[heading]What Is P2P Lending & How Does Bitcoin Oil Its’ Gears?[/heading]
Albert Einstein was a fan of the “thought experiment,” which is essentially when one uses their imagination to discover something new. Oftentimes these thought experiments served as precursors – a mental blueprint of sorts – to real-world experiments.
With that in mind, Financial Times takes us upon a thought experiment into the new world (dominated mainly by startups) of P2P lending:
There is a small manufacturing company in the northwest of England that is looking for £150,000 of working capital. It is traditionally the kind of need that might have been met by a bank loan. But, in the post-crisis world of bank belt-tightening, it is now the bread-and-butter of upstart peer-to-peer (P2P) lenders.
Within the past four days, Funding Circle, a P2P business finance specialist, has found 61 per cent of the money that the company was seeking – by offering savers like you and me as much as 15 per cent interest if we stump up our cash.
The appeal of P2P lending resides in the fact that, for those with money to invest, 15% returns means making money. In return, any company seeking a loan won’t have to put off dreams of expansion in the face of a bank denial, for P2P lending can fill the void. As Wikipedia defines P2P lending:
Peer-to-peer lending (also known as person-to-person lending, peer-to-peer investing, and social lending; abbreviated frequently as P2P lending) is the practice of lendingmoney to unrelated individuals, or “peers”, without going through a traditional financial intermediary such as a bank or other traditional financial institution. This lending takes place online on peer-to-peer lending companies’ websites using various different lending platforms and credit checking tools.
Alongside new virtual technologies like Bitcoin, P2P lending is growing with haste. In the UK, for instance, P2P lending has gone from non-existent to almost £380m in 2013. Other hotspots include the US, where the two largest P2P lending operators have altogether lent over $1.7 billion over five or so years, as well as China and eastern Europe. Lending Club, the lead US operator, is even led by John Mack, former head of Morgan Stanley, and Larry Summer, the former US Treasury secretary.
In the UK, the local division of Spain’s Santander is planning to cooperate with Funding Circle to help finance SME loans, similar to mergers and acquisitions now taking place in this market in the US. Simultaneously, behemoths Morgan Stanley have given its wealth management clients access to invest in Lending Club.
P2P currently lends a few billion dollars, which is nothing in the global scheme of things. There are 28 banks with assets of over $1 trillion each.
One criticism of P2P lending is the 15% interest rate. This may seem great for potential lenders, but an issue crops up when one begins to consider loan default. For now, P2P loan default information goes back but a few years, and so how reliant such loans are is still largely unknown.
But, many in the upstart Bitcoin community believe this issue can be solved. One hope of some in the Bitcoin community is that the decentralized virtual currency enables trust-free economic arrangements. In other words, Bitcoin wants to achieve a system of as little as possible. One way to solve this problem here, in a rather crude manner, would be to join together many individuals who pledge a small amount of money to a P2P network for considerable return. Lenders and borrowers are aligned at the micro level, and a lender loans to the network instead of the individual. Instead of lending to one person, lend less to that person, and more to others. Let a protocol manage this based on algos.
How does one get credit detail in a P2P soup? Well, perhaps the question should be: how does a P2P lending network depend less on credit? Over time, like eBay, a P2P lending network would weed out the bad borrowers much like the credit system does today. These individuals would be offered less ideal rates than those with splendid reputation. Some would be altogether shunned.
Some P2P lending companies have a robust system in place, whilst others advertise they can approve a loan in minutes with but a few pieces of information.
P2P lending will likely be a double-sided coin. There will be old fashioned companies doing what they can to apply P2P to old conceptions of doing business. On the flipside, the younger generation will look to Bitcoin as the seeds of a P2P lending network. Thus, there will be two competing P2P systems floating alongside each other: the establishment and Bitcoin.
While decentralized coiners will do what they can to reduce trust and rely on the protocol (in my opinion), the old-fashioned crowd-sourcers will approach their business as an intermediary company and take a hands-off approach. The company’s won’t know how to do their due-diligence in this environment or they won’t give many people access to credit. This will lead bankrupt the company’s or lead people elsewhere.
P2P has earned government support in the UK, as the Department for Innovation Business and Skills pledged to provide 20% of the cash that many loan applicants were seeking, via its Business Finance Partnership scheme.
Will banks become peer-to-peer intermediaries? Will bank depositors and bond investors be okay with taking on the risk of lending? What risk would the institution bear? They might, but first they’d have to be pretty convinced that their way of P2P lending was space age indeed.