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Why Bitcoin Is Not Ready for Peer Lending

Over the past ten years, as even the most perfunctory observation will be bound to conclude, the financial system has become more and more negligent in its responsibility to serve the underlying economy from both sides. Savers have seen the interest rates in their bank accounts fall to 1%, or real returns that are negative once inflation is taken into account, while borrowers are forced to deal with rates that often exceed 10%, and with credit cards, often 20%, leaving many in a cycle of perpetually increasing debt.

Economists often think of an interest rate as a price, where the good being sold is the ability to use the value embodied in a certain quantity of money for a given period of time. The present financial market, therefore, is one where the difference between the price that the intermediaries are paying for the good and the price at which they are selling it is a factor of ten. This is unprecedented; there is no other commodity market in existence where the intermediaries are able to maintain profit margins of 900% without competition.

As with many other industries over the past ten years, however, the internet is paving the road for a better way. Rather than going through a bank, sites like Zopa and Funding Circle in the UK and Prosper and Lending Club in the US connect borrowers and lenders directly, taking only a 1% fee for their service. Interest rates end up at a happy medium of about 6% for savers and 9% for investors. Zopa already boasts a total of $200 million worth of loans processed, and its American equivalents have processed $350 million and $650 million, respectively. There is no FDIC insurance, meaning that there is no institutional guarantee that lenders will get their money back, but the intermediaries perform credit checks on borrowers and split up lenders’ money among many loans, so that even with the occasional default, investors can be almost certain that they will net a profit.

To many Bitcoin users, this seems, at first glance, to be a natural market for Bitcoin to expand into. Decentralization and disintermediation are beloved buzzwords in the Bitcoin community, and if the currency can remove the need for banks as a place to store money, why can it not also eliminate the need for banks in their capacity as managers of capital? The reality, however, is that Bitcoin simply is not ready.

One argument that is often used in favor of Bitcoin is its lack of transaction fees. While this argument is a very compelling once for applications like online gambling, some forms of e-commerce and international money transfer, it simply does not apply in the case of lending. A 3% transaction fee both ways from a three year 8% APR loan is indeed a significant 23% cut of a lender’s profit, but what this argument does not take into account is the fact that for most users Bitcoin, as it stands, also has a transaction fee of 2-6% when cashing into and out of the fiat economy. If a hypothetical borrower spends large amounts of money on Bitcoin-friendly services already, then this effect can be bypassed by sending the borrower bitcoins, which he will spend on services, allowing him to use the fiat currency that the bitcoins replaced to fund the object of the loan, but outside of the Bitcoin community itself, such individuals are few and far between.

Another argument is Bitcoin’s ease of use. While it may take several minutes to fill in the necessary personal details to make a payment with a credit card or Paypal, Bitcoin, as its proponents argue, is instant. This argument does not deserve serious consideration in this case; while it is a compelling argument for buying a song for 0.199 BTC on Coindl, filling out a form is an insignificant inconvenience compared to the thousands of dollars that an investor usually commits to sites like Prosper.

Bitcoin’s potential for anonymity is another advantage heavily touted by Bitcoin enthusiasts, but once again, while anonymity is an advantage if one wishes to buy a private VPN service or goods that one’s family, community or government disapproves of, it is of little use when trying to establish that the recipient of your money is a trustworthy individual who has the ability, willingness and incentive to pay the money back.

A fourth problem is that Bitcoin’s existing lending community is specializing in a market far different from the kind of loans that peer lending sites intend to attract. In the Bitcoin community, the prevailing interest rate is 3-6% per week, and the projects that the loans are intended to fund, assuming that they are not outright Ponzi schemes, are all specific to Bitcoin itself. Furthermore, the market is focused on a small number of highly trusted borrowers, so the problems involving trust and borrower evaluation on the scale that mainstream peer lending sites have to deal with are nonexistent. Before they restructured their service in 2009, Prosper was barely surviving as investors in all but the highest rated loans found themselves losing more to defaults than they gained in returns. Prosper’s restructuring introduced more stringent measures in steps like identity verification and credit checks, the very sort of red tape that the Bitcoin community tries so hard to avoid.

Bitcoin has great potential to do a lot of good in many economic sectors around the world, but what the case of peer lending serves to remind us is that it is not the immediate solution to all of our financial problems. Not only is there no clear path for adoption, but there is no evidence that at this point in Bitcoin’s adoption, entering the peer lending market is even desirable. Inside the Bitcoin community, the Bitcoin lending market is a strong one, and there may be compelling arguments for using Bitcoin for investing and lending to specific markets in developing countries, but Bitcoin-based peer to peer loans on a national scale is a prospect in which Bitcoin may become the preferred currency only in the far future.


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  • Anonymous

    Borrowing where the loan is denominated in bitcoins is apropos financial suicide for the borrower because of the risk that the exchange rate would rocket up.  So not only could the future interest payment be more expensive, coming up with the principle could cost much more as well … in terms of the dollars needed versus how many were borrowed.

    Now if lenders were willing to offer dollar loans, and bitcoins are used simply as the way to transfer the value, then that’s reasonable.

    • disqus_TLcMqwnySr

      There is a lot of speculation that Ponzi schemes are aplenty, but lending in dollars and receiving back in Bitcoins is exactly what’s happening.

      In that sense, Bitcoin is actually serving as a source of lending funds and as a savings pool, effectively extracting wealth from existing currency pools (EUR, USD, etc). The shift is happening at the margin.

      Example: at $5/BTC, 20BTC are used to provide a $100 loan; the loan is repaid at $110; the $100 (20BTC) is lent out again, and the $10 or 2BTC profit returns to the Bitcoin system.

      The exchange rate dynamic would result in a steady transfer favoring the recipient of capital flows, exactly as has been seen over the past several months with Bitcoin gradually rising against other currencies. If it continues at a consistent rate, the absolute value will appear to accelerate.

    • Vitalik Buterin

      > Now if lenders were willing to offer dollar loans, and bitcoins are used simply as the way to transfer the value, then that’s reasonable.

      This is what I was thinking. I’m pretty sure no one in the Bitcoin economy is willing to hold a debt in BTC unless they have an automatic stop loss (eg. Zhoutonging) or they are borrowing for a business whose success is closely tied to the success of the Bitcoin economy.

    • austinhamman

       there is no guarantee that your loan with the bank won’t become subject to inflation.
      also if you are loaning in BTC and trading in BTC then the exchange between BTC and USD isnt important.
      so i borrow 10 BTC, i use this to buy something for 5 BTC and in turn i make back 20BTC, i pay my 10 plus interest. now if the exchange rate changed any point in there it doesnt mater because i wasnt using USD.
      now a change in exchange might cause a change in the buying power of BTC for those who judge the worth of BTC by its ability to buy USD, but by that its no different than the changes in buying power caused by fluctuations in ANY commodity market. (i borrow $20 to buy apples to sell but after i borrow the cost of apples goes up and i can’t buy as many apples, this makes it harder for me to make back the principal let alone the principal+interest)

  • joelhfx

    Lots of generalization in this article. It doesn’t reflect my experience at all.