The Achilles’ Heel(s) of Crypto P2P Lending

Peer-to-peer lending (P2PL) comprises of the lending activities between unrelated parties (peers) without the need for third party intermediaries (i.e. financial institutions). The recent advent of bitcoin within the P2PL concept has given rise to numerous crypto-lending platforms striving to establish their presence as first movers in this uncharted territory.

In a world where it is becoming increasingly difficult for the non-HNW individual to obtain a bank loan, P2P lending has been proposed as a possible alternative to the traditional financing for the average Joe that is not in the form of a credit card, friend, or family member. However, this is not to say that P2P is ready to replace credit cards. Crypto P2PL allows investing by those seeking yield with relatively little capital. On top of such low barriers to investment entry, crypto P2P lending platforms have provided automation services in the form of auto-investing, where returns are reinvested into new loans according to the investor’s objectives and pre-defined parameters.

As exciting and forward-thinking a concept P2P crypto lending may be, it is not quite ready to take on the fixed income investment industry and claim legitimacy in the eyes of the investing world. To begin a list of reasons why I find this to be the case, I will recall my experience when I visited a crypto P2P lending platform’s website (whose name I will not mention). As I was browsing loan listings, I found some of the prospective borrowers’ usernames to be somewhat disconcerting. The level of childishness and immaturity behind these screen names would scare off any rational investor. A point I think many crypto-anarchists seem to disregard is that investing has more to do with love and trust and less to do with 1s and 0s. For crypto P2PL to gain adoption as a legitimate avenue for fundraising and investing activities, these platforms will have to resemble more of a secure marketplace with with a stellar reputation, and less of a Magic: The Gathering online chat room.

Another hindrance to the prosperity of crypto P2PL has to do with research analysis. Because of the relative youth of this new technology, there is exists none of the guidance retail investors often look to when judging the merits of an investment. This absence of analytical structure would prevent any investment professional from performing the quality of investment research expected of them. It is quite difficult to find unbiased, quality analysis of crypto P2P loan listings as most of the statistics out there are prepared by the P2P lending platforms themselves. Independent, research-oriented coverage of P2P loans is something that will be needed for the space to thrive. When it comes to risk, there are a multitude of factors that increase the risk of taking on a crypto P2P loan to the point where its utilization as a fixed income investment cannot be justified. The exchange rate fluctuation of the loan’s underlying cryptocurrency alone is enough to make any investor sweat (although there are options to denominate such crypto loans in USD or other fiat currencies).

As I continued my browsing through this website, I realized that most borrowers were seeking to borrow money to fund their crypto mining operations. And to my amazement, many of these projects were getting funded! One does not have to be an investment professional to understand the risk involved with this type of loan. However, a strong possibility for this saturation of bitcoin miners on this platform could be that these were early adopters of the technology who are deeply involved in crypto mining. I also got the sense that the platform’s creators were trying to inject a social aspect to the P2P lending experience. One can follow different individuals and keep track of their activities on the platform via the user dashboard, similar to tweets or Facebook updates. While this splash of social media may one day help serve as a tool in developing a reputation system used as a guide for choosing loans, applying a social media approach to P2P lending activities will continue to be a problem so long as there exists the ability to create and use a fake profile that will hide one’s true identity. When it comes to serious investing involving pensions, IRAs, hedge funds, and individual brokerage accounts, the reality is that most investors (and borrowers) will choose a more serious approach to investing without demanding to know the particulars of the specific borrower’s situation.

Right now we see a lack of recourse for investors on these platforms when it comes to late payments and loan defaults. The screening process platform operators execute for adding borrowers into the system continues to be flawed as one can anonymously fake an identity with “good enough” documentation. Through these weak points, a scammer can skip out on their loan without much response from the platform operators as the investor will ultimately be responsible for finding out a borrower’s real identity and pursuing legal action. This is too time consuming and costly, especially if multiple jurisdictions are involved. To help curtail these problems, I would like to see smart contracts one day play a role in the enforcement of loan provisions in the decentralized environment specific to crypto P2PL. A smart contract is a protocol that will execute terms of a contract based on pre-defined parameters. As it stands, loan defaults will usually result in platform operators directing investors toward a particular arbitration service, washing their hands of the matter. The efforts of developers and entrepreneurs in this space could be put to better use in focusing on investor protection and loan securitization.

There will always be cheats, robbers and crooks. And it is naive to believe that bitcoin, P2PL, smart contracts, or blockchain technology altogether, will eliminate this aspect of human nature. However, instead over-exertion directed towards achieving an unrealistic utopia, the cryptocurrency community should work on trying to solve everyday problems for everyday people. Crypto P2P lending platforms should begin to create a dialogue with legacy system industry professionals to learn more about the nature of lending and help come up with answers to the lingering challenges that have plagued the art of money lending.

Despite all of these criticisms, I do see a genuine effort among platform operators toward making the lending process as fair and equitable as they possibly can. I applaud the creation of an open system where people are able to secure financing regardless of race, religion, credit history, criminal history, socio-economics or education. It is understandably difficult for centralized management teams to monitor blockchain transactions of lightning speed and near infinite complexity being made from all parts of the world 24/7. The hands-off approach of the platform operator only works if there is a replacement of the hands.