The peer-to-peer (P2P) lending marketplace industry is a fast-growing segment of the financial industry. It is an industry that was valued at more than $231 billion in 2018 and is expected to reach more than $820 billion in 2025. Millions of people are participating in the industry in one way or another.
In this article, we will look at the risks of investing in P2P lending.
Quick Overview of Peer to Peer Lending
- P2P lending is a fast-growing industry with millions of active users.
- The biggest P2P lender is Lending Club, which is valued at more than $1 billion.
- There are hundreds of P2P lending companies, most of them in Europe.
- Regulators are starting to focus on the industry with the goal of protecting users.
What is Peer to Peer Lending?
Peer to Peer lending is an industry that allows people to lend money to one another or to companies. The industry was built to mirror what happens in the banking sector. As you know, banks profit by lending out customer deposits. They lend the money to borrowers, who then pay back the money on interest. The customers who own the funds don’t get a share of the profit. As such, the P2P industry removes this middleman.
There are three (or four) main components of the peer to peer lending marketplace. There is the lender, who is an ordinary person like you who wants to make money through interest. Second, there is the borrower. This is the person or company who wants to get money. Third, there is the P2P company that creates a platform where these transactions happen. Finally, there is the loan originator. This is a company that supplies loans to the platform. Not all P2P lending companies have loan originators.
How Does Peer to Peer Lending Work?
As mentioned above, the model of P2P lending works in a very simple way. We have also mentioned the four main components of the peer to peer network. It starts with a technology company that creates a P2P lending platform. Borrowers then approach the company for financing. They can do this directly or by using an originator. The loans will then be listed on the platform, where lenders can extend credit to the borrowers. After this, the borrowers will pay back the money as they would when using a bank.
Is Peer to Peer Lending Safe?
The goal of this article is to identify the risks of investing in P2P lending. As with all investing platforms, there is a risk that comes with investing in peer to peer lending. Let us now look at the main risks you should be aware of when investing in P2P.
Regulatory Risks in P2P lending
The first major risk is that of regulations. The industry is relatively unregulated. In the United States, the regulations of P2P lending is done by states and the Securities Exchange Commission (SEC). In Europe, the industry has some loose regulations. However, there is a possibility of the industry having some tight regulations.
A good example of this is what happened in the United Kingdom, where the FCA implemented some tough regulations. These have led to some P2P lending companies shutting down or tweaking their business model. Some of the companies that have been forced to do this are Landbay and Thincats.
Currency Risk in P2P Lending
Peer to Peer lending is an illiquid method of investing. This means that it is difficult to exit an investment when it is made. This brings the challenge of a currency. When you lend money in a currency, it means that it is difficult to exit if the currency depreciates. A good example is what happened when the UK voted for Brexit. The value of the sterling dropped sharply. This means that people who had lent money in P2P were at a disadvantage. Therefore, you should always find ways to hedge against currency risks.
Company Risks in P2P Lending
Peer to peer lending works through a company as mentioned above. The company makes money when the borrowers pay back the money. As such, there is a risk that a company may go out of business. This is simply because many P2P companies are relatively new and have never made a profit. A good example of this is Lending Club, which was once valued at more than $15 billion. The company is now worth slightly above a billion dollars but has never made a profit. It has lost more than $500 million in the past decade. The chart below shows the Lending Club stock price.
Another example is Prosper Marketplace, that was once valued at more than $1.9 billion. The company’s valuation has dropped and is now worth about $500 million. A number of P2P companies have also shut down. When this happens, lenders are usually on the hook. Therefore, it is recommended that you diversify your investment across multiple P2P lending companies.
Inflation Risks in P2P Lending
Inflation is a simple concept that refers to the increase in price of goods and services. While many P2P investors don’t think of inflation, the reality is that it is a risk when investing in P2P investing. As mentioned above, P2P lending offers fixed loans. The lender does not have the tools to adjust interest rates when rates rise. The challenge for this is that when goods prices rise and you can’t adjust interest rates, you are in the hook. The total money you make will have a low buying power. Therefore, you should hope that there is no inflation when you lend out money.
Peer to Peer investing is a process that is enabled by the internet. All companies that operate in the industry offer the services through the internet. There are cybersecurity risks when you are dealing with a company that operates solely online. There has been no major cybercrime-related hack in the peer-to-peer lending industry. However, this does not mean that your account cannot be compromised.
Another risk of peer to peer investing is default. A default happens when the lender fails to pay the money. This can happen due to a number of reasons. Some borrowers can refuse to pay intentionally. Others can fail to pay because of being laid-off at work. Others can fail to pay because their businesses have collapsed. Finally, there are borrowers who die before they pay back the funds.
Examples of the Best Peer to Peer Lending Companies
These risks of peer to peer lending happen in all types of companies. However, using a good company can help you minimize these risks. We have conducted a review of the best European peer to peer lending companies. In no particular order, we recommend that you invest in the following peer to peer lending companies:
- CrowdEstate – A peer to peer company offering loans backed by real estate.
- BulkEstate – This is a European real estate and group buying platform.
- Grupeer – A basic consumer to consumer peer to peer lending company.
- The House Crowd – A UK based real estate P2P lending company.
- CrowdProperty – A European real estate peer to peer lending company.
- October – A European consumer to business lending company.
- Zopa – A UK peer to peer lending company.
- Monethera – A European asset-backed peer to peer lending company.
- Housers – A European real estate investment platform.
There are risks of investing in peer to peer lending companies. We have looked at these risks above. There are ways you can protect yourself. First, select a good P2P lending company. Second, select a company that has a secondary marketplace. Third, diversify across a number of loans in the company. Next, diversify across multiple assets such as bonds, mutual funds, Bitcoin and index funds.. Finally, invest only a small part of your funds in this industry.
Crispus is a finance professional with more than a decade experience in the industry. Over the years, Crispus has written in-depth articles on leading platforms like CCN, Marketwatch, and Seeking Alpha. He also runs a Forex education and managed account company called WestEndFx.