Bitcoin peer-to-peer lending - not for the faint of heart

I discovered the site BTCjam by online advertisement. The idea was very compelling to me as I had some idle bitcoins ... there are so many people out there having so many interesting projects in their pipeline, just missing a bit of funding. By assisting a bit, one can make the world a better place and in the same time earn interest on the Bitcoin holdings. Later I discovered the BitcoinLendingClub, now renamed Loanbase, and found that I liked their site better. There was also the BTCPOP, which was supposed to be even better, though I didn't invest there.

Fast forward a year or more, and ... oops, I've lost quite some Bitcoins. I'm hearing rumors that things are not all that well in the BTCPOP-land either. I've still not given completely up on the idea about Bitcoin peer-to-peer lending though, now I'm testing out http://getline.in - the latest and most beta site out there. Well, peer-to-peer bitcoin lending is really riddled with problems, though I do have some hopes to get my bitcoins back eventually, but anyone considering to lend out bitcoins should be aware of the risks.

Bitcoin lending is totally based on trust - how can I trust the borrower?

BTCJam has done some attempts on lawful collection. Loanbase made some agreement with some international collection bureau and announced loudly that all defaulted loans worldwide ... with the minor exception of US borrowers ... would be sent to collection. So far I think they've succeeded to recover some few percent of the defaulted loans. Some court cases have been successful, but they are far between. Lawful collection is a difficult thing. Lawful collection over country borders even more difficult. Lawful collection of peer-to-peer loans, where a borrower has many lenders, most of them lending an insignificant amount ... even worse. And the borrowed stake is not a "real" currency, but what did you call it ... eh ... "Bitcoins"? I'd say, attempts on lawful collection is probably not worth the effort.

So we're down to this ... if a borrower simply doesn't want to pay back, the lender has lost the funds, period. You need to trust the borrower. Usually you can trust the borrower if it's someone you know personally, or if you personally know someone that knows ... yes, there are actually tons and tons of real honest people out there! The problem is that some few rotten eggs really can turn profits into losses.

BTC price volatility hurts lenders

If the BTC value drops, then I'm also losing money as a BTC lender. That's fair enough, I'd be losing more money if I'd been hodling on to the bitcoins. The big problem is that if the BTC price grows a lot, borrowers tend to default, often causing a mess where the lender loses 100% of the investment. Hence, the lenders are at risk of ending up as a loser no matter which way the BTC price swings.

Some borrowers do have the ability to hedge against the risk of a raising BTC. People doing investments into mining or earning money through bitcoin trading will probably be fine. Others may have enough secure income to cover the loss. Unfortunately, some just won't accept the loss or be able to handle the loss ... and will simply go into hiding.

Too high interests is bad business

Due to the high risk of defaults, the interest rates also needs to be high to compensate for the defaults, this causes several problems ...

• high interest rates will cause a bias towards scamming; legitimate borrowers will find the rates too high while scammers don't really care about the rates. We saw this at Loanbase when they gave up the "dutch auction" model where lenders were free to set their rates, and enforced their calculated rates. Based on their statistics, the new enforced rates would make sure the lenders would go in plus, if they just spread the risk on enough borrowers. Unfortunately, quite many of the legitimate and trustworthy borrowers ran away because they couldn't afford the new rates. The scammers remained. I foresaw this ... and I put some money into their autoinvest system just to prove myself right. I think I lost around 25%.

• high interest rates will cause a bias towards the high-risk borrowers; the low-risk, business-minded borrowers will probably find that the interest rates are too high while the more naïve, risk-taking and less experienced borrowers will find the high interest acceptable. Many borrowers aren't prepared that their business plan will fail, they will all tell that they do have good backup plans for repaying the loan, but when the shit hits the fan they are unwilling to accept that they're personally responsible for repaying the loan - with interests.

• high interest rates increases the likelihood of defaults even among honest and business-minded borrowers - I think that by average maybe it's possible to expect a 10% return rate on business investments, meaning that most long-term loans with more than 10% APR are unsustainable. A 44% APR loan is normal at Getline, this is the order of magnitude we're speaking of at most of the P2P BTC lending sites out there, and quite often borrowers tend to accept loans at more than 100% APR.

Bitcoin forking risk

The bitcoin community has been quite split for the last couple of years over the blocksize limit issue, this may cause a fork. Let's say that after the fork we'll end up with two coins, "major bitcoin" and "minor bitcoin", with the "major bitcoin" being worth more than the "minor bitcoin".

In the best case the "major bitcoin" will be the winner, its value will soon grow higher than the pre-fork-value, and the "minor bitcoin" will have insignificant value. I'd expect the borrowers to pay back the "major bitcoin" and I'd ignore the "minor bitcoin", and the getline site to support the major bitcoin. However, there is a risk that the borrower fanatically will insist the "minor bitcoin" is the only Real Bitcoin, then the investors have to eat the loss.

In the very worst-case scenario there is not so much difference between the value of the "minor bitcoin" and "major bitcoin", both sides will claim their coin is the real Bitcoin. I'd expect my borrowers to pay back in both coins. There will for sure be lots of development costs supporting that from the P2P-lending site, and there will for sure be borrowers that disagrees with my expectation. The value of both branches will probably plunge so much from such a scenario that the debt will be worthless anyway.

Conclusion

Peer-to-peer BTC lending is possible, but only with extreme caution. It's needed to keep a close watch and a dialogue with the borrowers - people that one preferably should know personally - and at the same time it's important to spread the investments over many borrowers. I would recommend using Getline, but be prepared that it's a bit rough and unpolished.