Bitcoin is still a relatively new phenomenon. New things always bring opportunities and risks. So does Bitcoin, and so does Bitcoin P2P lending.
“The resources required for trade are provided by lenders: without lenders, not a ship, not a ship-owner, not a traveler could be put to sea.” - Fourth-century litigant speaking to an Athenian jury, Demosthenes 34.51
Active users of Bitbond are certainly familiar with Bitcoin P2P lending. But let’s recap what it really means. Bitcoin P2P lending can be many things depending on the perspective from which you look at it.
For lenders the most obvious thing about Bitcoin P2P lending is that they give away some of their Bitcoins over a certain time in prospect of a return. If you hold Bitcoins in your wallet they are not used in any productive way. It’s the same as putting money under the mattress. It is (hopefully) safe, but it does not do any good to anyone.
So far far there are only very few service providers that offer interest payments on Bitcoins. This means there aren’t many alternatives to Bitcoin P2P lending either. And those sites that do offer Bitcoin interest payments face a number of risks as we will see later.
Via Bitcoin P2P lending spare Bitcoins come to people who have productive and profitable uses for them. But Bitcoin P2P lending does not simply mean you are putting your Bitcoins to work somehow.
It rather means putting them to work in a particular project that is directly chosen by you, the lender. By participating in the fundraising of borrowers, lenders vote for those projects they find most attractive.
Therefore Bitcoin lenders are doing two things at a time. They have their coins employed productively and they make a choice about worthwile projects. But that’s still not everything. Bitcoin P2P lending also means that borrowers can get funded even if they don’t have access to a bank at all.
This is totally new and quite revolutionary. Before Bitcoin P2P lending came up, personal and small business loans were exclusively made by banks. You could also ask your family & friends of course, but that was really about it.
Bitcoin P2P lending gives access to loans for everybody who has an internet connection. No matter where they come from.
Bitcoin P2P lending has many interesting aspects. But when looking at the future opportunities that arise from it, there are three key things to mention. Let’s look at them one by one.
Interest rates in most countries are close to zero. Since the beginning of the financial crisis in 2007 central banks had to cut rates in order not to let the financial system collapse. This also affects the interest rate that savers get on their deposits.
In countries where the inflation rate is below 2-3%, the interest rate on fixed-term deposits is currently around 1%. Effectively this means that you make a negative return if you take inflation into account.
Bitcoin P2P lending gives access to an asset class that was only available to banksbefore the appearance of P2P lending. Personal and small business loans were not an investable asset for savers until the first P2P lending platform zopa started in 2005 in the UK. Since then, P2P lending has proven to yield returns of around 6-12% for lenders.
The effective return from lending depends on a number of factors like the diversification of the loan portfolio, the geographical focus and the industry focus of the portfolio.
But on average, P2P lenders made better returns than they could have earned from all other fixed income asset classes. This includes government and corporate bonds and all types of savings contracts with banks. Thus, bitcoin lending is here to disrupt banking.
If you are interested in data about returns, the US based P2P lending platform LendingClub is a great resource. Today, LendingClub is the largest P2P lending site worldwide by every measure. On their statistics page you will find detailed data about historical returns of different loan portfolios. A lot can be exported to a spreadsheet which allows you to do your own customized analyses.
What’s so special about Bitcoin P2P lending then, if sites like LendingClub work so well? The most obvious point is that in order to put your savings to work at LendingClub you need to have an US bank account. This excludes a large number of savers from around the world.
In contrast to that, Bitcoin is international and you don’t need a bank account at all. Hence, the same applies to Bitcoin P2P lending. It is truly accessible to everyone who has an internet connection.
Therefore Bitcoin P2P lending enables access in two sorts of ways. First of all it gives access to an asset class that potentially yields superior returns. Second, and equally important, Bitcoin P2P lending enables access to this asset class from all around the world and not just from countries that have a developed banking system.
Besides granting access to a profitable asset class, Bitcoin P2P lending enables one other important thing. It allows you to diversify. When you put your money into fixed-term deposits you trust one single entity to manage your savings well. If the bank goes bankrupt, there is nothing you can do. Usually there is deposit insurance, but it does not exist in every country and is limited to a certain amount of savings.
If you hold Bitcoins at a service provider that promises to pay interest on your Bitcoins the problem is even more severe. There is no deposit insurance in the Bitcoin world. So you trust one single entitiy to manage your Bitcoins in a profitable way. If they go bankrupt, all your Bitcoins are probably lost.
With Bitcoin P2P lending this is different. You can diversify very well. Even if you invest just smaller amounts. When you want to lend one Bitcoin, you can spread it to 100 different loans. Thereby you follow an important rule of investing which says “Don’t put all your eggs in one basket”.
Not all of the loans you fund might be successful, but on average you should do well. Distributing your fiat money savings over 100 different banks would be much harder. The transaction costs of opening so many accounts are massive. Plus you probably don’t even have so many banks around you.
Diversification is not limited to the number of different loans you are funding but also has a geographical and an industry scope. Bitcoin P2P lending enables you to get an exposure to many different markets around the world. At the time of writing of this blog post there were 17 different projects from 9 countries listed on the browse listingsoverview. All continets are represented.
If you have a loan portfolio that is so diverse you are less affected if there is an economic downturn in a certain part of the world. Also imagine the Bitbond loan marketplace in a few years. There will probably be projects from over 100 countries. This will let you diversify your portfolio to an unseen degree.
Besides the geographical dimension, diversification of industries also plays a role. The Bitbond loan listings show you the industry in which the borrower works. You can therefore select a portfolio that is also diversified in the industry dimension.
The combination of diversifying over many markets and industries at a very small minumum investment is what makes Bitcoin P2P lending so powerful. It lets you distribute your investment risk over many smaller tickets. Today this might not always be possible because not every project gets funded. But looking into the future the potential diversification that can be achieved is unique compared to other types of savings.
Besides the ‘hard’ opportunities access and diversification there is a third, rather soft aspect. Bitcoin P2P lending empowers you to support projects that you otherwise could not support directly. It is nearly impossible for individuals to support small projects of their choice in developing or emerging markets.
If you want to contribute small amounts on an individual level, the only option you would have is to donate to a larger organization. However, this is not very efficient. Only a small portion of your donation actually does what it’s supposed to do, i.e. help those who need it. The larger part of your donation is taken up by the operating costs of the charitable organization and its marketing activities.
This is not an accusation, the charities don’t have much of a choice. They need to be run as organizations. This point is here to highlight that there is a superior way of supporting causes now.
Bitcoin P2P lending enables individuals to support projects in distant locations of the world in a very efficient way. The overhead of running Bitbond is really small compared to charities that are mostly grown organizations. Additionally, with Bitcoin P2P lending you decide about every single project you support.
When you donate money to a charitable organization, the leaders of this very organization decide what they do with your money. You have very little influence about that.
So all in all you can support projects that you like from all over the world, no matter where you are from. You are independent of large organizations, you can do it with very small amounts starting form BTC 0.01. And you can even expect a financial return from it. This makes Bitcoin P2P lending a superior way to support causes international.
No new opportunity comes without a risk. It would be wrong to deny that. Currently Bitcoin P2P lending does face two main risks. They can and will be mitigated in the future. But for now we definitely need to be aware of them. This is the main reason why you should only lend Bitcoins you can afford to lose.
The Bitcoin exchange rate to other fiat currencies like the Euro fluctuates strongly. These fluctuations are also called volatility. The main reason for this is that the total value of all Bitcoins – the market capitalization – is still small.
The market cap is currently at around EUR 6 billion which is very little compared to stocks, commodities or other currencies. The good thing is that Bitcoin volatility is on a decline while the market cap is going up. See this Bitcoin volatility article for instance.
Looking at Bitcoin P2P lending, the Bitcoin volatility is a problem for both, borrowers and lenders. But there is also an exception to this. When borrowers purchase mining hardware, they remain almost neutral towards exchange rate fluctuations.
Their earnings are paid out in Bitcoins regardless of the exchange rate. But in other types of projects there is often a link between earnings and the exchange rate. Especially if the income generated through a project that is paid in a fiat currency.
When someone gets a Bitcoin loan to purchase supplies for a business, the income generated from that business will typically be paid in fiat money. So if the Bitcoin exchange rate goes up, the effective repayment measured in fiat will also be higher. This makes it more difficult to repay the loan. It should still be doable if the business is profitable, but the loan simply becomes more costly for the borrower. And this is not intended.
At the same time borrowers would benefit from a declining exchange rate. They should not count on this however. Generally speaking a smaller degree of exchange rate fluctuations would be economically beneficial for borrowers. As mentioned above, it’s getting there but it will definitely take a few years until Bitcoin will flucuate as litte as other established currencies.
The lender faces the opposite exchange rate risk as the borrower. If the Bitcoin exchange rate goes down, from a purely financial standpoint lenders would often like to sell Bitcoins. This is not possible when they have lent them out to other people. By the time lenders get repaid the exchange rate might be up again, but of course this is totally unforeseeable.
On the contrary, a rising Bitcoin price is something that lenders like. They earn interest and additionally the purchasing power of Bitcoins increases. However, if it makes repayment harder for the borrwer, it is not clear whether the lender will realize this profit.
We can conclude that the Bitcoin exchange rate flucuations as of today are definitely a risk that is specific to Bitcoin P2P lending. It will be interesting to see how Bitcoin volatility evolves. But as long as the Bitcoin ecosystem keeps growing as it does (a great site to watch this is bitcoin pulse), this risk should be mitigated in the medium-term.
Before discussing this second risk it is important to note that by its very nature the repayment risk of loans is not specific to Bitcoin P2P lending. Whenever funds are given to a third party, there is a repayment risk (in the financial world called credit risk). Nevertheless, some aspects of credit risk are special in Bitcoin P2P lending which is why this type of risk is covered here.
In a traditional setting when you lend money to other people or organizations you do it through an institution like a bank or an exchange. In the case of a bank you don’t even lend directly to others but the bank does it for you. The bank becomes your debtor and they a cut of the margin for this service.
The other way is purchasing bonds through an exchange. That way you can choose which company gets your money. Both schemes have in common that when your counterparty goes bankrupt you can join many others in your efforts to get back whatever is left.
The same applies to Bitcoin P2P lending but there is one restriction. Many Bitcoin loans have a ticket size that is relatively small. If a borrower defaults and the outstanding principal is small, the cost of debt collection might be higher than the actual claim.
In that case it will not be economical to start the process. So this is a situation where the risk is higher than when you hold a bond from XYZ Corp. that is listed on an exchange.
Other than that, all the usual disclaimers regarding credit risk apply. Some borrowers are more creditworthy than others. The best way to handle this is diversification. Just like in a traditional investment portfolio where you have a mix of different assets.
As we have seen, there are 3 specific Bitcoin P2P lending opportunities and 2 specific risks. Bitcoin P2P lending is a new phenomenon and therefore we are dealing with some unknown parameters. But the opportunities behind it are so big that it’s a worthwile endeavour.
These beneficial opportunities behind Bitcoin P2P lending are the reason why it will play a big role in the future. And you, the lenders, are the most important part in making Bitcoin P2P lending happen. You are making the future today. A future where the opportunities to start own projects will be more equally distributed around the world. Regardless of access to banks and regardless of geographical origin.