By Chris Grundy on Wednesday 12 October 2016
When Zopa burst onto the scene in 2005, it brought peer-to-peer lending online. In doing so, the platform heralded the next step in a fintech revolution. Since then, the US market leader alone, which is Lending CLub, has grown to 1.4 million customers and originations of $8.4 billion in 2015. From a regulatory perspective, the SEC, FCA and BaFin have set a steady course for peer-to-peer lending and it is fair to say this once alternative approach to finance has now become mainstream.
So what is the next step in this evolution? Nobody knows for sure, but bitcoin and the blockchain might be an interesting place to look. Most investors have heard of the awesome power of the blockchain but are only vaguely familiar with bitcoin. For those of you who need a refresher, let me just say that bitcoin is a form of online money which cannot be forged, faked or hidden. It operates without the backing of a bank or government body, and instead gains its power from the processing power of thousands of computers - called miners. One bitcoin is currently worth $616, or about 200 McDonalds Bic Macs.
Bitcoin’s unique characteristics give it three advantages over governmental currencies and conventional payment networks, making it an attractive proposition for peer-to-peer lenders. Let’s go into them in detail and see if peer-to-peer bitcoin lending might be the next step forward for this $180 billion market.
What do Lending Club, Prosper, Zopa, Funding Circle and Ratesetter have in common? They enable domestic lending only. As a lender on these platforms, you will only be able to invest in borrowers located in your country of residence.
This is a problem because investors miss out on two key opportunities:
The reason these platforms do not operate across borders despite these advantages, is that the money transfer and exchange process would take too long and would be too expensive for retail size loans.
To illustrate this point, let’s imagine a small business owner living in India. To grow his business he applies for working capital, and is funded by lenders from the US, UK and Australia. In this scenario, every lender would send their local currency to India, incurring an average fee of $40 for an outbound international wire transfer. Additionally, our Indian small business owner would most likely have to pay a $10 fee for every international wire transfer he receives.
On top of that, we should consider a 3.5% currency exchange fee for every transaction which switches the lenders’ currency into that of the borrowers’ and vice versa.
As we can see, international money transfers make cross-border lending uneconomical. The borrower’s effective interest rates would shoot through the roof, as fees from repayments pile up. Lenders on the other hand would see their returns eaten away by the prohibitively large transfer and exchange fees, and would stop investing.
This is the biggest advantage bitcoin powered lending has over traditional peer-to-peer lending. Moving money via bitcoin across the world takes less than an hour, and costs around $0.06 per transaction regardless of the sent amount. Using bitcoin, lenders from the UK, US and Australia can invest in an Indian small business owner at zero fees, making it an attractive proposition.
It’s incredible to think that 2 billion adults do not own a bank account. This cuts them off from basic financial services and prohibits access to working capital financing. Small businesses find it tough to grow without external funding, and local economies suffer as a result. In the developed world, loans and credit are the lifeblood of the economy.
Thanks to initiatives like Project Loon, global internet penetration is growing at a much higher rate than bank account penetration. In Africa, internet penetration has grown by 7,000% in the last 15 years, while Asia saw growth rates of 1,467% in the same period. This is where bitcoin has its second major advantage, needing only an internet connection to work.
Not only does bitcoin offer an opportunity to invest in people living all over the world, but it also offers a chance to make the modern economic system more inclusive. By freeing basic financial services from the banks, the 2 billion unbanked adults living in the emerging markets, are already accessing working capital and growing their businesses.
On a pragmatic level, this means that traditional peer-to-peer lending platforms close themselves off from this demographic by using conventional and mostly outdated means of money transmitting. On the other hand, platforms which embrace bitcoin or other forms of online currency, are much better positioned to serve this huge market.
Despite skyrocketing originations, most peer-to-peer lending platforms are operating at a loss. A case in point is Prosper, where a $35 million loss was recorded in Q2, after a $17.5 million and $6 million loss in the previous quarters.
Zopa, the UK’s market leader, posted an £8.9 million loss for 2015, while Lending Club’s losses for Q2 rose to $81.4 million. Basically, peer-to-peer lending platforms need to become much more efficient if they want to achieve sustainable growth.
Unsurprisingly, bitcoin might offer an interesting solution to the problem. Incredibly lightweight and without the need to work with banks, bitcoin powered peer-to-peer lending platforms make significant savings on infrastructure and overheads.
As a result, lean startups can bootstrap bank-independent lending platforms and become part of a thriving ecosystem.
Over the last 10 years, peer-to-peer lending has established itself as a credible competitor to traditional loan and investment opportunities. It provides access to an asset class with an exciting risk-and-return profile; net returns are hovering between 4% and 8% per year which is superior to most other interest bearing investments.
Platforms like Zopa and Lending Club represent the much needed step away from an antiquated borrowing and lending process. The question is: what is the next evolutionary step? Where can the peer-to-peer lending industry innovate further, now that it has established itself and become mainstream?
There are clearly many different answers to these questions, but with the three advantages fleshed out above, I think bitcoin powered lending is as viable as any.