What is Peer-to-Peer (P2P) Lending?
Let's find out Peer-to-Peer (P2P) Lending meaning, definition in crypto, what is Peer-to-Peer (P2P) Lending, and all other detailed facts.
In the crypto sector, Peer-to-Peer (P2P) Lending, crowdlending, or social lending is a method of borrowing or lending virtual assets without the interference of a middleman. The exchange usually goes through an intermediary platform, also referred to as a P2P platform.
In order to understand peer-to-peer lending, let’s have a deeper look at a traditional model of giving out loans. Let’s say, you’d like to borrow some money, so you go to a bank where you’re asked to fill out the forms, provide the necessary documents, and submit your application. If you qualify for a loan, then the bank will explain its terms and give you an offer.
If you agree to the terms, the bank will then obtain the funds from one of the two sources:
- Central bank;
- Bank deposits from their own customers like saving accounts.
The main issues with borrowing from a financial institution like a bank are:
- Lots of determining factors that you won’t be able to change quickly to qualify for a loan like low credit score and insufficient credit history;
- You’ll end up paying much more due to the relatively high-interest rates;
- Traditional banks can feel outdated and, in turn, be slow in handling your case and responding to your queries.
Overall, there is traditional P2P lending and cryptocurrency P2P lending.
Traditional peer-to-peer lending can be defined as the exchange of fiat currencies without an intermediary. For example, the pound sterling (GBP), the euro (EUR), the US dollar (USD), or the Japanese yen (YEN), among many others, are considered to be fiat currencies since they are backed by the government.
In the case of traditional lending, there are various platforms that connect potential investors and borrowers. It includes Peerform, Upstart, Funding Circle, and others that make their platforms appealing by offering the best interest rates, fewer fees, and various types of loans. They first appeared in 2005. These types of lending platforms allow a lot more flexibility and wiggle room for the borrowers since many of them target a specific type of borrower. For example, startups or small businesses. Plus the process is generally quicker than if you were to go through a financial institution such as a bank.
The P2P lending market struck gold once the cryptocurrency market was introduced and began to grow in popularity.
The blockchain technology that backs cryptocurrencies is the key feature that enables P2P lending and eliminates the need for an intermediary. In this case, both parties engage in a trustless transaction. This means that loans are backed by smart contracts that are completed based on the terms both parties, the lender and the borrower, agreed to.
Cryptocurrency peer-to-peer lending started gaining momentum after Ethereum was launched in 2015. Nowadays, it’s usually referred to as decentralized finance (DeFi) that’s based on smart contracts and is widely used within the crypto community.
In the crypto sector, peer-to-peer lending is utilized differently than the traditional solution. Although, they do have their similarities.
The main similarity between traditional and cryptocurrency P2P lending is that both require collateral. When it comes to crypto, collateral generally is either a fiat currency or a digital asset. It’s usually held in an agreed-upon smart contract by the chosen platform that acts as an intermediary.
Moreover, the collateral provided acts as a metric in deciding the maximum possible loan. It’s also referred to as the collateral ratio or collateral factor. The collateral ratio is necessary for this type of P2P lending since creditworthiness is a factor that’s impossible to evaluate. That’s because in most cases, both parties choose to remain anonymous.
In cryptocurrency P2P lending, the KYC process is not required so the identities of both parties usually remain unknown. Therefore, it’s not possible to establish what kind of past credit history an individual might hide, or their creditworthiness in general.
Much like in traditional banks, both parties agree on an interest rate for the loan. This way the lenders, also known as investors, earn interest.
There are also some cryptocurrency P2P lending platforms that try to incentivize lenders by offering bonuses. By doing this, these websites hope to gain more traffic and maintain the ecosystem.
Blockfi, Aave, Celsius Network, and Binance are among some of the most well-known cryptocurrency peer-to-peer lending platforms on the market today.
The main downside is that the process of lending using this method is a bit complex. Therefore, it can take a longer time to learn the ins and outs of the platform in question. Additionally, the majority of crypto P2P lending websites are not intuitive to use.
Plus some of them have been under cyber-attacks which resulted in financial losses and continued to raise questions regarding the security of these platforms.
We can expect these platforms to improve as the popularity of cryptocurrencies continues to grow.