers exhibit high ethical and moral standards.
Read that again, and consider for a moment what it means. Bankers occupy a critical place within our lives – we trust them to keep our life savings safe, and lend and invest in the businesses that need it – yet just 4% believe they’ve actually earned that trust.
It doesn’t take a long memory to remember how banks got this reputation; what happened during the global financial crisis hardly needs repeating in depth – the irresponsible risk taking with other people’s money to chase bonuses, the huge losses that resulted when these investments went bad, and the massive taxpayer-funded bailouts that were required to bring the world back from the brink of financial ruin.
Is there any way to solve the problem?
We’ve tried regulation, implementing codes of ethics, and punishments for unscrupulous financiers. To some extent, they help, but history shows that ultimately all of them fall short. To properly solve the principal-agent problem, the one doing the investing must gain or lose a dollar in direct proportion to the one whose wealth is being used to do the investing. And to do this, there are really only two ways:
The first is direct ownership. When someone takes responsibility for investing their own money, rather than through a bank or a fund manager, there is perfect alignment – obviously, because the one who does the investing and the one gaining or losing the money is the same person.
The second way is syndicated investing. An investment syndicate sees a party (or parties) investing in some proposition. Because their own money is at stake, syndicate leaders have their own money at stake. So capital is being allocated more efficiently.
The rise of crowdfunding investing
The simple genius of crowdfunding investing is its ability to facilitate both of these totally-aligned investing options. Investments can be made directly by individuals, without the banks or the brokers acting as an intermediary. Syndicated investment is also facilitated.
When we move towards a culture of more direct ownership, we get people with greater levels of financial education, taking responsibility for themselves. Due to the internet, information can be distributed more efficiently for investors to evaluate, and banks become less and less necessary as a place for investor and fund-raiser to meet. The impact of this on the world of finance could be as significant as the impact of social media has been on journalism – a move to far more decentralised power.
Centralised systems require a centralised place of trust. Banks have been that centralised place of trust, but the transition can be rapid, and painful – as we have seen in the last 15 years with journalism. We will likely see the same for the banks who have lost our trust, as we redefine what are acceptable fees for these professional middlemen.
Does crowdfunding have its risks? Absolutely. But it’s not as if banks and professional investors have a great record of taking care of our money either. Again, just look back under 10 years to the global financial crisis for positive proof of that.
Crowdfunding is part of a larger cultural change towards a more open, more technologically-based, more decentralized economy – cutting out the middlemen and giving worthy companies the access to investors who want to back them. It tears down the barriers. It opens up investment beyond deals made the bar and the boardroom. We are in the midst of forging more direct relationships between companies and investors – and changing the culture of investing irrevocably in the process.
Nathan Rose is the Director of Assemble Advisory, a finance agency
for companies wishing to pursue equity crowdfunding. Assemble Advisory
assists with picking the right platform, putting together offer content
and financial models, and campaign management – allowing
companies to raise money sooner.