The US is currently a low-interest-rate environment.
A low-interest-rate environment occurs when the interest rate you earn on a “low-risk investment” (generally considered treasury securities) is substantially below the average for a long period. That can be tough on small investors trying to grow their wealth.
When American investors want a “safe investment” they turn to traditionally reliable investment vehicles: bank CDs, treasury bonds, and index funds. But since the 2008 recession, CDs and treasury bonds have returned far less than they did in the second half of the 20th century. Index funds tracking exchanges like the S&P (NYSE: SPY) were set back almost 3 years in early 2020.
In the current market downturn, investors are running out of options for earning pre-2008 returns. However, they may be in luck.
Riding on the back of expanding financial technology, a new form of investment called peer-to-peer (P2P) lending has emerged. It allows investors to directly fund loans through the internet. It’s a market that experts expect to reach $558.9 billion by 2027 at 29.7% annual growth. Two-thirds of industry growth took place in the US last year.
P2P lending grew up during the 2008 recession. Most notably in the UK with platforms like Zopa (unlisted) where investors scrambled for new ways to earn. In China, P2P platforms like Yiren Digital Ltd (NYSE: YRD) also grew because investment options and personal loans were much more difficult to obtain than in the west.
In its early years, P2P differentiated itself by offering much higher interest rates to investors than banks and using their own systems to assess the creditworthiness of borrowers. However, in practice, many platforms were plagued with borrower defaults and investor losses. Many platforms disappeared as the economy picked up over the next decade.
Today, the global COVID-19 pandemic has again shined a spotlight on the shortcomings in our credit system. Banks, the longtime gatekeepers of consumer credit have dropped savings rates and reduced lending. To incentivize bank lending and better interest rates, the Fed recently dropped bank reserve requirement to 0 percent.
However, this has had little effect. In fact, Reuters reported in April that JPMorgan (NYSE: JPM) had raised the requirements for borrowers to obtain new home loans. “JP Morgan is one of the top originators in the market, and they in some ways set the standard for what other lenders are going to do,” said Kristy Fercho, president of mortgage at Flagstar Bank.
The global economy may be offering P2P lending another shot at the spotlight.
Today, P2P lending platforms like US-based startup, Constant, solve the problem of borrower defaults through cryptocurrency. By backing borrower loans with escrowed crypto, they claim to have never lost a cent of investor principal while maintaining an average eight percent yearly return on personal loans. Constant has grown a healthy following in the US and Southeast Asia matching over $20 million in loans in their first year.
Other P2P platforms have moved into everything from home to small business loans. Loan origination platform Mintos has built a strong reputation in the EU by giving investors broad access to international borrowers and a buyback guarantee on loans. They claim to have matched over €5 billion ($5.4 billion USD) in investment.
P2P’s expansion has been bogged down by mistrust and regulatory hurdles, but it has already grabbed the attention (and dollars) of investors around the world and brought capital to those turned away by the traditional credit system. It may prove to be the disruption needed to rejuvenate slowing economies.
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