The Wild and Weird World of Chinese Crowd-Funding

A new chapter was written in the saga of crowd-funding earlier this month as the Federal Trade Commission (FTC) dipped for the first time into the murky waters of crowd-funding in the United States. The FTC took action against Erik Chevalier, who successfully raised $123 thousand for the creation of a board game on the popular crowd-funding website, Kickstarter. Chevalier failed to deliver on the promised board game and allegedly used the raised funds for personal purposes, leading to the investigation by the FTC.

The FTC also announced that even if crowd-funding sites or supporters are initially unable to reveal fraud, the FTC will be looking to take more action in the future. It's a significant threat to a market that has been largely without regulation for many years now.

The United States isn't the only government taking note of the growing internet crowd-funding market. China too is looking to figure out its own gargantuan crowd-funding business.

Traditional forms of "crowd-funding" is illegal in China, as the government views it as a form of a pyramid scheme. Under these rules, websites like Kickstarter or Kiva cannot exist. However, a number of Chinese companies are skirting around these regulations to make crowdfunding possible.

The crowd-funding system of most relevance, and perhaps the scariest, is Yule Bao, launched by Alibaba last year. Alibaba is probably the world's biggest online commerce company and they handle more online business than any other "e-commerce" company in the world. They have a massively popular smart-phone app called Taobao, and Yule Bao (roughly translating to "entertainment treasure) is a section of this app.

Essentially, Alibaba curates a set of entertainment projects to appear on the app, whether it be games, movies, or TV series, and normal consumers can invest in the project. Unlike Kickstarter, where supporters are donating money, Yule Bao is an investment - each project as an expected annualized return of seven percent. A backer might also get short-term perks, like signed posters, visits to the set, or discounted tickets.

In the first 5 days of being launched, the platform raised over 11 million dollars and hundreds of thousands of investors. Last month they revealed that it has raised a total of five billion yuan ($805 million) over its short lifespan.

Jackie Chan's new film starring John Cusack and Adrien Brody, Dragon Blade, raised over $4.8 million dollars in just two and a half days. In total, Yule Bao raised $53 million dollars in 2014 for twelve movie productions, and the movies had over $483 million dollars in ticket sales (ten percent of the total box office revenue in China.)

Obviously, the platform is only partially funding the movies, but here's what separates Yule Bao. Essentially, Alibaba want the platform to be a major source of "Big Data," where they can hone consumer preferences and find what exactly the public want. In a recent conference, an executive at Alibaba said that they would even refund investors if a film flopped. The end goal of the system is to allow public investors to "select the directors, heroes and heroines of a movie or TV show."

One bizarre project that was funded by Yule Bao was Outcast, starring Nicolas Cage and Hayden Christensen. The movie has a six percent Rotten Tomato rating, but already is signed for a sequel because of its success in China.

The major difficulty of crowd-funding in China is that companies cannot directly solicit funding from individuals. Companies looking to follow the crowd-funding model have to devise ingenious methods to slip around the law. Another massive "e-commerce" company in China, Tencent, set up a crowd-funding system where NGOs and non-profits could upload a proposal and Tencent would donate about $0.10 per retweet of the proposal.

Some websites, like Demohour and Angelcrunch, manage to follow the Kickstarter model and avoid the legal restriction placed on soliciting funding. However, websites that follow the Kickstarter model face an uphill battle. Online crowd-funding typically have had little success because of the massive fear of online scams in China. Also, due to the wealth inequality present in the country, many people look at donating money as a waste and donators are sometimes even ridiculed. Demohour is the largest Kickstarter-like and it's only raised a few million dollars in its history. But even as these models are still nascent, Yule Bao and Tencent have been proving that crowd-funding in China is a lucrative space.

Recognizing this growing business model, The People's Bank of China (PBOC) is looking to crack-down on online finance in China, which has been a wild west for the past few years without any regulation at all. The major change proposed will be a limit on the spending by individuals using third-party payment platforms and transfers from bank accounts to accounts managed by third-party companies.

There were 1.2 trillion dollars in online transactions in China just in 2013; it's not a market to toy with.

China's well known for its highly regulated market structure and it's about time the PBOC to step in. There is yet to be a instance of fraud in crowd-funding similar to the likes of Chevalier, but for a country well versed in online scams and fraud, the PBOC is searching to restrain this inchoate system.