Blockchain technology serves as an ideal platform to build efficient large-scale decentralized business models. The emergence of decentralized peer-to-peer (P2P) lending is one prominent use case of blockchain in financial services.
Peer-to-peer lending is the practice of directly borrowing and lending unsecured loans. Traditionally, financial institutions like banks serve as an intermediary to disburse and avail loans. Effectively, it makes peer-to-peer lending subject to third-party limitation and increases the cost and time of a transaction.
In decentralized P2P lending, either third-party is not required, or that the operational costs of third-party services (generally transaction verifying authorities) are quite low. It reduces interest rates for borrowers and increases the earnings of lenders. Furthermore, the decentralization aspect expedites lending procedures and executes them within minutes. It enables a P2P lending system to serve as a unified platform for individuals and businesses to borrow and lend loans easily without involving any intermediary.
In decentralized P2P lending, interest rates and repayment terms are flexible. It results in lower interest rates than what banks and financial institutions charge. However, repayment periods remain shorter than traditional lending.
Decentralized P2P lending lays the foundation for a unified platform where applicants at global level apply for loans at competitive rates. In addition, it executes fast credit checks and KYC/AML ( Know Your Customer and Anti Money Laundering) protocols, with a more holistic view of a user’s capacity to repay. Another major advantage of decentralized P2P lending is it provides anywhere, any time accessibility. Unlike traditional lending, the new decentralized system grants access to anyone with a digital device and an internet connection.
In decentralized P2P lending, blockchain technology provides the platform for secure record-keeping, as well as the creation of smart contracts. It enables a smart contract to execute predefined business parameters, which are essentially computer codes.
For example, a smart contract can execute the payment requests, receive payments, and adjust the due amount automatically. It can even add penalties for late or missed payment without requiring any third-party verification to reduce overhead costs. At the same time, we can embed a smart award system that would adjust credit ratings, and deduct percentages for early loan repayments automatically.
Typically, a peer-to-peer lending platform is not a financial institution (bank/credit union, insurer, or investor) and might bypass most banking regulations. In p2p lending, loans are unsecured and if a lender loses money on the loan, there is no protection as a guarantor (unlike banks, who get government protection for losses). Then, they need to obtain a broker license and registration from an appropriate government agency, like the Securities Exchange Commission (SEC) in the U.S. or the Financial Services Authority (FSA) in the U.K.
A disadvantage of P2P lending is that a lender earns profit through repayments, while the borrower’s gain is immediate. For reducing this, a smart KYC compensation solution provides vital insight into a borrower’s repayment history and score. Also, lenders can offer syndicated loans. In a syndicated loan, several parties collectively lend the money to one person, instead of one person lending to another. It benefits multiple aggregators and aids them in retaining the capacity to offer attractive low-interest loans.
Understand how the technology and the concept would work together with the following overview of public p2p lending platform.
The prototype P2P lending platform uses a decentralized blockchain technology like Ethereum, third-party integrations, and its smart contract technology to enhance the entire process.
An Ethereum based platform can offer loans with a provision to make repayments on any ERC20 currencies. These Ethereum based ERC-20 token contracts combine a decentralized transaction system along with smart contracts coded in EVM (Ethereum Virtual Machine).
It takes about 3-4 minutes to process a loan application on the decentralized p2p platform (website). During the process, it creates a blockchain based loan smart contract, containing a unique identifier for the individual and the requested amount. The platform requests the borrower to upload their PII (personally identifiable information) to ensure adherence to local regulations and KYC protocols. It sends this information to multiple verification providers to get a more holistic view of an applicant’s profiles. The resulting score takes into account social media profiles, professional organizations, and verifiable background information on websites to enhance the KYC process. After successful verification and scoring of the information, the platform lists or publishes the loan request for lenders. In a reverse auction system, interested lenders offer the loan to potential borrowers at low competitive interest rates. Further, the provision for lenders to offer syndicated loans reduces the overall risk of decentralized p2p lending.
The borrower downloads the funds after agreeing to one of the offered loans. It triggers the execution of a blockchain based smart contract loan to autonomously issue payment reminders, collect payments, remit assigned payments to an account, and collect the fees. A blockchain smart contract handles non-payments or default by applying penalties (such as late fees, and higher interest rate) and notifying verification providers about it. It sends a notice to the borrower when the payment time is near and process funds from their wallet through the platform. If payment is late, interest charges increase and get automatically applied to subsequent payments.
The platform uses Smart Compensation Fund Contract plan to reduce the last major risk of P2P lending, such as default borrower. After each loan application process, it assigns a small payment to the Smart Compensation Fund. The amount gets accumulated fractionally as the volume of loan applications increases. It makes the Smart Compensation Fund serve as a guarantor for lenders, reducing or even eliminating the last major risk in the system. This fee arrangement is applied to cover operational and growth costs and transform tokens into a high-value digital currency.
The terms of the loan exist within the ledger itself and use smart contracts to automate processes like payment and collection. It provides greater visibility and traceability into the lending environment to comply with financial risk management regulations. Evidently, Blockchain and smart contracts technology lay the groundwork for efficient, secure, and reliable decentralized p2p unsecured lending.
Oodles is a blockchain development company that provide modern blockchain solutions for financial services like syndicate loans, p2p transfers, mutual funds, asset registry and much more. We build blockchain based financial applications that allow the platform stakeholders to analyze business circumstances and make accurate decisions.