Peer-to-Peer Lending and Investing Guide

Oct 28, 2021 03:37 PM ET
Peer-to-Peer Lending and Investing Guide

The peer-to-peer lending industry has been going through significant changes and growth in the past few years. According to MarketWatch, the industry was valued at more than $68 billion in 2019 and is expected to grow by more than 30% in the coming years. In this article, we will look at what peer-to-peer lending is, how it is changing, how you can invest in it, and the risks involved.

What is peer-to-peer lending?

The concept of peer-to-peer (P2P) lending has been around for centuries. Historically, people have been lending money to their friends and relatives. This process, however, was relatively ineffective and at a relatively lower scale. Also, most times, people do not charge their friends and relatives interest.

Technology solved some of the biggest challenges. For example, a P2P platform now allows people to lend and borrow money using the internet. The process is relatively simple. If you want to borrow, you create an account, send the verification details, and then access capital.

On the other hand, if you are an investor, you will need to create an account, deposit money, and then extend these funds to other people. The P2P company will handle most of the hard work, such as checking the borrower’s credit score. 

The P2P industry became relatively popular after the Global Financial Crisis (GFC) of 2008/9. It became popular because at the time, internet use was booming. At the same time, central banks brought interest rates to record lows in a bid to save their economies. Therefore, the industry flourished as interest rates remained so low and the unemployment rate soared.

As such, the number of people borrowing rose. People with money, on the other hand, moved to P2P marketplaces in a bid to gain more returns. 

Lending Club share price performance

The same cycle happened during the Covid-19 pandemic. Indeed, as shown above, LendingClub saw its share price surge by more than 500% as demand for loans rose. Its market capitalization surged to more than $3.5 billion.

How peer-to-peer lending is changing

P2P lending and investing is a relatively new industry. As such, it is bound to go through significant changes as more approaches emerge. Indeed, while many companies in the sector came up in the past few decades, most of them have either struggled or gone out of business. 

One way through which the industry is changing is through blockchain technology. Millions of people have abandoned centralized P2P marketplaces like LendingClub and Prosper. Instead, they have shifted to decentralized marketplaces that offer more solutions.

Centralized platforms like LendingClub have a single authority and are driven to maximize shareholder returns. They also operate under strict laws and regulations. For example, these laws mean that a company like Prosper cannot provide its services to people in some states and most countries. Also, these companies are required by law to do Know Your Customer (KYC) and Anti-Money Laundering (AML) checks.

Decentralized platforms are different. For one, they disguise their business by using ERC tokens and stablecoins. A stablecoin is a cryptocurrency that tracks a certain fiat currency like the US dollar. They include the USD Coin and Tether. 

Also, these platforms are not controlled by any person and interest rates are set by the market. It depends on the overall liquidity of the marketplace. Also, most of these platforms do not require one to create an account with them. 

In the past few years, the total value locked (TVL) in some of the biggest decentralized finance (DeFI) peer-to-peer lending marketplaces are Aave, Curve Finance, Maker, and Compound. These are large platforms, with Aave having a TVL of more than $18 billion. Maker and Compound have a TVL of more than $12 billion as well.

How to invest in P2P lending

There are several stages you need to follow when you want to invest in these platforms. First, you need to select your preferred platform. You can select centralized platforms like Prosper and LendingClub or decentralized platforms like Aave and Compound. 

If you want platforms that are relatively stable and those that have been around for a long time, you should select centralized options. If you are a risk-taker who wants higher returns at significant risk, you should opt for decentralized options.

After selecting a platform, you should create an account, be verified, and then deposit your money. Companies like LendingClub accept payment options like bank transfer and check. If you select a decentralized option like Aave, you will need to deposit your cryptocurrency into their pool. After this, the platform will automatically provide the loans on your behalf. 

Some P2P platforms give you a chance to lend money directly to other people. Others like Prosper Marketplace enable you to create a custom portfolio of loans and see your finances grow.

Benefits of peer-to-peer lending

There are several benefits that you get by participating in the peer-to-peer lending marketplace. First, it enables you to gain uncorrelated returns on your investment. By uncorrelated returns, I mean that your returns don’t have any similarity with what is offered by other assets like stocks and bonds.

Second, these assets give you an opportunity to diversify your income. I recommend that you create a broad diversified portfolio that includes bonds, stocks, commodities, real estate, and cryptocurrencies. Allocating some of your resources to these platforms will help you have a diversified portfolio.

Third, the process of P2P investing is a relatively simple one. You just need to create an account, deposit funds, and then extend the funding.

However, there are some risks involved in P2P. For decentralized platforms, there is the risk of cryptocurrency volatility. There is also the risk of tightened regulations in the industry. Also, since cryptocurrencies require complex addresses, it is often difficult to make a follow-up when there is an error.

Final thoughts

The peer-to-peer industry is seeing strong growth, helped by the rising demand for loans as the world economy recovers from the pandemic. At the same time, with more data available, companies are able to reduce the overall risk involved in the industry. In this article, we have looked at how the industry works and some of the top benefits of investing in it.

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