How Does Peer-to-Peer Lending Work And What Is It?
Peer-to-peer lendings is a relatively new model of online lending in the financial services industry, but the idea behind this innovative form of fintech-based financing really isn’t that new at all. When we strip away the modern technology around some of the most successful peer-to-peer lending platforms that have launched in North America-platforms like Prosper and LendingClub-and really look at this financial service in its simplest form, peer-to-peer lending ultimately comes down to the act of one person borrowing money from another person, at a cost, with the agreement to pay them back within a certain period of time. There are no banks involved. Just people lending money to other people. It’s really quite simple.
Maybe you borrowed money from a sibling when you were younger, just enough to buy yourself the latest copy of R.L. Stine’s Goosebumps at your local elementary school’s bookfair. If you did, you would have learned a valuable lesson that day-that you don’t get to borrow money for free. A loan-even a small one-almost always comes at a cost. In order for both the lender and the borrower to collectively benefit from any form of lending, some kind of fee, interest rate, or payment is generally involved in addition to an agreement that the borrower will repay the loan back in full. That’s traditionally how lending works.
Even when technology is involved, the fundamental concept behind lending money remains the same. Lending is based on an arrangement that’s mutually beneficial to both parties. Without a financial return, a lender is out of money for a period of time and stuck wondering, well, what’s in this for me? Lending amounts can be different, interest rates can be different, and payment terms can be different in any situation. The one thing that generally remains the same when it comes to lending is that the lender must feel like they’re making an investment-they’re exchanging money now with the expectation of receiving a return on that investment in the future.
Even your very own siblings were willing to take a quarter of your next allowance when lending out their money.
In fact, there’s a chance some of the homegrown businesses you see on the main streets of any Canadian small town were initially funded through some early form of peer-to-peer lending. Peer lending has been around for, well, about as long as banks have been denying loans to loan applicants and forcing those prospective borrowers to turn to people in their own communities for alternative financing-whether it was family or friends or even wealthy strangers.
That’s not to say traditional person-to-person lending doesn’t happen anymore-of course it does-but the term peer-to-peer lending was essentially redefined in the mid-to-late 2000s with the emergence of innovative financial technology companies focused on using modern apps and online platforms to connect strangers for the purpose of facilitating alternative financial services. After over decade of spin-off peer-to-peer lending fintechs funded by venture capitalists and moderate success that has led to at times multi-billion-dollar valuations, peer-to-peer lending has now come to evoke a specific model of fintech business that facilitates lending between people.
How Do You Define Peer-to-Peer Lending?
So, what is peer-to-peer lending? Peer-to-peer lending is a modern alternative lending model that leverages financial technology or fintech platforms to connect individual borrowers with individual lenders. Using a digital platform as an intermediary between borrowers and lenders, these peer-to-peer lending fintechs cuts out the bank or traditional financial institution, handling transactions and facilitating the funding and repayment of loans between borrowers and individual investors.
