Crowdfunding: Fraud and Money Laundering Risks

Crowdfunding is the funding of a project or initiative by a group of people via the internet. Crowdfunding, one of the new investment trends in the world, has been introduced as a way to help small businesses and entrepreneurs looking for investment capital to remove their business ventures from scratch. Crowdfunding isn't actually a new concept. In the 18th century, writers and musicians were collecting money from many investors to spread their works worldwide. Similar to non-governmental organizations gathering aid to build schools or to carry out a social project, such local communities can now reach a larger audience with the contribution of the Internet. It can be said that it is an updated version of the traditional fundraising process.


Types of Crowdfunding


  • Donation-Based Crowdfunding is a way to fund a project by asking a large number of participants to donate a small amount.
  • Reward-Based Crowdfunding involves identifying rewards at different levels corresponding to collateral amounts. A standard reward campaign offers at least three levels of collateral/reward.
  • In peer-to-peer (P2P) or Debt Based Crowdfunding system, start-ups borrow money from several people online and pay them back after the project is over.
  • In the Lending Type of Crowdfunding System, entrepreneurs created a periodical fund in the form of loans they would repay to lenders on a predetermined timeline with a set interest rate.
  • In the Equity Crowd Funding system, investors invest in a company that is not quoted on the Stock Exchange in exchange for equal rights in the shares of the shareholders.


Risks Rising by the Growth of Crowdfunding


Crowdfunding has become popular all over the world in recent years. Billions of dollars change hands every year through crowdfunding platforms. The fact that money changes hands over crowdfunding platforms raises some risks. In the case of financing with both donation and reward-based and investment-based crowdfunding models, there are real risks perceived by investors. These risks can generally be classified as failure of investment, fraud and money laundering.


Investment Failure


Within the scope of crowdfunding investments, the most risk faced by investors is the risk of investment failure. By the nature of the crowdfunding system, early-stage companies are invested. Investments in early-stage companies always involve more risk than investments in companies that have reached a certain level of maturity and have a certain level of cash flow data, have professional management, and have reached the appropriate structure.


According to global data, 50% of early-stage firms fail in the first five years. While experienced investors have sufficient information about the high level of this risk, crowdfunding investors should be informed about the level of this risk and their awareness should be increased. Entrepreneurs who want to provide financing with Crowdfunding do not always have the necessary experience and knowledge to successfully manage an early-stage company. Therefore, the risk of investment failure increases. In order to reduce this risk, the culture of entrepreneurship should be supported, and wide educational opportunities and supporting institutions should be developed for entrepreneurs. In addition, obliging the participation of investors experienced in the management of the company, and professionals in the fields of finance, accounting and law, may also reduce this risk.


    Fraud


    Although qualified fraud is a rare situation within the scope of crowdfunding, the most common example of fraud is through false platforms and collecting money for counterfeit and non-fraudulent companies. Fraud risk can be minimized by taking the following measures:


      • Investigation of past activities of fundraisers.
      • Compulsory audit, financial statements and preparation of review reports.
      • To raise awareness about fraud by informing investors about past fraud examples.
      • Crowdfunding investments should be made only through platforms authorized by a national supervisory regulatory body.


      Money Laundering


      As with all other investment platforms, crowdfunding platforms carry the risk of money laundering. However, electronic payment systems used in crowdfunding platforms can reduce this risk to a certain extent. The effective implementation of laws against money laundering in the country where the platforms are located can almost eliminate this risk.


      In addition, this risk can be minimized by taking the following measures:

      • To set a maximum limit for the amount of money that can be collected within a certain time interval.
      • To set a minimum period between the collection of the fund and the use of the fund to create time for further investigation for investors and regulatory authorities.
      • Applying anti money laundering, know your customer and customer due diligence procedures to fundraisers and funders.

      Crimes Committed Through Crowdfunding Platforms Increase


      Performing financial transactions of a total of $ 300 billion are expected in 2025 through the crowdfunding industry. With the crowdfunding industry growing so much, it has become a new option for criminals for money laundering and fraud. In recent years, many crowdfunding campaigns have been identified that exploit people's emotions. According to the information announced by law enforcement officers, people who collect funds with unrealistic information, using these funds in various crimes. As a consequence of these threats, crowdfunding platforms have been regulated by regulatory agencies. These regulations aim to prevent fraud and money laundering risks in crowdfunding. The Jumpstart Our Business Startups (JOBS) Act in force in the USA is an example.


      Crowdfunding Platforms Must Implement AML Controls


      Under these risks, Crowdfunding platforms must both meet their legal obligations and ensure their reliability in order to function. Crowdfunding platforms must check fundraisers and funder with AML, KYC and CDD procedures to prevent them from preventing suspicious activities on the platform. These checks enable potential threats to be a detect and potential crime to be prevented. Thus, crowdfunding platforms maintain their reputation and meet legal obligations.



      Sanction Scanner collects and updates the sanction, PEP and adverse media data of more than two hundred countries. With Sanction Scanner, crowdfunding platforms can check funder and fundraiser among these AML data in seconds and detect potential threats. You can contact us for information about Sanction Scanner solutions for Crowdfunding Platforms.

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