The past year has seen the launch of several platforms that claim to offer borrowers better rates by combining peer-to-peer (P2P) lending with cryptocurrencies. We spoke to the experts to find out the pros and cons of the new lending model.
What is P2P lending?
P2P lending enables individuals to borrow and lend money without using a financial institution as the middleman. Lenders can get higher rates of interest than they would with a savings account, with some P2P platforms offering projected returns of more than 10%. Equally, borrowers can get loans more easily and at more favourable rates than with a bank. On average, a borrower with a strong credit score could get a rate of 5.7% from a P2P lender compared with 9.5% from a bank. Borrowers and lenders are matched up via online platforms, such as Zopa, RateSetter and LendingClub.
How are blockchain providers getting involved?
Over the past year several P2P lending platforms have emerged that are built on blockchain technology. They include ETHLend, Celsius Network, Lendoit and Inspeer.
These platforms claim that introducing blockchain into P2P lending makes it more transparent, secure and traceable. In addition, people can join the platform from anywhere in the world, rather than being confined to platforms operating into their own country.
ETHLend is the most well-known crypto P2P platform. Borrowers set the terms of the loan contract, including the amount, premium and payment date, and lenders can fund the loan if they deem it suitable. Borrowers send ERC20 standard tokens or Ethereum Name Service (ENS) domains as collateral, which is held within the smart contract.
Why is crypto P2P lending being criticised?
Critics argue that crypto-based P2P lending is extremely risky. Alex Kampa, founder of Sikoba, a blockchain-based IoU (an informal document acknowledging debt) platform, believes anyone who borrows via a crypto P2P lending platform is “completely mad”. He said cryptocurrencies are so volatile that someone who borrows GBP 10,000 could end up owing GBP 50,000.
“By focusing on blockchain, these platforms are hiding the fact that the risk is still there. No amount of blockchain will resolve the risk of defaults. They are giving people a false sense of confidence,” Kampa argued.
P2P lending marketplace Savy explored the option of transferring its loan contracts to Ethereum in 2016, but decided the technology was unsuitable.
Vytautas Zabulis, chief executive and co-founder of Savy, said in an ideal world blockchain would help to verify the client by supplying credit scoring information from blockchain-based registries, with smart contracts taking care of loan repayments.
In the real world, Zabulis said, regulated lending platforms must ensure the individual borrower’s identity is verified, a credit check is done, money is transferred and, in the case of a default, there is clear process of litigation and/or debt collection.
“Smart contracts are not very smart when the borrower does not pay. It is much more expensive to run a lending business on the blockchain than on regular data bases,” he added.
Do the criticisms stack up?
The crypto P2P lending platforms argue that these criticisms are unfounded. Keith Baumwald, chief marketing officer at Celsius, said the volatility of cryptocurrency is not an issue because loans to coin holders on its platform will always be in US dollars. Cryptocurrency is merely being used as collateral.
“Right now, if you're a crypto holder and you need to make a large purchase like a car, your best option is to sell some of your coins. We want to provide an alternative. We will provide our community with the ability to use their cryptocurrency as collateral in order to secure a low interest loan in dollars, regardless of their credit score,” Baumwald explained.
He claimed Celsius’ goal is to lend with interest rates at single digits, no matter what the person’s credit score, adding: “Most of our members have not been able to access sub 10% borrowing rates in their lifetimes.”
Celsius pools lenders’ crypto in order to lend more dollars to other crypto holders and enable hedge funds to pay lenders for enabling them to short the crypto market. This aims to ensure members get higher borrowing limits.
“In the Blockchain model all the value is created on the token side so members can enjoy the best borrow rates as the organisation does not have to focus on maximising profits. In addition, the profits made on the interest from the loans stays within the cryptocurrency community instead of being transferred back to Wall Street,” Baumwald said.
He added that Celsius plans to follow all the relevant laws in the US and issue loans via licensed financial institutions.
How are lenders and borrowers protected?
Stani Kulecho, chief executive of ETHLend, said it has substantial measures in place to protect lenders and borrowers. It requires borrowers to submit 150% collateral and it will shortly introduce oracles – tools that show the market performance of the given coin. It has also introduced US dollar pegged loans that aim to stabilise the volatility of US dollars to ETH.
“Practically it means that if a borrower has a loan for USD 100 worth of ether and 5% interest, s/he will repay USD 105 worth of ether back. We are constantly educating our users on all the aspects of the crypto volatility and encourage them to take informed and well-balanced decisions,” said Kulecho.
He argued that at present borrowers and lenders are limited by their geographical location, which affects fair competition.
“The ETHLend platform powered by the Ethereum blockchain has allowed us to connect interested parties from around the world into one, unified global lending market which is democratic and market driven in nature. More to the point, all transactions can be verified and audited and a full credit history can be shown,” he said.
Kulecho added that ETHLend is fully compliant with existing laws and working closely with European and national legislators.
Who are the platforms targeting?
So far the platforms are predominantly used by professional traders and technically-savvy people. However, Kulecho said ETHLend sees many use cases in the broader lending market, including household loans and business loans.
“Due to the nature of the platform it is operational 24/7 and it provides endless possibilities to responsible lenders and borrowers,” he added.