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What is Peer to Peer (P2P) Lending? A Quick Introduction

Michiel Mulders
June 14, 2020
p2p, lending, loans, crypto loans, crypto backed loans, crypto lending

Peer-to-peer lending or "P2P lending" as it is popularly known enables lending and borrowing between individuals and businesses. Here, lending platforms facilitate this process by bringing both counterparties together and it also oversees the deal. 

Many SMEs struggle while obtaining loans through traditional means like banks and other traditional financial institutions. P2P lending has proved to be a lifeline for such businesses. However, it does come with a high-cost as some lending platform charges a significant amount of fees. 

Crypto-based P2P lending platforms also charge an exorbitant fee just like the traditional peer-to-peer lending platforms. However, with the advent of crypto-based peer-to-peer lending platforms, the lending process has become more efficient. 

The P2P lending platforms that allow to lend and borrow cryptocurrencies have brought in a more productive andcost-effective deal for both the lenders and borrowers. Crypto-based peer-to-peer lending has opened the door for new forms of collateralization, allowing digital assets to be collateralized. Cryptocurrency is an ideal format for peer-to-peer cash transactions and hence, it was about time for it to be deployed for peer-to-peer lending. 

How Does P2P Lending Works?

Blockchain technology forms the core of P2P crypto lending. It allows both lenders and borrowers to exchange funds without any middlemen or intermediary. Instead, the smart contract records the lending agreement on the blockchain. 

Blockchain-based peer-to-peer lending has simplified the lending process. It takes 2 hours to max 7 days for the borrower to receive funds after all contractual obligations are met. The associated transaction fees of the whole process are very minimal. 

The users are required to collateralize their digital assets on the P2P lending platform. Additionally, they are compulsorily required to complete the KYC/AML identification process, along with income verification. Some peer-to-peer lending platforms also ask for personal references. 

The overall onboarding process of P2P lending platforms is comparatively less difficult than traditional financial institutions. Once the verification process is completed, the users can select their favorite type of loan, the duration of the loan period, the amount of required loan, and lending rates. 

The best thing about peer-to-peer lending is that a user with an internet connection can directly access lending and borrowing services from across the world. 

Key Concepts of Blockchain and P2P Lending

#1. Transparency

A blockchain-based peer-to-peer lending platform provides a comparatively larger degree of transparency as the transactions are recorded on the blockchain.

Both borrowers and lenders can interact directly as no single intermediary controls the system. It leads to smooth and uninterrupted transactions. 

#2. Data Integrity

Blockchain is a distributed ledger that stores transaction records in a faster, secure, and transparent manner. The transactions once uploaded on the blockchain network cannot be tampered with as blockchain uses hashing algorithms and cryptography to make the added information tamper-proof. 

#3. Data Immutability 

Immutability is a key advantage of blockchain technology as the data once recorded in the blockchain network cannot be altered. This makes the blockchain system unaltered and indelible. 

The blockchain contains blocks of information like transaction records and it proceeds as per the principle of cryptography. Each block generates a hash value and it consists of an alphanumeric string. Each block also contains a hash of the previous block in addition to its own.

Blockchain's information processing system ensures that the blocks of information are connected in a coupled manner and are unrelenting. No one can interfere with the data stored in the block because of such a complex and intimate functionality of blockchain technology. 

It is important to note that the decentralized and distributed nature of blockchains mandates a consensus among various nodes that store the replica of data. This ensures that the original data remains tamper-proof. 

Immutability has proved to be a defining feature of blockchain technology. This feature can revolutionize the data auditing process and bring in efficiency, cost-effectiveness, trust, and integrity to the data. 

Benefits of Peer-to-Peer Lending 

#1. Higher Returns

P2P lending offers lenders an excellent return on their assets. Currently, interest rates on saving accounts are almost 0. Therefore, p2p lending offers savings percentages of up to 12%. For this exact reason, p2p lending offers an alternative, passive income stream for users that don’t want to actively use their assets.

Similarly, borrowers are at an advantage too as the overall associated costs are lower when borrowing from peer-to-peer lending platforms compared to the banks. 

#2. Faster Process

P2P lending platforms are faster in disbursing loans compared to traditional financial institutions. Peer-to-peer lending platforms also benefit from the absence of any middlemen as this decreases the overall time it takes to complete the full lending process. 

For example, you spot a great trading opportunity that almost holds no risks. You want to quickly take out a loan to open the trade so you can gain a bigger return. After the trade has been closed, you keep the profit and you repay the loan. Of course, using loans for trading is risky, do your own research first!

#3. Flexibility 

Some peer-to-peer lending platforms allow borrowers and lenders to negotiate the duration and the interest rates associated with the loan. However, this is not a very common practice.

#4. Sense of Personal Security 

Many lenders prefer knowing whom they are lending money to and why does the borrower need the money. It gives lenders a sense of security as they can choose borrowers who they feel will repay the full loan on time. 

#5. Charitable Feeling

P2P lending has an aspect of charity to it. For example, a potential borrower with a sympathetic story to tell may get funds from lenders even if the borrower has a problematic financial history. In this case, the lenders willingly lend the money that the borrower needs. They also assume a greater share of risk by funding the loan. 

#6. Sense of Community 

The users who are a part of the peer-to-peer lending websites are very likely to feel a true sense of community there. The forums of P2P lending platforms tend to be pretty engaging with various active conversations happening daily. This is a totally different world than traditional lending by banks.

The users regularly share their experiences about lending and borrowing on such forums. Any proposed changes applicable to the P2P lending policies are also vigorously debated on these forums. 

How Safe is P2P Lending?

Generally, P2P lending platforms are safe for lenders as well as borrowers. The peer-to-peer lending websites have put in multiple measures to ensure that the overall lending process at their platforms remains safe. 

P2P platforms usually conduct due diligence to vet the borrowers and give them a rating. These ratings are displayed to the lenders to decide if they want to lend money to respective borrowers. 

The platforms also assure the lenders through insurance-backed buy-back guarantees. The insurer will compensate the lender if the borrower defaults on the given loan. The P2P lending platform also makes sure that each loan request is fulfilled by multiple lenders. It helps reduce risks for lenders as they would have a diversified portfolio by investing in multiple places. 

Overall outlook regarding P2P lending platforms is positive and hence, it generally safe for both lenders and borrowers. However, it does not mean that P2P lending has no risks whatsoever. 

We should not close our eyes to a few of the associated risks. Two types of risks are associated with peer-to-peer lending and these are:

  1. Defaults

A lender could be affected if a situation of loan default arises as the money that is borrowed through the P2P lending sites belong to the lenders. 

  1. The bankruptcy of the company owning the Lending Platform 

The company behind the lending website may go bankrupt if the lending website takes on too many loans and is unable to fund them all. This instance also affects users directly. 

How P2P Lending differs from Traditional Finance?

Unlike bank deposits, there is no middleman involved in P2P lending platforms as the P2P platform connects lenders and borrowers directly through its marketplace. 

Peer-to-peer lending platforms not only connect the lenders and borrowers directly but unlike the banks, it also offers a choice of loans for lenders to choose from. Hence, lenders are given a choice, and the decision about the loans that they want to fund fully rests on lenders. 

In the absence of a middleman, borrowers can interact with the lenders directly. Hence, the borrowers and lenders can negotiate on the rate of return and repayment duration. Peer-to-peer lending has also provided an option for investors to earn higher interest without worrying about market volatility. 

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Future of P2P Lending

P2P lending is expected to maintain its momentum of growth in the future. The industry will benefit from comparatively greater transparency, simplified online platforms, low interest on loans, and faster loan approval process. 

Blockchain technology has contributed greatly to further increase the transparency of the whole lending process. It will make P2P lending more trustworthy and reliable in the eyes of both lenders and borrowers. 

P2P lending platforms that are based on smart contracts and blockchain technologies will improve the user experience for lenders and borrowers alike. It will help ensure that the peer-to-peer lending industry maintains its growth momentum and it retains a significant portion of the global financial industry.

New age innovations will bring in even more transparency to the financing process. It will result in a lending process that will be even more transparent, secured, and reliable for lenders and borrowers.

Want to earn a passive income on your assets via crypto lending or want to take out a loan? Visit YouHodler’s homepage for more information.

About the Author
Contributor

Michiel Mulders is a blockchain developer with a passion for the crypto space. His interests include blockchain, entrepreneurship, marketing, and carefully crafted beers. Cheers!

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