Tesla, Inc. raised almost $400 million by selling cars that did not exist. In one week, the company presold almost 400,000 Model 3 electric vehicles, projecting nearly $20 billion in net revenue from a product that had not yet been manufactured. From a regulatory perspective, this unprecedented “presale” does not exist. There is no law designed to govern it, because nothing like it had ever happened before.

In Hyperfunding: Regulating Financial Innovations, published in the University of Colorado Law Review, I coin a term for this phenomenon and argue that it exposes a dangerous gap in financial regulation – one that leaves consumers unprotected and invites abuse by less scrupulous imitators.

What is hyperfunding?

“Hyperfunding” is fundraising many millions of dollars in a brief campaign that directly targets a broad base of consumers or investors via the internet. I named it both for the high speed at which capital is raised and as a nod to Elon Musk’s Hyperloop – capturing the zeitgeist of accelerated financial innovation.

The critical feature of hyperfunding is what it is not. It is not equity financing, because consumers are placing deposits for products, not buying stock. So it does not meet the Howey test and is not regulated by securities laws. It is not crowdfunding, because it does not use an intermediary or portal. It is not a traditional presale, because it is several orders of magnitude larger and more uncertain than any presale program before it.

Hyperfunding is not equity financing because it does not meet the Howey test, so it is not regulated by securities laws. Hyperfunding is not crowdfunding because it does not use an intermediary or portal to indirectly raise funds, so it is not regulated by crowdfunding laws either.

The result is a financial innovation that falls through every regulatory crack.

The Elon Musk and Henry Ford parallel

I draw a historical parallel between Musk and Henry Ford. Both used presales to finance manufacturing revolutions. Ford presold Model T cars to fund production in the early twentieth century, leveraging consumer demand to bypass traditional capital markets. Musk did the same thing a century later, collecting $1,000 deposits from hundreds of thousands of consumers to finance the Model 3 production line.

The difference is scale and speed. Ford’s presales were local and incremental. Tesla’s were global and instantaneous, powered by the internet and social media. A single tweet from Musk could generate billions in commitments overnight. This speed and scale changes the risk profile entirely.

Why consumers are exposed

When you buy stock in Tesla, securities law protects you. The company must file disclosures with the SEC. If Tesla lies about its financials or misses milestones, you have a colorable claim of fraud. You can sell your shares if you lose confidence.

When you place a $1,000 deposit on a Model 3 that does not yet exist, you get almost none of these protections. Risks were not disclosed. Delivery timelines were uncertain. If Tesla had failed to deliver – as many observers predicted – consumers could only get their deposits back if the company had the financial and reputational capital to issue refunds. There was no disclosure requirement, no independent audit, no regulatory oversight of the presale process.

Unwary consumers may not have realized that they were underwriting Tesla’s bold strategy to transform multiple product markets. Risks were not disclosed. Rewards proved illusory.

Tesla had the resources and brand loyalty to follow through (eventually, after significant delays). But what happens when an undercapitalized or fraudulent firm uses the same technique? What stops a startup with no track record from collecting millions in deposits for a product it cannot build?

The ICO connection

I identify hyperfunding as part of a broader pattern of unregulated financial innovation. Initial coin offerings (ICOs) on cryptocurrency blockchains exhibit remarkably similar characteristics: massive fundraising, direct-to-consumer, internet-enabled, and operating in a regulatory vacuum.

Both hyperfunding and ICOs exploit the same gap. They are not securities (no equity, no profit-sharing). They are not traditional presales (too large, too speculative). They are not crowdfunding (no portal, no intermediary). Existing regulatory frameworks were designed for a world where financial innovations fit neatly into established categories. These innovations do not.

Financial regulatory theory and the problem of novelty

The deeper problem, I argue, is structural. We are entering an era when innovation outpaces regulation. Public watchdogs and legislatures lack the capacity to keep up with emerging fintech. Private consumers will become increasingly responsible for their own financial security in areas where they have no expertise and no legal protection.

Financial regulatory theory offers three traditional approaches: disclosure-based regulation (require information sharing), merit-based regulation (require government approval before offering), and antifraud regulation (punish bad actors after the fact). None works well for hyperfunding.

Disclosure-based regulation assumes there is meaningful information to disclose – but for a product that does not yet exist, what exactly would be disclosed? Merit-based regulation requires regulators who understand the innovation well enough to evaluate it – but by definition, novel financial products outrun existing expertise. Antifraud regulation only works after harm has occurred, which may be too late for millions of consumers who placed deposits.

A framework for the future

I do not propose a single regulatory fix. The first step is correctly classifying the phenomenon. By coining “hyperfunding” and mapping it against existing legal categories – securities, crowdfunding, presales, and ICOs – I create the analytical framework needed for regulators to respond.

I examine each potential regulatory regime: securities law (which would require registration or an exemption), crowdfunding law (which imposes intermediary requirements and dollar caps), consumer protection law (which offers Fair Credit Billing Act protections but was not designed for this scale), and bankruptcy law (which determines deposit-holders’ priority in insolvency). None is individually adequate. The challenge is to craft protections that address the unique risks of hyperfunding – massive scale, unproven products, consumer-investors who think they are customers – without stifling the financial innovation that makes ventures like Tesla possible.

Read the full article: Seth C. Oranburg, Hyperfunding: Regulating Financial Innovations, 89 U. Colo. L. Rev. 1033 (2018).