PayPal pulls buyer protection for crowdfunding sites

Aidan Crawley | Bloomberg | Getty Images

Online payments firm PayPal has announced that it will no longer provide purchase protection for purchases made on crowdfunding platforms, potentially dealing a blow for the nascent industry.

While this is not great news for fans of crowdfunding platforms, it also adds to the growing concern about the risks of crowdfunding. The new policy comes into effect on June 25 and says payments on crowdfunding platforms are not eligible for reimbursement under PayPal Purchase Protection.

"PayPal is changing its user agreement … we encourage you to review this policy update and familiarize yourself with the changes that are being made. If you do not agree to the amended user agreement, you may close your account before June 25, 2016 and you will not be bound by the amended terms," PayPal said in a policy change statement on its website that was first reported on Monday.

It further explained that while your payment is not eligible for PayPal Purchase Protection, you can still file a dispute to try to resolve the issue directly with the seller. However it added there are some caveats. "PayPal will generally not find in your favor if you escalate a dispute to a claim for an item which is not eligible for PayPal Purchase Protection," the statement read.

In an emailed statement to CNBC, PayPal explained that the decision to remove payment protection is in line with the risks the sector poses.

"In Australia, Brazil, Canada, Japan, United States and other countries, we have excluded payments made to crowdfunding campaigns from our buyer protection programs. This is consistent with the risks and uncertainties involved in contributing to crowdfunding campaigns, which do not guarantee a return for the investment made in these types of campaigns."

The era of 'crowd diligence'
The era of 'crowd diligence'

This puts investors in crowdfunding platforms at a bigger risk of exposure to failed projects. The growing popularity of crowdfunding platforms has been a concern for many. In 2015, the total global crowdfunding industry saw fundraising volumes hit $34 billion, according to a Massolution Crowdfunding Industry 2015 report. Of this, $25 billion is in peer-to-peer lending, $5.5 billion in reward and donation crowdfunding and the remaining $2.5 billion in equity crowdfunding.

While the asset class is massively growing, there are risks due to the unregulated nature of this investment. A report from crowdfunding site Kickstarter last year said 9 percent of projects failed to deliver rewards, while 8 percent of dollars pledged went to failed projects.

The numbers limited only to Kickstarter further showed that 7 percent of backers failed to receive their chosen reward and nearly 65 percent of backers agreed or strongly agreed with the statement "the reward was delivered on time." The report also warned that project backers should expect a failure rate of around 1-in-10 projects and to receive a refund 13 percent of the time.

While we await more details on how this is going to impact crowdfunding platforms, a spokesperson from PayPal told CNBC via phone that the policy changes will not be applied to customers in the U.K. and the company has no plans in the near future to make changes to that decision. PayPal has also dropped purchase protection on anything bought from or paid to a government agency as well as gambling and any activity with an entry fee and a prize.

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