The original premise of online peer-to-peer lending platforms was simple and democratic: A single mom from Kalamazoo, Mich., could post her story explaining why she needed $5,000 to pay off her credit card, and a retired electrician in Illinois could read it, decide to fund her loan and receive interest far exceeding what he could get on his savings account.
LendingClub and others that proffered this people-helping-people model quickly found they needed to make changes. They turned to large institutions to buy the loans in bulk.
Is it possible that blockchain or distributed ledger technology — a mechanism through which many parties share a record of transactions and supporting documents — could be used to revive the original idea of P-to-P lending?
Eric Piscini, a principal in banking and technology at Deloitte Consulting, suggests that blockchain technology could bring a return to the way people got funding even before banks existed.
“Blockchain is a way to go back in history, because when you think about the way we were lending, the way we were paying, the way we were trusting each other, it was peer-to-peer. Over time we added intermediaries and third parties because we stopped trusting each other,” he said.
Blockchain or distributed ledger technology makes it possible to transfer ownership of an asset from one person to another, without the need for an intermediary.
“I can say, ‘Here’s the original copy of the document, and I’m transferring ownership to you and I don’t have the original anymore,’ ” said Subhankar Sinha, director and co-founder of the blockchain practice at PwC. “In the current world it’s possible to do the transfer of ownership, but we require a trusted third party to record the transfer.”
And where today intermediaries are needed to manage credit risk and service loans, those also could be replaced with distributed ledgers.
“You can create a smart contract on a public utility blockchain, and you don’t have to trust a third party for execution of that contract,” Piscini said. “That’s a very appealing low-cost, high-trust platform that you can build that you couldn’t build before.”
A few startups are creating platforms to offer secured loans on a blockchain. Celsius is building a person-to-person lending platform on a blockchain for people who are holding digital assets, such as ethereum and bitcoin, for the long term. These people are sometimes called “hodlers.” (Apparently this term was started by a Reddit post that went viral; it was titled “I am Hodling,” with a misspelling of “holding” that the writer acknowledged.)
This could be particularly appealing for millennials. In a recent Harris Poll, 27% of millennials said they would rather own $1,000 of bitcoin than $1,000 worth of stocks. Among male millennials, 38% said they prefer bitcoin.
Through the Celsius platform, such cryptocurrency investors will be able to earn interest on their holdings while Celsius uses them as collateral for consumer loans.
“If you really like ethereum long term, you’re willing to lend it out but you don’t want to sell it,” said David Brill, founder of Celsius. On the other side of the equation, “the borrower gets an opportunity to get capital at a lower interest rate.”
Celsius’s proprietary algorithm creates a credit score that’s presented through the platform to potential lenders. “We will give positive weight to someone who, for instance, is a good Amazon or eBay merchant,” Brill said.
The volatility of the underlying digital currencies doesn’t affect the loans, Brill said. If a digital currency is worth $100 and the owner agrees to lend it out at 7% interest for a year, and if the value of the digital currency drops during that year, the effective interest rate would be higher than 7%, because the loan is locked in at the price and rate on the date it was made.
Celsius is testing its platform internally. “We’re being deliberate about not rolling it out until it’s mature,” Brill said.
Salt Lending has built a mechanism for collateralized lending based on value being stored in a smart contract on a blockchain. This could be a security, a bond, a property, a title, data, or gold — anything that could be used as collateral.
The asset has to have been digitized and recorded on a blockchain. For instance, some gold storage houses and banks that store gold are representing it on a distributed ledger. The platform is mostly built on a bitcoin and ethereum blockchain.
Salt Lending is not currently using a peer-to-peer model. It’s more akin to securities-backed lending and is designed for lenders like banks. The company’s website says it can provide fast approval of loans with no credit checks.
“Because we’re taking the senior position on the assets on behalf of the lender, if the contract is compromised in any way, you don’t have to go after second forms of repayment, because we already have the primary source of repayment in possession,” said Shawn Owen, Salt Lending’s chief executive.
Banks could fund loans on the network, or they could use Salt Lending’s technology and license the ability to manage the collateral through the contract with their customers.
“Ultimately it’s around allowing them to service their existing borrower base or client base in a new way, where many of their clients may have digital assets and would be interested in using those as collateral for dollar-denominated loans, in the same way they do with stock portfolios,” said Gregg Bell, chief operating officer at Salt Lending.
Salt Lending has several bank partnerships in the works, Owen said.
In blockchain-based lending, the identity verification and credit scoring process banks go through today could be replaced with a “distributed reputation” system and a “distributed identity” system, Sinha said.
Part of a distributed reputation system would be “social intelligence,” he said. “There are currently a lot of lenders who are using social intelligence and other data points in addition to credit score,” Sinha said.
Celsius, for instance, collects data from social media sites as part of its credit-scoring algorithm. Reputation information from Yelp has been known to correlate with revenue for a small business.
“What a credit score largely ignores is social and other behaviors, which also reflect on a person’s creditworthiness,” Sinha said. “If we can combine the notion of financial behavior and social behavior together and attach it with a person’s identity but let individuals be in control of their data, it solves quite a few problems.”
Under this model there would be less need for centralized identity data stores such as those maintained by credit rating agencies, which are a big target for cyberattacks.
Another startup, Bloom, is developing an identity protocol and credit score that runs on a blockchain. The user submits information to the network, like name, address, and phone number. Bloom’s artificial intelligence engine learns more about the person and their creditworthiness over time.
The many obstacles to be overcome to enable person-to-person lending on a blockchain include adherence to know- your-customer rules, establishing and verifying identities, onboarding new customers, determining creditworthiness, monitoring customers and collecting on the loans.
Lenders have strict KYC and anti-money-laundering rules to follow. How do you truly 'know' a customer with whom you only interact over a blockchain?
Lenders have strict KYC and anti-money-laundering rules to follow. How do you truly “know” a customer with whom you only interact over a blockchain?
Alex Mashinsky, CEO and founder of Celsius, said his company has an extensive KYC/AML process that analyzes where a borrower or lender is from, checks names against known lists and verifies many data points, looking for inconsistencies.
“If you try to transfer coins from CoinBase, our system gives you a higher score and passes you with fewer questions than if you are trying to transfer from an unknown source, or worse, a questionable one,” Mashinsky said.
Another tricky aspect of lending on a blockchain, if cryptocurrency is being used as collateral (as so far it typically is), is assessing its value. “If you lend against bitcoin today, bitcoin is so volatile; how do you do a margin call and so on?” Sinha said. “Those are the details that a lot of people on Wall Street know how to handle in the current financial system.”
Piscini predicts that blockchain technology alone may trigger a new wave of peer-to-peer lending, minus the use of cryptocurrency.
That leaves the problem LendingClub discovered — that it can be hard to do enough volume to make money with so many small transactions.
“LendingClub was not making a lot of money until they started to bring in large investors and a secondary market,” Piscini said.
Another challenge is collecting on loans made on a blockchain. This will test the legality of smart contracts.
“I don’t think courts in any country are recognizing smart contracts as a valid way to do business,” Piscini said. “So you still have to write something down and use documents, or you expose yourself to not being paid.”
