But we’ll begin with a brief overview of…
Peer-to-peer lending (crowdfunding) is an alternative financial system, the essence of which is to provide individual lenders and borrowers with a way of lending money to unrelated persons, or equal parties, without involving a traditional financial intermediary.
This method of individual lending has a long history and is even culturally traditional in certain regions of the world. But in modern manifestations, it is usually found in the form of specialized online platforms that bring together those willing to lend with those who would like to borrow. Since such websites operate exclusively online, they have fewer and lower fixed costs, and can, therefore, provide their services cheaper than traditional financial institutions.
As a result, borrowers can earn more than interest on deposits and other investment products offered by banks, and borrowers can get a loan with lower interest rates. That’s even taking into account the commission of the P2P lending provider itself, which it charges for its services of bringing together borrowers with lenders, as well as the service of checking the creditworthiness of a borrower.
It is expected that by the year 2050, the global P2P lending industry will reach an annual turnover of 1 trillion USD.
This is also a great moment to create decentralized P2P lending platforms, as more and more countries are now beginning to regulate their P2P lending industries. In countries such as the USA, Canada, Australia, and Germany (where the industry is already regulated), it’s already become a popular alternative financing model. Across these countries, about 25% of the population is already using decentralized P2P lending to borrow funds.
China (where P2P is largely unregulated) and India (where P2P has until recently been largely self-regulated) also have a potentially huge P2P market. As more and more countries recognize P2P as a mainstream financing option, startups in this area will only look better.
A decentralized credit system is a very attractive idea, especially when compared to conventional systems tied to large credit institutions. However, it also has its own innate problems.
In particular, the creditor’s investments in P2P lending are usually not protected by any government guarantee. In some services, lenders may try to reduce the overall risk by diversifying their investments among different borrowers, and to reduce the risk of bad debts, having the ability to choose the borrowers to which they provide loans. But then the question arises: what information forms the basis to make this choice? Some P2P lending services use external Know-Your-Customer (KYC) solutions as well as solutions for determining the credit rating of potential borrowers. In other words, one must arbitrarily rely on the decisions of trusted third parties.
Other problems include the limited scalability of local P2P lending services on an international scale. This ties in with the aforementioned problems of loan repayment guarantees, as well as with regulatory issues (rules and regulations vary from country to country). There is also work to be done on accelerating the process of granting loans, etc.
Also, despite the supposed decentralization of P2P lending platforms, they still retain a certain degree of centralization. In particular, all records and identification data are stored and maintained by the central party, leaving room for human error or manipulation. This point may also impede the growth and coverage of a platform since centralization makes a system more vulnerable to regulations at the regional level. These regulations may differ significantly from country to country, which makes things even harder.
And this is only a small sampler of the problems that traditional P2P lending services face; which, by the way, are in one way or another characteristic of all traditional financial institutions. Taken as a whole, they not only slow the business down but also reduce the possibility of scaling.
First of all, the property of decentralization, already inherent in the P2P industry, makes it the blockchain’s natural use case. Also, transparency, equality of interest rates, and improved due diligence analysis makes the use of blockchain technology in the P2P lending industry a good fit for both lenders and borrowers.
Unsurprisingly, we’ve already witnessed the first P2P lending services beginning to appear on the blockchain. Let’s consider a few of them. We’ll divide them into several groups, and start with cryptocurrency-to-fiat P2P lending solutions, before considering pure cryptocurrency P2P lending solutions. Finally, we’ll discover how they all differ from decentralized credit networks.
SALT (Secure Automated Lending Technology) is a centralized cryptocurrency credit platform. Currently, SALT is the leader in the realm of blockchain-based loans.
SALT is differentiated by focusing on institutional cash loans, which are backed up by cryptocurrency, whereas many other projects in this area use a pure peer-to-peer approach. However, both options should have a place in the market. In addition, SALT competes with more traditional platforms that provide loans secured by crypto assets, but do not use a specific token.
Based on this, the main advantage for SALT borrowers is the ability to borrow FIAT cash against the security of their crypto assets, which looks more practical to ordinary people in terms of their daily needs than pure cryptocurrency lending solutions. But that’s exactly what leads to the fact that P2P lending must impose more stringent requirements on its users.
First, this service is available only to customers in 33 states of the US, the United Kingdom, and New Zealand. Thus, potential users in other parts of the planet are forced to look for other (similar) services, which in general does not contribute to scaling, as well as interoperability, as we mentioned above.
Secondly, you can become a lender only if you are an accredited investor. In the US, that requires being able to demonstrate a net worth of at least $1 million. Finally, SALT will require a client to undergo KYC / AML (Know-Your-Customer / Anti-Money Laundering) validation before he or she can create contracts in the service.
The SALT loan process differs from that of ETHLend (see below) only in the fact that a cryptocurrency backs FIAT money loans in the SALT system, unlike the pure cryptocurrency-based operations in ETHLend. After the terms of the loan are agreed and approved, the lender will make a deposit, (for example, US dollars), into the borrower’s bank account, while the smart contract will lock the borrower’s cryptocurrency. The borrower will be obligated to make repayments in US dollars on a regular basis; and in the event of a default, its crypto assets will be transferred to the lender. Today, the lending accepts only ether (ETH) and bitcoins (BTC) as collateral.
SALT tokens, also known as membership tokens, are ERC-20 tokens that a user spends to become a member of the SALT lending platform. In addition, one can use these tokens to repay interest on loans, get better rates and purchase goods in the SALT online store.
In general, the Nexo project followed almost the same footsteps as the SALT, taking advantage of the hard lessons learned by the latter. As with SALT, Nexo tokens can be used for discounted interest rates and loan repayments; they can also be used as collateral, and according to the Nexo website, they even plan to pay holders some of their profits.
The loan approval process is fully automated, which allows borrowers to receive borrowed funds immediately. Nexo has also announced plans to issue loans worldwide, including in “at least” 36 US states. The plans also float the possibility of using ERC-20 tokens as collateral and issuing a crypto credit card.
At the moment, deposits can be made in a range of cryptocurrencies including BTC, ETH, and NEXO. Loan repayments can be performed in US dollars or euros, as well as in the cryptocurrencies.
Nexo reserves the right to change the loan-to-value ratio at its discretion based on historical volatility and market liquidity of an asset. Currently, the loan-to-value ratios are as follows:
Essentially, this means that if you lodge 2 bitcoins as collateral, Nexo will lend you FIAT money with a total value of 1 bitcoin (i.e. 50% of what you gave them).
Nexo loans have a pretty simple interest rate policy: either 16% or 8% per annum. Interest rates are not based on the size or duration of a loan, and do not depend on the borrower’s credit rating. A loan of 16% per annum is the standard rate that everyone pays. However, it can be reduced to 8% for one of two reasons: first, if the borrower uses the Nexo token as collateral for the loan; second, if it repays the loan using Nexo tokens. Nexo interest is not compounded and is charged daily to the borrower’s account. No interest payments are due during the term of the loan so a borrower does not need to make any repayments whilst the loan is outstanding.
Benefits of the service: the Nexo lending model has no fees and has a fixed interest rate. That provides a competitive advantage over SALT, and is provides some stability against market fluctuations.
Cons: Although the company claims to offer loans at 8%, in fact, this is just a publicity stunt. In most cases, the real figure will be on average twice as large.
The Argentinian startup Ripio has facilitated P2P micro loans for more than 200,000 users in Argentina, Brazil, and Mexico. After attracting 37 million dollars during the ICO in 2017, Ripio became one of that rare breed: a crypto company with an actual working financial product. The funds raised by the ICO were used to create their own P2P loan service that efficiently connects individual borrowers and lenders around the world using smart contracts.
Current plans are for the full deployment of the micro-loans service to follow the Beta test, in which more than 800 clients in Argentina have received loans. Ripio now claims that there are already several thousand lenders issuing loans in local fiat currencies through their platform, equivalent to between $150 and $750. These are lenders mainly from the Asian continent, and they help to fund people throughout South America.
Unlike the most similar lending and exchange services, unbanked users of cryptocurrency can access new Ripio lending services. The South American market is known for a diverse and often extremely complex relationship with the financial industry. For example, recent World Bank reports show that up to 54% of the adult population of Colombia do not use banking services, and up to 30% in Brazil. Ripio’s internal survey found that 19% of its users did not have a credit card. They used convenience stores to deposit money and top-up their wallets. However, thanks to the Ripio credit service, such people now have the opportunity to keep a permanent record of their debt payments, which can help them receive other financial services in the future.
Ripio plans to expand its services to markets in Uruguay, Chile, and Colombia, although this is dependent on overcoming a variety of local regulatory restrictions. At the same time, political and economic instability, an opaque regulatory environment and security problems stopped the service from entering the Venezuelan market.
Despite the fact that borrowers get their micro-loans in FIAT currencies, the Ripio service is supported by its own token — RCN. The lender sends the loan using RCN. At that moment, a cut goes to all parties involved, including credit rating agents, identity verification services, cosigners, etc., before Ripio finally converts it back into fiat and then delivers the funds to a specific borrower.
Cosigners is a security feature that protects lenders from bad debts: the guarantor of the borrower. This improves the terms of the contract and retains access to the borrower’s local legal system, securing the loan in case of debtor’s default.
Overall, this service very neatly solves the specific problems of a particular region, and this is its undoubted plus. The question of how applicable this solution is, outside the region, and its global scalability remain open.
BlockFi, another participant in the P2P lending race, is a recent entrant with a much smaller burden. Unlike other platforms, BlockFi did not conduct an ICO: all financing was made by institutional investors. “Raising funds from this audience comes with stringent requirements and diligence on our platform,” a BlockFi representative said. “This requires us to be the most trustworthy and reliable lender in the space.”
Since there was no initial coin offering, the BlockFi token also does not exist. BlockFi says that this saves them from the problem of yet another crypto asset: “There is no need whatsoever for a utility token in a lending business model. Having one creates a conflict of interest and confusing user experience.”
The company is actively spreading into new jurisdictions. It recently entered California and Maryland, and, in total, provides its services in 45 US states.
The advantages include the fact that the company provides some of the lowest prices on the market. Loans are quick, charged at about 13% per annum and can provide about 35% leverage.
Cons: the company is shamelessly centralized. Unlike SALT, they do not match lenders with borrowers; BlockFi is the lender.
Overall, cryptocurrency-to-FIAT lending solutions are more like traditional semi-centralized P2P lending services, with nearly all their associated problems and disadvantages. In fact, they act as a third party and escrow in the lending transactions between their clients. The only difference from ordinary P2P lending services is that they don’t limit users to working with fiat, but facilitate the use of cryptocurrencies, and also use their own token for various services and additional incentives for customers. On the other hand, the ability to get cash for cryptocurrency collateral is a very attractive option, which is currently more in demand in real life than pure cryptocurrency loans.
ETHlend is also a decentralized cryptocurrency credit platform, but, unlike SALT and Nexio, it operates exclusively through Ethereum smart contracts. Thus, ETHlend never stores the funds or assets of its users. In addition, this means that when entering into a contract through ETHlend, borrowers and lenders can only use ETH or ETH-based assets (for example, ERC-20 tokens), such as OmiseGo, Augur, etc.
This is perhaps the biggest disadvantage of a pure cryptocurrency ecosystem. Most of us still make deals in FIAT currency and will most likely want to receive loans in them: US dollars, euros, or some other local currency. But, of course, we should remember that by adding a FIAT currency to the equation, we increase the level of centralization, which has both positive and negative sides.
On the other hand, a fully decentralized cryptocurrency ecosystem most likely won’t comply with most of the laws of a country or a state. However, it will create a much more accessible system for people all over the world.
The lending process at ETHlend is quite simple.
When creating a smart contract, ETHLend requires borrowers to send ERC-20 compatible tokens or Ethereum Name Service (ENS) domains as collateral for ETH loans in the event of a borrower’s default. Currently, only borrowers can create loan applications for ETHLend. To place a request for a loan, the borrower must establish data such as the loan term, the interest rate and the number of tokens required for collateral. If the lender agrees to these conditions, a loan agreement will be created and the lender will be able to send its ETH.
Further, the borrower repays the debt, in accordance with the contract, plus interest on the loan, sending them to a smart contract. The lender receives its ETH and interest from the smart contract, and the pledged tokens are unlocked and sent back to the borrower. In the event that the borrower cannot repay its loan, the lender will receive the announced security of the borrower in the form of tokens, which it can dispose of at his discretion.
The ETHLend LEND token is an ERC-20 compatible token that was sold as part of a pre-sale offer and an ICO. The LEND token performs several important functions in the dApp. In particular, users of LEND tokens will receive a 25% discount on the fee for the platform compared to payment through Ethereum. Although LEND tokens can be bought and sold on coin exchanges, the main use of LEND is to create a discount when paying fees for deploying the ETHLend dApp.
Quarterly airdrops will be distributed to active lenders and borrowers. ETHLend plans to use 20% of its decentralized fees from filing applications for the purchase of LEND from the market, and to distribute that LEND between all lenders and borrowers on ETHLend. Airdrops will be used to increase user acceptance, as well as to increase loan volumes. In addition, particular services on ETHLend will only be available to be purchased for LEND. Examples of these services are lists of featured loans, as well as email marketing campaigns. Finally, ETHLend plans to additionally use LEND to reward lenders and borrowers, who invite new members to the decentralized lending platform (referral bonuses).
ETHLend also plans to offer unsecured loans to its users in the future, i.e. loans in which the borrower does not provide any collateral. Such loans are much more risky for the lender. To help lenders deal with the difficulties of assessing the underlying risk of unsecured loans, ETHLend plans to create a decentralized credit rating for all its users. In short, ETHlend borrowers will be able to build their reputations over time, as they successfully repay loans.
Each ETHLend borrower will have a decentralized credit rating created from several data sources. The main data source for these credit ratings will be Credit Tokens (CRE), which will be issued by ETHLend itself. Credit tokens are special ERC-20 tokens that will be used exclusively on ETHLend to represent the reputation of the borrower. These tokens cannot be exchanged or even transferred to another address. The more credit tokens associated with a user account, the more reliable that account it. For each borrowed 1 ETH that the user successfully repays, the user will receive 0.1 CRE. In addition, ETHLend plans to “burn” credit tokens from accounts that cannot repay loans. A user with a large amount of CRE will be able to get loans that another user with a low amount of CRE could not have access to. Users with higher CRE amounts will be rewarded with better interest rates, and will also be required to provide lower levels of collateral for similar loans than users with lower CREs.
Reputation-based lending will allow ETHlend to introduce the concept of unsecured loans to users, as well as to provide more information for potential lenders. In addition, ETHLend plans to provide users with the opportunity to broadcast their decentralized credit rating to other blockchains. Borrowers will then be able to use their well-earned credit rating in applications on other ecosystems.
But whatever the case, the ETHlend service will remain enclosed within the Ethereum ecosystem.
Elix is yet another Ethereum based platform for lending, crowdfunding and payments. Developers are primarily focused on mobile platforms and usability in order to attract as large a user base as possible from the very beginning.
We won’t consider here the payment and crowdfunding functionality of this solution, but concentrate only on its lending aspect.
The uniqueness of this system lies in the fact that Elix offers a peer-to-peer lending program based on mutual incentives for the lender and the borrower. In traditional credit systems, the borrower pays the lender via a series of installments over time. In addition to repaying the loan sum itself, these installments also include the interest rate specified in the loan terms. Such a system does not provide any additional incentives for the borrower to repay the debt on time, except for the risk of dealing with collectors.
In Elix, both the lender and the borrower are incentivized by the system to meet the terms of the loan. When applying for a loan, participants can choose a mining period in order to receive additional rewards after the loan has been fully repaid. If this option is enabled, the lender must hold the ELIX token in his wallet for a certain time in the system (similar to the Proof-of-Stake). When this retention period ends, the Elix system gives out rewards in the form of a new token, “Token P” (this token will most likely have a different name in the future).
If the borrower pays the loan on time, the reward is divided between the lender receiving 65% and the borrower who receives 35%. If the borrower has late payments, the lender receives 100% of this fee.
Token P will have a fixed maximum supply that the team expects to achieve in only a few decades.
ETHLend (see above) is probably Elix’s largest competitor in the P2P lending industry. ETHLend supports a wider range of cryptocurrencies that users can borrow, but there is no rewards program like that which Elix offers.
Over the past few months, the Maker DAO ecosystem has grown steadily, while the price of ETH has declined. The total issued debt today is more than $76 million in Dai (a stablecoin linked to the US dollar) with more than 2 million ETH (worth more than $200 million at the current exchange rate at the press time) as a collateral. This means that for every dollar issued in Dai, about 3 dollars in ETH are pledged as collateral. This is done to compensate for the volatility of ETH.
Maker DAO is one of the most valuable dApps in the Ethereum ecosystem, and has been successful due to its decentralized management structure. Thanks to a rather complex system of smart contracts, users can borrow dollar-bound Dai tokens with ETH locked as collateral.
The CDP (Collateralized Debt Position) is a smart contract that allows creation of the new Dai tokens with ETH as collateral. If the ETH price falls below the price level of the collateral, then the position is liquidated, and the user keeps borrowed Dai tokens. CDPs are becoming increasingly popular; despite the bear market, the total number of CDPs has increased by 300% over the past four months on the Maker DAO platform.
There are several reasons why CDPs are beneficial for both the ordinary borrower and the crypto speculator.
Firstly, as a regular loan: just as people borrow money on their houses or gold, one can borrow dollar-pegged Dai with Ethereum as collateral. But the difference is that the process is automated, and also more risky due to the ETH’s volatility.
Secondly, these are leveraged positions: one can borrow Dai and use it to buy more ETH. For example, let’s say you take 15 ETH and open the CDP to get Dai worth 10 ETH. Now, if you buy ETH with the borrowed DAI, then your exposure becomes 25 ETH instead of 15. But this is obviously associated with the risk of liquidation if the price drops significantly.
Thirdly, as an arbitrage token: let’s say you hold ETH. Now, instead of liquidating your position, you can just borrow Dai and use it to buy other tokens. If the token outperforms ETH, you can sell a part of this asset and redeem your ETH back, while preserving both the excess tokens you purchased and your original ETHs.
The Maker DAO ecosystem is managed by the Maker (MKR) token. Its market capitalization is a whopping $313 million, making it one of the most valuable ERC-20 tokens.
In general, the Maker DAO has several applications, the primary of which is their stablecoin. But the loans function is also significant. Nonetheless, it remains a pure crypto lending service only; additionally, the service is de-facto “trapped” within a single blockchain ecosystem (Ethereum).
As we see, the market for decentralized P2P lending solutions is gradually filling with projects based on blockchain technologies. However, all these solutions have a number of impossible (or at least difficult-to-overcome) limitations.
One of the main limitations is that most of these solutions are “closed” within a single cryptocurrency/blockchain ecosystem (Ethereum, in particular). But even when some of these lending services work with several different crypto-assets, their variety is often limited to a couple of the most popular ones. In addition, most of the services are trying to tie their users to their native token — that contributes to the exclusiveness of these systems, rather than to their openness. So, in these cases, we can leave out any network effect, serious scalability, or possibility to build a more or less global network.
In other words, blockchain-based decentralized P2P lending solutions inherit all the same problems from the basic Layer 1 blockchain projects (Bitcoin, Ethereum, etc). These problems also include the lack of transaction atomicity (in cases where cross-chain transactions are involved, or there are fiat-to-crypto transactions).
Unlike decentralized credit services, the decentralized credit networks can not only overcome the above-mentioned disadvantages of blockchain-based services, but also significantly expand the opportunities offered to existing and potential users (including businesses).
The principal difference between decentralized credit services and decentralized credit networks is that the latter, in addition to ensuring greater scalability and interoperability, also provide the transitivity of trust. The services must rely on third parties (in particular, to assess the creditworthiness of borrowers). In contrast, each network member in the transitive trust networks establish his/her own trustlines with other users. And by doing go he/she evaluates and weighs all the risks. At the same time, other participants can use its trustlines (for example, when making multi-hop payments, etc.). A dishonest participant will have fewer trustlines with other network members, or indeed have none at all. Thus self-regulation of the credit network will occur without the need for additional involvement of third parties.
All this is made possible by the special technological solutions used in them.
Trustlines Network is an Ethereum-based P2P platform for creating IOU networks. Based on the original concept behind Ripple, introduced by Ryan Fugger in 2004, the Trustlines Network will allow users to create money and make secure payments among themselves. The high-level idea is that individuals provide credit for the people they trust, and only for an amount they consider fair. This provided credit is money that is valid for anyone who trusts the creditor. Thus, Trustlines Network is like the current credit-based monetary system, in a sense, but instead of just banks, anyone can become a creditor.
Since the system’s scalability depends on well-connected users, users are motivated to establish as many connections as possible. This is done by including a small capacity fee in every transaction, which is paid to users/nodes that work as middlemen connecting two end nodes. In addition to the capacity fee, there is a relay fee (more on relays below), an imbalance fee (a fee for adding imbalance to a used trustline), and the Ethereum transaction fee. Optionally, users can also add an interest rate to any of their debtors.
There can be an arbitrary number of currency networks within the Trustlines Network ecosystem, using a related Currency Network Token Factory smart contract. Thus, there is no single “Trustlines token”, but instead an arbitrary number of coexisting currencies that share only the Trustlines Network platform, which are called Trustlines Money. From the point of view of Helsinki, this type of dynamic IOU network would essentially mean that the city should act as a central bank of sorts.
The idea is quite promising, but TN is still tied exclusively to the Ethereum platform, which severely limits the versatility and scalability of this solution.
The GEO Protocol is a decentralized P2P protocol for value transfer. The basic idea is very similar to the idea of the Trustlines Network (or rather, Ryan Fugger’s original Ripple idea). But, unlike TN, the GEO has a more global approach to the problem — plus it is not tied to Ethereum or any other Layer 1 blockchain.
The GEO is a Layer 3 protocol solution, one of the main goals of which is to solve the interoperability problem of various cryptocurrency and blockchain ecosystems, as well as interconnecting them with traditional financial systems. In other words, the developers of the GEO Protocol set themselves the task to provide the possibility of creating the so-called Internet of Value: a universal system that unites all possible carriers of value, as well as systems for its transfer, into a single global network of value exchange.
As you can see, this task is much broader than that considered in this article. However, the GEO Protocol also enables the creation of a number of use cases based on its technology, one of which is a decentralized P2P credit network: a network in which each user can define, create and maintain their own credit links.
Other benefits of the GEO Protocol technology include the following:
The Dharma Protocol is also a protocol solution, but with a view to debts’ tokenization in the broad sense. The project plans to achieve this by standardizing the process of issuing, certifying and administering tokenized debts.
Earlier, the Dharma development team tried to implement individual solutions for specific types of debt obligations but later realized the need to create a global and universal solution, which is what they started to do.
Possible use cases are building the following specialized solutions on the Dharma Protocol such as:
So, Dharma is an interesting project with an appropriate approach to a specific problem. But they are eager to solve exactly this particular problem, rather than dealing with broader goals. However, this project can contribute greatly to those broader tasks.
The real power of decentralized P2P lending solutions will be recognized only if they manage to become not just services, but networks (or an integral part of more extensive global networks). Then, in fact, the original idea of these systems will be fully realized, and their utility for everyone will increase in proportion to the number of lenders and borrowers in the network (the network effect).
Any (largely or entirely) centralized service, or its binding to any of the existing ecosystems (or the creation of its own one, closed and/or unconnected to the rest) represents half measures only. That would be an attempt to limit and prioritize what should be open, borderless, and accessible to all.
At present, most of the existing solutions so far represent, to a greater or lesser extent, these same half measures we just mentioned. However, technologies such as the GEO Protocol are emerging, giving the opportunity to unleash the full potential of decentralized credit networks and more.