What Is Peer to Peer (P2P) Lending?

Long before the arrival of peer-to-peer lending websites in 2005, popular platforms like Napster were building on a decentralized network infrastructure.

P2P networks consist of two or more computers interacting to communicate or share data without needing a central server. That is, each computer acts as a node within the broader network, keeping a copy of the same information. In contrast, client-server networks connect multiple clients to one server that acts as a central repository.

Let’s take a closer look at the evolution of P2P lending.

What Are the Types of P2P Lending ?

To better understand P2P lending, it is important to have a firm grasp of the two types of P2P Lending.

There are two common types of Peer-2-Peer Lending:

1. Traditional Peer-to-Peer Lending

2. Crypto Based Peer-to-Peer Lending

Traditional Peer-to-Peer Lending

Peer-to-peer lending allows you to source loans directly from others without the need for an intermediary like a bank. Because of this dynamic, P2P lending is also known as “social lending” or “crowdlending” and has seen immense growth as an alternative form of financing in recent years.

Traditional P2P lending results when funds in fiat currency -like dollars- are exchanged outside the conventional banking system. Companies such as Prosper, Lending Club, Peerform, Upstart, and StreetShares compete in this digital-heavy space to great effect. Traditional P2P lending has given small and medium-sized businesses an alternative source of capital when faced with increasingly stringent bank regulations.

Crypto-Based Peer-to-Peer Lending

With the advent of cryptocurrency, the P2P market continues to evolve as decentralized networks and smart contracts present new avenues for accessing financial services outside the traditional banking infrastructure. Utilizing blockchain technology, borrowers and lenders are able to enter a loan agreement without the need for an intermediary. Instead, self-executing smart contracts enable trustless transactions. According to DeFi Pulse, a DeFi analytics and rankings publication, $2.29 billion of value was locked in the DeFi lending market as of September 2020.

The term “crypto-backed loan” represents a P2P loan denominated in cryptocurrency and executed on a blockchain network. Loans occurring on-chain require collateral, either in fiat or cryptocurrency. This dynamic is similar to conventional banks requiring collateral, such as a car or house to facilitate a loan agreement.

The maximum amount a user can borrow is determined by the amount of collateral provided, also known as the collateral factor or collateral ratio. In exchange for these funds, lenders receive interest from the borrower and repayment of their principal sometimes, but not always, within a set timeframe. Smart contracts automatically execute the loan and uphold its terms.

Crypto-backed loans are breathing new life into the peer-to-peer lending market. By removing intermediaries from the process, costs have been lowered, the settlement period is faster, and a more diverse and potentially equitable market is emerging.

Centralized vs. Decentralized Crypto Lending

Even though some people might automatically link cryptocurrency use to the notion of decentralization, this is not necessarily the case. There are centralized P2P lending platforms that are considered FinTech businesses that function similarly to traditional banks and financial services providers, but they use cryptocurrencies. But there are also decentralized platforms that operate in the same way, let’s take a look at them:

A centralized crypto lending service, such as a bank or a lending platform, is responsible for facilitating the loan process. This means that the entity will determine the terms of the loan, including the interest rate, and handle the lending and repayment process. The borrower, on the other hand, typically puts up cryptocurrency as collateral and receives a loan in fiat currency or stablecoins (he can also receive other cryptocurrencies). The borrower then repays the loan, plus interest, at a later date.

A decentralized crypto lending service, such as a DeFi platform, involves the use of smart contracts to facilitate the lending and repayment process on a blockchain. In this case, the terms of the loan, including the interest rate and the length of the loan, are typically determined by the network itself, rather than a central entity. Usually, a decentralized lending service has lower fees and better interest rates, but it is also more risky to use, as it requires a certain technical preparation on the part of the user.

What Are the Benefits of P2P Lending?

The benefits of using a P2P crypto lending service mainly apply to the lender. Borrowers should consider aspects like rates, the amount of collateral required, and measures the platform takes to protect your crypto assets.

• More control over risk and returns: When you put your assets into P2P crypto lending, you have more control over the interest rate and terms than you would if you put the funds in a crypto savings account. This allows you more control over the type of crypto backing your loan — and the level of returns you receive for your investment.
• Secured with collateral: Unlike traditional P2P loans, crypto P2P loans are backed by collateral. It means that if the borrower defaults, you can sell or keep the collateral to make up for your losses. Most crypto lenders require borrowers to provide collateral worth twice the amount they want to borrow. And platforms typically have a process to request more collateral if the value of the collateral drops.
• No credit check for borrowers: You can qualify for a P2P crypto loan even if you’ve had trouble getting a traditional personal loan due to bad credit or inconsistent income — as long as you have enough crypto to provide as collateral.
• Quick approval: P2P crypto lending platforms typically require you to verify your identity before you can access the P2P marketplace. This means that there’s less of an underwriting process than a traditional P2P loan. And like with other crypto loans, you can usually get approved instantly.

Risks and Drawbacks in P2P Lending

P2P crypto lending comes with more risks than your average crypto or traditional P2P loan. And risks can affect both the lender and the borrower.

• Reputable platforms are hard to find: P2P crypto lending isn’t a common feature of established crypto lending platforms. It’s more difficult to confirm the legitimacy of a new crypto lending platform, inviting potential risk for both lenders and borrowers. That’s why you should always trust in exchanges like Gate.io for this type of investment.
• High risk of platform shutdown: Losing funds due to platform insolvency is a notable risk because they tend to be new. About half of all traditional new businesses shut down in the first five years, according to the Bureau of Labor Statistics.
• No access to investment or collateral: Unlike many crypto savings accounts, lenders must wait until the loan term is up before they can access the funds they invested in the loan. And like with any secured loan, the borrower has no access to collateral until they make their last payment.

History of P2P Lending

P2P lending in traditional finance is almost as new as cryptocurrency. The first P2P marketplace was Prosper, which became available to the public in 2006 — only three years before the first Bitcoin (BTC) was mined. It offered a new way for nonaccredited investors to earn higher returns than depositing funds into a savings account. And with more relaxed credit requirements than a bank, it offered borrowers with fair credit an alternative to high-interest credit cards or payday loans.

Like with crypto lending, P2P lending is a common first stop for new financial technology — better known as fintech — companies. Lenders like SoFi and Upstart started off as P2P lenders before moving to directly funding loans.

Conclusion

P2P lending is an interesting and potentially profitable addition to the credit investment universe. The use of new technology allows credit to be made available to more potential borrowers at lower interest rates.

The place of individuals as the main lenders is likely to fade over time, with their replacements being banks and securitisation markets who can offer a lower cost of capital, the availability of peer-to-peer lending alternatives and their blockchain-based counterparts has made a considerable impact on how borrowers and lenders come together.

As cryptocurrency and blockchain technology continue to mature, crypto P2P lending platforms are guiding the way to a financial future that’s more inclusive and accessible than ever.