Introduction to Marketplace Lending With Bitcoin – Part 1

[Editor’s note: This is the first in a two part series on bitcoin P2P lending by Stu Lustman of p2plendingexpert.com. Stu is a lifer in finance who has spent the last 10 years doing credit analysis and structuring transactions in the equipment finance industry. Almost 2 years ago, he started his blog on marketplace/peer to peer lending to share how a commercial credit professional would look at and analyze these loans. For the last 6 months, his loans have included lending in Bitcoin as well across 3 different platforms.]

Bitcoin lending is something new in the world of marketplace lending. It is a complicated and confusing topic for a couple of reasons. Bitcoin is something that many people have heard of but not many understand. First of all, there are 2 Bitcoins really: Bitcoin the technology and Bitcoin the currency/payment system. The primary focus of this article is Bitcoin the currency/payment system and how marketplace lending/peer to peer lending is emerging in this currency.

Before we get to that, we need to understand a little bit about Bitcoin (BTC) the technology. BTC is based on a ‘trustless’ decentralized public ledger called the Block Chain. The Block Chain is considered trustless because each transaction on it is confirmed numerous times by independent third parties, none of which are directly involved in the transaction they are confirming. So think of a credit card transaction where the merchant gets a confirmation from Visa and allows you to purchase your goods from their store. Now, imagine that Visa isn’t one network or bank, but it is many little distributed unrelated networks that do the confirming. That is the Block Chain. Here is a screenshot of what the Block Chain looks like (click the image below to see it at full size):

BTC Blockchain Transaction

Every transaction done in BTC shows up here at Blockchain.info. What is important to note, and you can see it on this transaction, is that BTC is pseudo-anonymous. It is not totally anonymous as the sending address, which you see begins with 1HK3q is a specific identifier to a specific person and account. However, it’s not public in the way that it shows that Jimmy sent .001 BTC to Cindy. Instead address 1HK3q sent .001 BTC to 1DD2ST. This is an important feature of Bitcoin that we need to remember when we look at how to lend BTC for profit as well as how the lending platforms operate.

It is these features and Bitcoin’s use as a payment system that explain why we don’t measure how good of an investment it is. The investment potential and this article by Quartz in particular is something that Peter asked me to comment on for this post. The Quartz article looks at it differently calling it the worst investment of 2014. This article looks at Bitcoin from the viewpoint of any investment or currency. While the Quartz article does acknowledge that we enthusiasts don’t really care about price, those looking to build BTC based businesses have no more interest in its price against the dollar than a USD based business that serves its local community cares about the price of the Euro or the Ruble. It’s just a number. For me personally, I hope I never have to cash my BTC in for any other currency. The article does make concessions that many value the technology and potential payment system mentioned above as part of the 2 Bitcoins. What is important and what we do care about is price stability and despite the decline in price in 2014, we have much greater price stability and less volatility in its price. This is vitally important to increasing BTC’s reach and more widespread merchant adoption of it as a form of payment.

The idea that money gets its power from the government to consider it legal tender, as Quartz says, is to not understand what money is. Money is a store of value and a medium of exchange. It has to have both characteristics. Bitcoin is already a medium of exchange. Legal tender doesn’t make it a store of value. After all, compare what new car prices are today versus 10 years ago. The dollar is legal tender but steadily losing value each year in terms of what it buys. Price stability for BTC will help people to believe it is a store of value as well and make it an alternative form of money.

Now, back to lending in Bitcoin.

What’s different about BTC lending versus USD lending?

  • Double blind versus Double Sighted
    We know who our borrower is and we can interact with them directly.
  • Cheap Cross border lending & Geographical Diversification
    One of the biggest advantages of BTC generally, and BTC lending in particular is how cheap it is to do all financial transactions but especially cross border transactions for the equivalent of a few cents. We aren’t limited to Americans and USD. We can lend to anyone we want. I think I have more Australian borrowers I lend to than any other country including the US.
  • No Credit Scores
    Why we must engage with our borrowers.
  • Varying loan purposes
    Rates are higher so debt consolidation is less likely than the standard Prosper or Lending Club loan.
  • Currency Diversification
    This difference seems pretty obvious since we are lending in Bitcoin and being repaid in Bitcoin. Some platforms let you lock in a BTC/USD rate and others have it as an option and others don’t.

However, not all of the differences are benefits.

  • The Wild West
    The USD peer lending world has established companies, great infrastructure and great stability. The BTC lending world is so new that it has none of these things yet. It is truly the wild wild west.
  • Pseudo-Anonymity
    Like I mentioned above, it’s important to understand this.
  • Much Higher Default Rates
    There is a much higher likelihood, even with good diversification, that you can lose money lending out your coin. Default rates are high based on some of these reasons we have discussed already like the Wild West nature of the infrastructure and the ease of running and hiding the coin behind these complex wallet addresses.

I have been fortunate to make money and I outline my BTC loan returns on my blog p2plendingexpert.com each month but many people barely break even or lose money. Done correctly, it can really boost your overall peer lending returns.

In the second part of this series we will take a look at the three major BTC p2p lending platforms.

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Andrew N.
Andrew N.
Dec. 29, 2014 9:38 am

Unlike lending in Bitcoin, the payments you receive back from P2P lending aren’t in a currency that’s worth significantly less than when you loaned the money out.

Stu
Stu
Dec. 29, 2014 9:50 am
Reply to  Andrew N.

Andrew, that’s true if you intend to convert back into USD.

Like I said in the post, I hope I never have to convert it back to USD and in that case its just a number like saying that your Prosper interest earned buys fewer Russian Rubles than it did 6 months ago. It’s true but that doesn’t mean that it affects us.

I appreciate your comments, Andrew. Hope to hear some more on the topic.

Dan B
Dan B
Dec. 29, 2014 3:21 pm
Reply to  Stu

You may never see yourself converting to any other currency, but I’m assuming that you intend to spend some of it at some point. If that’s the case, then how do you suspect the people you’re buying whatever from are going to price that item? Do you think their pricing in Bitcoin remains unchanged regardless of whether Bitcoin goes for $300 or $500 or $100? I don’t.

Yes the dollar or euro or any fiat currency will lose value over time & they all have unpleasant characteristics. But the reality is that it is the system under which the world & It must remain relatively stable or chaos will break out everywhere.

I know the value of a dollar tomorrow will be within a few percent of where it is today compared to other major currencies simply because it must be that way. if I’m wrong all of us will have much more important things to worry about than posting our thoughts on a blog. Of that I’m pretty certain. On the other hand if Bitcoin declines 50% tomorrow vs the dollar or euro, few people anyware will care (or know)
If it vanishes in a year, the world will go on with barely a stumble. To me that insignificance is the main danger. You may say that you hope never to have to convert any Bitcoins you have back to dollars…………….but what you’re also saying is that you hope to be able to do that because most of your money won’t be in Bitcoin. Right? 🙂

Stu
Stu
Dec. 30, 2014 6:07 am
Reply to  Dan B

Dan, thanks for your comment.

You’re right that currently like most Americans my base of expenses is in the USD so I need to keep USD available to pay for things.

As to your good question about spending it, the hope of Bitcoin enthusiasts is that an economy/ecosystem will develop that allows for pricing in Bitcoin because a company’s expenses are also in Bitcoin, or more realistically that some expenses are in fiat and some are in Bitcoin. BTC can only gain mass acceptance with merchant adoption and merchants will only adopt it when, as you say, it becomes less volatile. Thankfully that path to lower volatility has already started in 2014. If a company only has expenses in USD then they will adjust their price when BTC rises or falls. If they have expenses in BTC or multiple currencies then those adjustments are less likely.

Just as an FYI, most merchants that accept BTC convert it back immediately into fiat since their base of expenses is in fiat but the number that are holding more of it in Bitcoin is growing each month.

As to Bitcoin declining versus USD declining, the USD is declining in value each year thanks to inflation. Bitcoin’s decline in price would be noticed by many, not just some techies since companies like Microsoft, Dell and Overstock accept it as payment. It’s becoming more mainstream everyday. It won’t overtake the dollar (that would be silly) but there is lots of room for both to co-exist.

Great questions. I hope to see more.

Stu
Stu
Dec. 29, 2014 9:51 am

Well at least it was true for 2014, who knows what future years hold.

RawRaw
RawRaw
Dec. 29, 2014 11:10 am

You seriously can’t be downplaying the “foreign exchange” risk of a bitcoin investment?

Stu
Stu
Dec. 30, 2014 5:57 am
Reply to  RawRaw

Raw, no I am not downplaying the currency exchange risk. To see this as only a risk and not also an opportunity is to see only one side of the coin. The risk and the opportunity go together.

RawRaw
RawRaw
Dec. 30, 2014 11:04 am
Reply to  Stu

I’m not so sure. Seems more like currency speculation in the form of loans than actual loan derived income.

Dan B
Dan B
Dec. 29, 2014 4:55 pm

Peter…………What happened to the “edit” buttons that used to be available?

JayP
JayP
Dec. 30, 2014 11:13 am

Posting recent comment on Bitcoin by Warren Buffet.

Stay Away From Bitcoin
——————————–
Given Buffett’s almost wholesale aversion to tech, this one isn’t a surprise; the Oracle refuses to invest in what he doesn’t know, and he doesn’t know the technology sector, IBM notwithstanding. But Buffett’s problem with Bitcoin isn’t that it’s a tech investment — it’s that it’s not any kind of investment at all, because it doesn’t have value, as he explained in a March interview with CNBC.

“Stay away from it. It’s a mirage, basically. … It’s a method of transmitting money. It’s a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money, too. Are checks worth a whole lot of money just because they can transmit money? Are money orders? You can transmit money by money orders. People do it. I hope Bitcoin becomes a better way of doing it, but you can replicate it a bunch of different ways and it will be. The idea that it has some huge intrinsic value is just a joke in my view.”