What Does Blockchain Tokenization Mean for P2P Lending?

tokenization P2P lending

The growth of peer-to-peer lending was a direct result of the 2008 economic recession. Banks vacated the consumer and SMB lending space, which allowed fintechs to capture the demand left by that gaping hole. According to a recent study, by the end of 2024, the P2P lending industry will be worth $897.85 billion. The market […]

tokenization P2P lending

The growth of peer-to-peer lending was a direct result of the 2008 economic recession. Banks vacated the consumer and SMB lending space, which allowed fintechs to capture the demand left by that gaping hole. According to a recent study, by the end of 2024, the P2P lending industry will be worth $897.85 billion. The market expects to grow at a CAGR of 48.2%.

Hitting a trillion dollars an important milestone. But with traditional banks and lenders investing heavily in getting their digital lending game right, it is critical to evaluate the source of the next wave of innovation in fintech lending. Though crypto lending is on the verge of hitting the mainstream, it is tokenization that we believe can change the face of the industry in myriad ways.

TOKENIZATION: The New Disintegration Technique?

Tokenization is a method that converts real world assets into transferable digital tokens that live on a blockchain.

  • Liquidity: Liquidity is a major concern when people invest. From real estate to VC funds, many lucrative assets are constrained by their ability to provide the investor a timely exit. Thus, investors are stuck with an investment for 5 – 10 years because they have no way to trade it. Tokenization brings in the necessary liquidity by converting interest into a tradeable asset.
  • Monetization: Many assets such as patents, copyrights, and carbon credits do not have a physical identity but exist in a digital format. The easiest way to convert these into their monetary equivalent is to tokenize them.
  • Access: 99.9% of investors do not have access to the next Facebook because they cannot invest the minimum 10 million dollars required for getting entry into Peter Thiel’s next fund. Tokenization creates democracy of access as it allows the everyday investor to bet just $1,000 on the next unicorn. Tokenization empowers inclusion of retail investors, and their participation is a game changer in the long term.
  • Use Case: For instance, you would like to own the Empire State Building (ESB), but you do not have the estimated $3 billion required to buy the building. On the other hand, ESB is on sale and its owners can’t find a ready buyer for such a large asset. Selling it piecemeal would degrade its value. With the help of tokenization, you can convert ESB into 3 billion tokens worth $1 each and sell it across the investing world. The investor gets to own an iconic asset at $1, and the seller will have a larger buyer universe to pitch a $3 billion asset.

How Would Tokenization Work for P2P Lending?

There are new applications coming out daily, but we believe these are the earliest use cases:

  • Tokenization would allow P2P loans to be funded by thousands of micro investors. Instead of institutional investors controlling the lending on platforms, the ‘P’ in P2P lending can be an individual investing $100 in a loan.
  • The loans would become truly tradeable, and liquid. If you invested in a 3-year loan but need the money back after 6 months, you can simply sell your digital asset on an exchange at a fair price.
  • Crypto P2P loans can enter the mainstream with tokenization, allowing development of fixed income instruments in crypto. This will allow wider participation and lure institutional investors to the market.

CASE STUDY

Blackmoon has launched a tokenization platform on this theme. Its Prime Meridian real estate lending fund is built on a similar thesis that tokenization has the power to change P2P lending fundamentally. It is in a strong position to capture a currently niche market, which will soon to grow to encompass the primary P2P lending industry.

Impact on the P2P Lending System

A P2P loan is not liquid, and the lender usually has to see through the period of the loan tenure. It can be difficult to find a third party looking to buy the same loan. The lender might need to sell at a deep discount due to lack of liquidity. Tokenization will help create more buyers/sellers and a functioning secondary market for the sector leading to more liquidity.

The process of tokenization allows for fractionalization so that the lender can sell any portion and at any time. This breaks everything you own into its digital equivalent. This enables users to create a stock or single proof of ownership tied to the specific asset. It will also make investing easier for the average investor.

Tokenization reduces trading friction and transaction costs. It would also make fractional ownership simple and easier to execute. As the financial asset is already divided into tokens, there would no duplication of legal costs after every transaction.

With integration of the tokenization process in P2P lending, lenders can list their assets as collateral. It is through tokenization, that assets such as patents, intellectual property, or even branding, can be used for raising loans. Moreover, tokenization can allow a brand new form of P2P funding to arise. Tokenized assets can also be offered for collateral funding. So if you own 10% of an apartment, you can borrow against that fractional asset on the alt-lending market.

It can spread risk across a variety of loans. Tokenization will attract more investors to alt-lending platforms as you can now diversify risk for even an amount as small as $100.

Investors have more freedom to invest around the globe. Tokenized currencies enable investors to trade in any geographic area they wish to. Now an American Investor can lend to Asian borrowers in US-denominated loans and Asian accredited investors can invest in certain property loan platforms that are open only to a certain class of investors.

Conclusion

Tokenization is an interesting development with myriad applications in finance. One of its biggest impacts should be felt in the P2P lending industry. With the advent of new players like Blackmoon, P2P lending 2.0 is on the horizon.

Author:

Written by Heena Dhir.

What Investors Should Know About Non-Bank Lenders

nonbank lenders

Investors looking to add private debt and private equity to their portfolios may feel overwhelmed by all the choices. From peer-to-peer lending to crowdfunding, there are countless industry players across a wide range of alternative lending and financing models, serving everyone from individual borrowers to small and medium-sized businesses. Any funding model ultimately comes down […]

nonbank lenders

Investors looking to add private debt and private equity to their portfolios may feel overwhelmed by all the choices. From peer-to-peer lending to crowdfunding, there are countless industry players across a wide range of alternative lending and financing models, serving everyone from individual borrowers to small and medium-sized businesses.

Any funding model ultimately comes down to matching the needs of those who want capital with those who can supply capital. Typically, banks or other large financial institutions would act as the intermediary between investors and borrowers or entrepreneurs. But with many banks pulling back after the financial crisis, and the internet making it easier than ever to play matchmaker, the alternative finance universe is attracting more and more capital.

However, there is still broad-based confusion among both institutional and retail investors about the differences between the various alternative funding models. This confusion is exacerbated by how often the terminology is used interchangeably in the media and the larger financial community. The truth is that each funding model has distinct nuances, rewards and challenges, and it’s important for investors and their financial advisors to understand the differences before incorporating alternative lending or financing into an investment portfolio.

In general, these models can be broken down as either debt or equity investments, with a similar risk-reward profile as any other debt or equity investment.

DEBT (lower risk, lower reward)

Peer-to-peer lending

In a peer-to-peer (P2P) lending model, an individual or business borrows from an outside source or sources – a “peer” – rather than a bank. This process is facilitated through a third party, such as an online platform, which makes it easier to aggregate enough peers to fund the loan. These loans typically come with fixed terms and set repayment schedules. Many loans will also include details about the borrower—such as their income, credit score, occupation, and risk level—to help the “peers” (or lenders) determine whether to fund the loan and at what amount. Examples of peer-to-peer loans include consumer loans, student loans, small business loans, and fix and flip loans on single family homes.

Investors can get into the peer-to-peer lending market by purchasing the whole loan, a fractional interest in a loan or building a portfolio of fractional and/or whole loans. Investors then collect the proceeds of each loan payment, with the peer-to-peer lender taking a fee to cover the costs of running the platform. While even the most creditworthy borrowers may default on their loans, investors can mitigate this risk by building a diversified portfolio that includes multiple loans across different risk spectrums. Investors should also consider if the P2P loans they are investing in are unsecured or have some form of collateral securing the loan. Consumer and student loans tend to be unsecured, while small business and fix and flip loans tend to be secured.

Marketplace lending

Marketplace lending is another term used to further describe peer-to-peer lending. While the two terms are used interchangeably, an important differentiator is the source of capital. Whereas P2P lending platforms tend to rely on a group of small retail investors or large institutional investors to fund loans, marketplace lenders prefer to first pre-fund loans and then offer them to investors.

The marketplace lending model, therefore, offers qualified borrowers a guarantee that their loan will be funded within a specific timeframe, which may be an important consideration for some borrowers. For example, while a consumer borrower may be willing to wait until his loan is assessed and funded by multiple peers, a borrower looking to finance a real estate transaction has a closing date that must be met otherwise he will lose his down payment.

Direct lending/balance sheet business lending

In contrast to marketplace or peer-to-peer lending models, a direct lender will rely on its own balance sheet or proprietary access to funds as its primary source of capital. Instead of having to find enough retail and institutional investor capital to match the needs of borrowers, a direct lender can look to its unrestricted access of funds before making a lending decision.

The advantage of this approach is that the direct lender is better positioned to survive a potential downturn since each of the loans on its balance sheet represents a piece of collateral that can be used to offset any potential losses. Investors in these loans will therefore have a better opportunity to allocate capital in all market cycles. Many direct lenders may also manage a fund for accredited investors that consists of a portfolio of some, but not all, of the loans made by the lender.

EQUITY (higher risk, higher reward)

Crowdfunding

In the crowdfunding model, investors are given the opportunity to provide seed capital in up-and-coming products and businesses. Capital is provided in several forms including equity, preferred equity, mezzanine debt and senior debt . While equity stakes are typically small—often less than 1%—even a modest upfront investment can generate a large eventual payoff if the company is successful. This is particularly true of technology start-ups, which can grow quickly if their product or service is well received among customers.

This model is also popular in the arts and entertainment industries. For example, people might choose to fund an independently produced movie, music album or play in exchange for a small piece of revenues and/or additional perks like attending rehearsals and premiere parties, meeting the artist, or receiving a memento from the set. In real estate, crowdfunding is most typically used by developers seeking to raise money to fund development or redevelopment projects.

Investors should find out if the crowdfunder is providing equity and debt on the same project. This is critical should a recovery plan need to be put in place if the project does not go as expected. Typically, equity investors want to hold on and wait for an increase in value , while debt investors want to liquidate immediately in hopes of recovering their investment. A crowdfunder that is representing both equity and debt investors in the same project will have a conflict of interest. In addition, these investments also tend to be fairly illiquid, so investors should tread carefully. While these early stage equity investments could potentially pay off handsomely, there’s always the risk that the company or project is a flop.

Initial coin offerings

An initial coin offering, or ICO, is a brand-new type of funding model that is attracting many of the same types of companies that previously relied on crowdfunding. However, instead of acquiring an equity stake in the company, investors in ICOs receive cryptocurrency coins, like Bitcoin or Ether, which are redeemable for cash on certain exchanges. The idea is that as the company grows and becomes more valuable, the coins will also become more valuable.

Since ICOs are still loosely regulated, investors should take extra precautions when evaluating a crypto-related investment opportunity. While a business idea may sound great on paper, investors should look for growth signs like recurring revenues and a large potential market.

These five models only scrape the surface of the full universe of funding options for individuals and businesses. A company or a funding model doesn’t always fit neatly into a box either, and investors should take care to understand how each funding platform generates revenue and where its capital comes from.

When choosing which segment of the market to pursue, investors and advisors should also consider their risk tolerance, which will help determine whether a debt or equity investment is most appropriate, and at what scale.

Author:

Written by Evan Gentry, CEO of Money360.