Earlier this week, my friend Trace, who is writing a book to inspire children with disabilities, reached his $5,000 goal on Kickstarter.com. Like Trace, who was born without a right hand, Kickstarter itself earned a major victory this week, when a judge ended a four-year patent dispute in their favor.
U.S. District Judge Katherine Faila has ruled that ArtistShare’s patent on crowdfunding platforms is invalid. The two companies compete against each other to spur altruistic donations. Both platforms allow friends and strangers alike to donate to charitable causes, individuals or businesses who need capital.
ArtistShare, founded in 2003 to encourage donations to artists, obtained a patent in 2011 that claims that its platform encouraging patronage was a new service. The company demanded Kickstarter pay a licensing fee in order to use their idea. Kickstarter refused and filed suit.
Unlike peer-to-peer lending platforms, those who donate on “rewards-based” websites do not receive debt payments or equity. Instead, discounted services, merchandise or intangible services are offered. My donation to Trace’s campaign, which was only taken out of my bank account once he reached his goal, guarantees me an autographed copy of the book and a smile the next time I see my friend.
The lawsuit rested on two questions, known as the Alice framework. In layman’s terms, first, is ArtistShare’s claim to a patent ineligible because it is natural phenomena, natural law or an abstract idea? If so, does their claim at least have additional elements that apply the concept or do the additional elements just add to the concept?
Judge Faila first ruled that ArtistShare’s claim was ineligible because it was an abstract idea. For centuries before the platform arrived, people were charitable and it is not reasonable to conclude that ArtistShare “invented” the practice of donating to a cause, with possible gifts of thanks offered in return. Then, Judge Faila ruled that simply by creating a mechanism for money to be donated online, ArtistShare had not applied the concept of charitable giving in a novel way, even if they have made it more efficient. She writes.
At best, [the patent] describes the use of the Internet or a computer network to make identifying and soliciting funds from potential patrons easier and more efficient. But relying on a computer to perform routine tasks more quickly or more accurately is insufficient to render a claim patent eligible.
The decision is a key victory for crowdsourcing. Patents are not necessary to protect against small advances in efficiency through the application of technology. They are, however, necessary to protect the investments of scientists and entrepreneurs embarking on projects that introduce new products and services into the marketplace.
We must make sure Schumpeterian innovators have the protection they deserve, while making sure groups like ArtistShare do not gain monopoly power because they filed for a patent eight years after a basic online platform was introduced.
According to a recent study by R Street Institute Associate Fellow Oren Litwin, the Kickstarter model of crowdfunding has thus far negligible impact on small businesses. However, Litwin argues that peer-to-peer (P2P) lending platforms, another form of crowdfunding, do offer possible new streams for small businesses looking for capital. Platforms like Prosper.com and LendingClub allow borrowers to ask for loans from individual investors.
They have succeeded, partly, because of the decline of community banks, which used to hold local knowledge as their competitive advantage. Over the last few decades, small banks have been incorporated into larger networks and/or shifted their focus from small businesses to lending to consumers, especially on the home mortgage market.
P2P platforms are experiencing regulatory hurdles. Because of the high costs associated with publicly registering securities, only accredited investors can invest on these sites. According the R Street study, only 8.5 million Americans have this status. Further, the Securities and Exchange Commission waited three years after being ordered by Congress, in the Jobs Act of 2012, to build a regulatory framework to allow Americans to directly invest in small businesses. Though new rules, dubbed the “Regulation A+ framework” were introduced two weeks ago, many worry they do not go far enough and will be buried.
Promising work is being done in the laboratories of democracy, where states are opening the market for P2P lending for non-accredited investors (though only the Michigan Legislature has approved a secondary marketplace). More work should be done to free these markets, and Litwin argues the Department of Labor should allow 401(k) account holders to invest in the emerging intrastate markets.
Crowdfunding is yet another case of the government trying to protect consumers, but the application of outdated laws to new products is instead hurting Americans and encroaching on personal liberty. The SEC, state legislators and policymakers should think critically about how they can help new markets thrive. In some cases, that may mean getting out of the way. Meanwhile, thanks to ArtistShare decision, more entrepreneurs will be free to bring innovative crowdfunding options to the market in the future.