P2P Lending Business Model Intuitively Fits the DLT & Smart Contracts
Smart contracts have opened up many opportunities in the trade finance sector — credits to the massive advancements in blockchain technology. The market players have accepted the change with open arms and are ready to play around with innovations that could dramatically disrupt the marketplace.
As per the reports, the market size of Smart Contracts is expected to reach USD 345.4 Million by 2026, from USD 106.7 Million in 2019, at a CAGR of 18.1%, where the forecast period is 2021–2026.
These smart contracts can be imbibed in sundry applications making the whole system a robust one. The article details how smart contracts have paved the way for peer-to-peer lending transactions.
The Concept
Peer-to-peer lending is a method in which people lend money to individuals or businesses. The lender usually earns interest and gets the money back after the loan is repaid. Well, it is considered much riskier than the savings account.
You all know that DLT technology has eliminated the need for intermediaries like banks and agents. And, the approvals and processes involving the intermediaries are replaced by smart contracts. It has also reduced transaction cost overheads and has also speeded up the transaction process.
A considerable growth is seen in the use of blockchain for peer-to-peer lending transactions, especially where the transaction cost and the transaction time are usually a disadvantage for both the sender and receiver. Also, there is an upsurge in the acceptance of significant cryptocurrencies by traditional retailers.
The elimination of intermediaries has the potential to unlock the financial services for people & businesses with pandemic-induced financial stress & are not getting financial support from banks at a fair price.
This could further orient the interest of people towards adopting smart contracts for P2P lending. But, before moving ahead, let me brief you about the working of smart contracts.
How do smart contracts work?
Smart contracts are executable codes that are hosted on blockchain by invoking the constructor function. It is called initially when a transaction is submitted to the blockchain network.
As the constructor function gets executed, the blockchain stores the final code of the smart contract. After the deployment, the creator of the smart contract gets the return parameters (e.g., contract address), and the users can easily invoke the available smart contracts function by sending a transaction. Smart contracts code is verifiable and in the public domain. Therefore, everyone participating in the smart contract-based transaction is fully aware of the immutable terms of the agreement embedded in the “contract code”.
P2P lending in the blockchain using smart contracts
In peer-to-peer lending, an online platform links the investors/lenders with the borrowers. This online platform, further, acts as an authentic third party. The following stakeholders get involved in the complete process:
- Fund providers (individuals or private firms)
- Transaction management tool (online p2p)
- Individual or company seeking funds
The involvement of intermediaries in transactions on traditional peer-to-peer sites is subject to cost overheads and time restrictions along with security concerns.
Since blockchain has transformed a variety of sectors, its use in peer-to-peer lending, removing intermediaries from the lending process, has gained it a lot of traction and popularity.
Well, some people have different opinions, as can be seen from the tweet below.
Key features of P2P lending with Smart Contracts
Transparency:
Blockchain-based P2P lending allows information to be available to the participants — lenders and borrowers — enhancing the overall trustworthiness of the system. All the transactions — past, current and ongoing — are visible to the participants. In addition, since there is no centralized mechanism, lenders and borrowers could participate directly in the process, reducing friction and enhancing transparency.
Information Integrity & Immutability:
There is a provision of authentic data exchange where transactions are reviewed, allowing direct contact through cryptography public keys. The user can easily check the accuracy of the information that is being broadcasted based on defined laws and regulations.
Furthermore, the transactions on the blockchain are immutable, which means that nobody can alter anything once created. The addition of information to a block is done through an agreement mechanism that involves proof of work.
Privacy & Authenticity:
The identity of the users is hidden with the help of pseudonyms which usually depends on the type of blockchain in use. Furthermore,public-key cryptography protects the interactions, which further enhances the degree of privacy for P2P loan platforms.
The authenticity of the system is developed by exchanging and storing information about the transactions within the network itself. Furthermore, the steps are automated to reduce the need for manual intervention, thereby reducing the risk of human errors.
Blockchain technology allows peer participation in creating the underlying code that supports the database and creating open frameworks where participants can develop and distribute their code and functionality. This makes the system versatile, allowing the creation of smart contracts, in which contractual arrangement is made between two parties: lender and borrower in P2P lending. This is all based on the piece of code that is configured to satisfy the contract terms automatically.
To better understand, I am quoting an instance of how blockchain technology is helping the seamless execution of peer-to-peer lending procedures.
Validus P2P Lending Platform
Validus is a peer-to-peer lending platform that has been helping in bridging the cash flow gap that SMEs face.
In order to attract liquidity from a variety of asset investors, it is essential to have a liquidity market aggregator. It could then connect to any Distributed Ledger or Non-Distributed Ledger tech platform through a middleware. This is where Trade Finex and Xinfin come into play. Trade Finex is a liquidity network that allows MSMEs and financial originators to access decentralized liquidity pools. Xinfin is a DLT platform that acts as middleware.
As a liquidity market aggregator platform on the blockchain, Xinfin benefits originators in attracting liquidity from alternative asset investors. In collaboration with platforms like Validus, it provides an extra edge in cutting costs of financial intermediation. Further, allowing SMEs to reap maximum benefits that are associated with short and medium-term financing from alternate asset investors.
Signing Off:
Smart-contract-based solutions ensure that the transactions between the parties (lenders/borrowers) get autonomously executed. There are a set of rules specified within smart contracts. Well, the smart contracts in P2P lending will include the initial loan amount and the repayment terms.
The future beholds disruption in the way blockchain solutions empower the concept of decentralization.
Further Readings and Information:
