DeFi Peer-to-Peer Lending and Borrowing
What Is Peer-to-Peer (P2P) Lending & Borrowing?
Peer-to-peer lending and borrowing, which is also referred to as P2P, Social or Crowd lending and borrowing, allows lenders to connect directly with borrowers without the use of a middleman which is closely engaged in the traditional banking systems. In a P2P lending scenario, lenders are typically referred to as “investors,” who loan money to qualified applicants. An intermediary website (P2P platform) usually sets the rates and the term for the lending agreement, and once the terms are agreed by both parties, the transaction is facilitated.
Traditional Banking System
To better understand P2P lending, it is important to have a firm grasp of the traditional banking system. Typically, if you want to take out a loan, you must fill out an application and submit it to the bank. The bank will then assess your creditworthiness and any other factors they deem relevant before deciding on whether or not they will grant you the loan and the terms you will be offered. Once terms have been agreed, the bank will then source the capital from either the central bank or the savings deposits of their other banking customers.
There are a few challenges involved with this method:
- Banks generally operate with a strict risk management strategy, which automatically disqualifies those with poor credit scores or a lack of credit history.
- Banks usually offer poor rates and often apply fees to the total loan value, which increases the price of repayments.
- The traditional banking system can be slow due to a lack of innovation and failure to adopt new technology.
Cryptocurrency P2P Lending and Borrowing
In recent past, the P2P lending market has continued to evolve with the introduction of the blockchain technology and cryptocurrency. Now, P2P lenders can utilize decentralised networks and smart contracts to open up new possibilities for accessing financial services outside of traditional banking infrastructure.
Thanks to blockchain technology, borrowers and lenders may engage in a loan arrangement without the necessity for a middleman. With the use of this tech, smart contracts are automatically executed as per the loan terms, which enables trustless transactions between both parties.
Just like traditional P2P loans, loans that occur on the blockchain still require collateral, usually deposited in digital currencies such as BTC, ETH, A2ZFin or USDT. In most cases, the collateral is held on an intermediary website, pool or crypto P2P platform, where it will be held in a smart contract in accordance with the terms stipulated in the agreement.
The maximum quantity an individual can borrow is decided by the value of the collateral given due to the fact that there is no creditworthiness evaluation or past history to consider because the lender generally does not reveal their identity in accordance to DeFi annonymity. On the other side of the transaction, lenders earn interest from borrowers, which is usually set at a pre-agreed rate. In some cases, crypto P2P platforms such as the A2ZFinance Protocol, amongst others, offer incentives and other bonuses to lenders in order to attract more volume to their platform so that their lending ecosystem can function adequately.
Furthermore, there is no need for any KYC (Know-Your-Customer) process, which means that lenders and borrowers can interact anonymously, which would have been thought impossible in the not-so-distant past.
With that said, one of the main criticisms of crypto P2P lending is the steep learning curve associated with the process, especially for those who are unfamiliar with the fundamentals of cryptocurrency transactions. The UX of most major platforms is relatively clunky, and there is still an element of uncertainty towards the safety and security of these platforms. Unfortunately, many of the major lending platforms have experienced hacks and exploits in some respect, which has caused both lenders and borrowers to lose funds and suffer financial losses.