Analysis of Reward-Based Crowfunding in Islamic Finance

Analysis of Reward-Based Crowdfunding in Islamic Finance

Rahma Aulia Sidik, Yaga Tria Wandani Sukma

 

ABSTRACT 

This paper explores reward-based crowdfunding in the context of Islamic finance, looking at its operational aspects, compatibility with Islamic principles, and overall framework. Examining how Shariah principles mesh with rewardbased crowdfunding mechanics and practices, the study evaluates how well it adheres to Islamic finance doctrines. The first part of the analysis outlines the basic ideas of Islamic finance, emphasizing its moral, legal, and Shariahcompliant foundations. After that, it shifts to explaining the ins and outs of reward-based crowdfunding, breaking down its incentive systems, operational framework, and effects on investors and project developers. The suitability of reward-based crowdfunding models with Islamic finance principles---such as the proscription of riba (interest), gharar (uncertainty), and conformity to moral investment standards---is then critically examined. The study investigates whether reward-based crowdfunding methods can be made compliant with the moral and legal guidelines set forth by Islamic finance.

Keywords: Crowdfunding, Fintech, Islamic finance 

 

INTRODUCTION

Crowdfunding has become a disruptive force in the financial industry in recent years, changing the way that money is raised traditionally and putting entrepreneurs in contact with a large pool of potential investors. Thanks to the increasing popularity of different crowdfunding models, crowdfunding platforms have emerged as a popular means for both individuals and businesses to raise capital for their projects.

A model that has attracted a lot of interest is reward-based crowdfunding. With this model, business owners can provide non-monetary incentives or rewards to supporters who provide funding for their initiatives. Although reward-based crowdfunding offers investors and entrepreneurs special opportunities, there has been much discussion and debate regarding whether or not it is compatible with Islamic beliefs and practices.

Based on the tenets of Shariah law, Islamic finance forbids the payment or receipt of interest (Riba) and places a strong emphasis on risk-sharing, social justice, and ethical investing. Reward-based crowdfunding raises concerns regarding the permissibility of such transactions within the Islamic finance framework because it involves the provision of nonfinancial rewards.

The objective of this paper is to present a thorough examination of reward-based crowdfunding within the framework of Islamic finance. It will examine how the fundamental ideas of Islamic finance relate to---or don't relate to---the workings and procedures of rewardbased crowdfunding. It will also look at the possible effects of reward-based crowdfunding in Islamic finance, including the social and economic as well as legal ramifications.

This analysis will aid in the creation of an Islamic framework for crowdfunding by looking at the moral and legal issues that arise in reward-based crowdfunding. It will clarify possible obstacles and advantages for investors and business owners who want to use rewardbased crowdfunding in accordance with Islamic law. Moreover, it will assist industry participants in Islamic finance in comprehending and navigating the intricacies of this cuttingedge financing model.

To sum up, the objective of this analysis is to establish a connection between the concepts of Islamic finance and the quickly changing realm of crowdfunding. It aims to support the expansion and development of reward-based crowdfunding within the context of Islamic finance by highlighting the main areas of convergence and divergence and offering viable solutions.

METHODOLOGY

The methodology in this research is a method of gathering information from various points of view in order to promote the quality of the research and achieve objective and comprehensive conclusions. The data collection approaches used in the research include library research, field research, and documentation studies. The sources of information used in this study approach are regulations governing the merging of Islamic State-owned banks, books, literature, previous research, and other related books. Only those that are specifically linked to the topic are chosen for this data source. The authors used the qualitative research method in this study, which is a research approach that examines and generates descriptive data results in the form of written words. This research approach uses the written word method rather than the statistical method to generate data (Nurdin & Hartati, 2019). 

ANALYSIS AND DISCUSSION RBCF Business Model

Rewards-based, or seed, crowdfunding is a type of small-business financing in which entrepreneurs solicit financial donations from individuals in return for a product or service.

There are about 19 times as many rewards campaigns as there are for its closely related counterpart, equity-based crowdfunding.

Business owners describe their project or business idea and fundraising goal on a crowdfunding platform. In return for donations, businesses provide rewards. For example, a jewelry designer might reward everyone who contributes $100 with an original handmade bracelet, or an inventor of solar-powered lawn mowers might give a mower to contributors at the $1,000 level.

This type of financing is geared toward startups, particularly in creative fields, that don't qualify for traditional small-business loans but have compelling projects or want to test a market. Small businesses with a complex product or service might want to explore traditional funding options; it might be hard to explain the value of your company in layman's terms to a crowdfunding audience. Anyone --- family, friends, customers, business partners --- can contribute to a rewards crowdfunding campaign. Individual donations are often small, so business owners need to persuade as many people as possible to pitch in. Often, the campaign is shared on social media with the hope that the business owner's followers will, in turn, share the campaign with their networks. Platforms typically charge a percentage that can be as low as 5% to as high as 13% of funds raised, and may charge an additional processing fee.

 Reward-based crowdfunding can be considered as the most publicly familiar crowdfunding model, where backers contribute to projects without any monetary returns (Mollick 2014). Instead, they expect to receive material compensations (e.g. real products) as well as immaterial compensations (e.g. thank-you letters) in return of their contributions (Gerber et al. 2012).

The rewards commonly used in reward-based crowdfunding campaigns fall into three categories (Colombo et al. 2015; Thrridl and Kamleitner 2016): pre-orders, services, and recognition. Particularly, campaign creators offer their products in a pre-order mechanism through which backers have early access to the products. As part of the process, contributors also evaluate the products and may offer creators useful suggestions on how to make the products better to satisfy their needs. Recognition and services are examples of immaterial rewards. Recognition as a reward applies to the entry-level backers (backers contributing a small amount of money). Here, creators may write thank-you letters to such backers or display their names on the website in order to acknowledge their contribution. Creators may also provide special services, instead of physical products, as rewards for backers. Examples of these may include private performances and screenings, training and educational experiences, free use of commercial services being developed, and so on.

Reward-based crowdfunding is a two-sided market (Tomczak and Brem 2013). Specifically, the supply side of the market consists of a group of backers who are willing to contribute to crowdfunding campaigns to achieve material or immaterial compensation. The demand side of the market consists of a group of campaign creators who design their campaigns in order to get projects they are developing funded. This two-sided market is in most cases operated through an online intermediary (crowdfunding platform) such as Kickstarter.

In this chapter, a framework is applied to explain the mechanism of reward-based crowdfunding. It consists of four essential elements (campaigns, creators, backers, and platforms) of the whole reward-based crowdfunding process (Ordanini et al. 2011). The three elements (creators, backers, and platforms) will be discussed separately at the different phases of the crowdfunding process namely---the preparation phase, the crowdfunding phase, and the outcome phase. Specifically, the preparation phase refers to the period before launching campaigns. The crowdfunding phase refers to the active fundraising period of campaigns, and the outcome phase refers to the consequences of crowdfunding campaigns, once they are closed and the fundraising period is over.

 

Figure 1. Reward-based Crowd Funding Model 

RBCF Key Player

Key players in reward-based crowdfunding (RBCF) include the project creators, backers, crowdfunding platforms, and intermediaries.

Project Creators: These are individuals or businesses that propose a project or idea and seek funding through RBCF. They create a campaign on a crowdfunding platform, set

a funding goal, and offer various rewards or perks to attract backers. Project creators can be entrepreneurs, artists, inventors, or social causes seeking financial support.

Backers: Backers are individuals or organizations that support a project financially by making pledges or contributions. They are driven by various motivations, such as interest in the project, desire to help the creator, or interest in the rewards offered. Backers typically receive rewards based on their level of support, which can range from a simple thank-you note to exclusive access to the product or service being developed.

Crowdfunding Platforms: These online platforms serve as intermediaries connecting project creators and backers. Popular RBCF platforms include Kickstarter, Indiegogo, GoFundMe, and Patreon. These platforms provide project creators with tools to create and manage campaigns, showcase their projects, receive funds, and facilitate communication between creators and backers. They may charge fees, such as a percentage of the funds raised or transaction fees.

Intermediaries: In some instances, intermediaries or consultants play a role in RBCF campaigns. They offer services to project creators, helping them optimize their campaigns, set funding goals, develop rewards, and market their projects. Intermediaries can be marketing agencies, crowdfunding consultants, or freelance professionals with expertise in crowdfunding campaigns.

 

The dynamics among these key players work as follows: Project creators present their ideas on crowdfunding platforms, often accompanied by detailed descriptions, videos, and prototypes. Backers visit the crowdfunding platform and explore various projects. When they find a project that resonates with them, they can make a financial pledge and become backers. The platform facilitates all financial transactions securely, collecting funds from backers and managing the transfer to the project creator.

As the campaign progresses, backers may share the project with their networks, helping to spread the word and attract more backers. The success of RBCF campaigns largely depends on effective communication, marketing efforts, and the quality of the rewards or perks offered.

Overall, RBCF has become a popular and accessible way for project creators to secure funding, gain validation and market exposure, and engage with their target audience. It allows backers to participate in the development of projects they believe in and receive exclusive rewards in return. The key players in RBCF collectively contribute to the success and growth of this alternative form of financing.

Risk Aspects and Issues in RBCF

Rewards-based crowdfunding can be a useful way to sell product or service in front of a large group of people and build a community around your business. However, there are also several risks associated with this type of crowdfunding, including:

Not reaching the funding goal: When entrepreneurs do not reach their funding goal, they may not receive as much money as they would with other types of funding. This can be discouraging for them.

Logistical challenges: Managing the logistics of fulfilling rewards can be a significant undertaking for a small team or an individual, and it can be challenging to keep up with the demand if their crowdfunding campaign becomes very successful.

Costs: Rewards-based crowdfunding can incur higher costs compared to other crowdfunding types. This is because it involves factoring in the expenses related to manufacturing and shipping the rewards offered. Additionally, campaigners may need to allocate funds for additional marketing and advertising to promote their campaign.

Legal issues: When individuals accept funding in exchange for offering perks or rewards, they may be entering into a contract with their backers. This means they will be obligated to deliver whatever they promised, and failing to do so can expose them to potential claims under consumer protection laws, false advertising laws, or common law claims such as fraud or negligent misrepresentation.

Delivery delays: Delays in delivery can have various impacts on funders, some of which could be detrimental to the sustainability and growth of crowdfunding.

Shariah Aspects of the RBCF Business Model

Islam emphasizes the principle of Halal (permitted activity) emanating from the Shariah, which governs all activities in the life of Muslims. The Islamic Finance, ideally, is an alternative way of financing based on ethical and socially responsible standards, which ensures fair distribution of benefits and obligations between all the parties in any financial transaction.

The crowdfunding carries these characteristics and provides the ground for new developments in the field, as it can use Islamic finance as an ethical and socially responsible tool to promote financing and development. Islamic finance and crowdfunding both conceptualize customers as investors and can potentially provide investment opportunities with higher returns. Investors take an equity stake in the project and gain returns based on the principle, which ensures a fair distribution between shareholders and entrepreneurs.

The Sharia-compliant crowdfunding invests in halal socially responsible projects/products, shares the risks of the investment, and is characterized by the absence of an interest rate. The originality of product-based crowdfunding lies in the fact that in return, the investor does not receive interest, but the product itself, which promotes the creation of new products and furthers innovation. Investors that pay for a product they wish to have can track the production process and see how their money is spent through weekly updates on the progress of the projects. 

Transparency is a very important part of the project, and a direct link between the customer and the workshop owner is established from the beginning. Islamic finance to comply with the Quran requires socially responsible investment, with a real impact on the community.

Sharia prohibits interest on loans and speculation.

There are four types of Sharia-compliant crowdfunding platforms:

Donation-based crowdfunding: In the case of donation, donors pay relatively small amounts to support a nonprofit project or a social development initiative through Zakat or Sadaq.

Reward-based crowdfunding: Donors contribute small amounts of money in exchange for a reward after the completion of the project. The reward is typically a product generated by the project itself.

Equity-based crowdfunding: At this stage, investors provide sums of money and, in return, become shareholders. They share in the profits and losses, similar to the concept of Musharakah.

Debt crowdfunding: Lenders grant a loan and expect the repayment of the capital along with the distribution of profit. These platforms rely on Islamic financial contracts and processes without involving interest, such as the use of Murabaha and Ijarah.

Table 1. Shariahcompliant Crowd Funding Models and Instruments

 

Source: Marzban & Austay, (2014). 

In the case of reward-based crowdfunding, potential beneficiaries include microfinance, small enterprises and startups. While microfinance and startups are generally financed through pure equity, small enterprises, notably family businesses, prefer to purchase back their own shares rather than being acquired by outside parties, therefore all of them use sale akad.

According to the study, the results show that both fintech and crowdfunding are still in their early stages in the Islamic world, with a relatively small number of participants, remain closely oriented to start-ups, and there are not enough investors while adopting shariacompliant methods and procedures for finding investors and selecting business ideas (Biancone et al., 2019).

CONCLUSION

In summary, reward-based crowdfunding is used to fund microfinance, small and medium businesses, and startups. Crowdfunding based on rewards can also be used to fund a wide range of initiatives, works, creative ideas, and projects. Based on the notion of social solidarity to reward or service ideas or projects, as well as the better allocation and utilization of financial resources. It is consistent with Islamic finance, which, if practiced properly, is seen as a revolution in financing techniques in the Islamic world.

Crowdfunding in the Islamic world continues to progress slowly, encountering several challenges. These challenges include technological limitations, slow processing of digital financial transactions, issues related to liquidity, and the relatively high living standards prevalent in the Gulf Cooperation Council (GCC) nations. 

However, it's clear that within the Islamic world, a community of innovative and entrepreneurial minds exists. For these individuals, crowdfunding provides a promising avenue to navigate away from the complexities of traditional financing methods. It offers a swifter, more accessible, and less risky alternative. The fusion of Islamic finance principles, crowdfunding, technological advancements, and the burgeoning Fintech sector presents a substantial opportunity. It can significantly enhance the entrepreneurial landscape within the Islamic world and contribute to fostering social and economic progress.

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