Cryptocurrencies entered the mainstream in 2017. The million dollar fortunes made and 1,000% returns hogged the headlines. But behind all the hoopla is blockchain, the technology behind cryptocurrencies, quietly and steadily changing the business universe. The technology has myriad applications. Also called distributed ledger technology (DLT), it can reimagine entire industries in hitherto unknown ways. From issues of security to scalability and cost effectiveness, entrepreneurs are incorporating DLT to bring the benefits to the masses.
Similarly, alternative lending has changed how Americans borrow. Small business and consumer lending was hard hit when banks decamped en masse after the 2008-09 crisis. Online lending came to the fore with players like Lending Club, SoFi, OnDeck building multi-billion dollar lending platforms.
Almost 10 years since, alternative lending is growing but not at the speed which experts had imagined. Morgan Stanley had predicted trillion dollar funding via such platforms in the coming future. The sector is nowhere close to these figures. Aside from corporate governance issues, fraud and high default rates have been the true bane of the industry. IdentityMind, a RegTech company, reports that fraud caused 12% of losses in P2P online lending. That translates to almost 1.2% of total funding, which is also 2-3 times as compared to banks or retail cards.
Blockchain and Alternative Lending
Putting digital assets (contracts, documents, financial data, etc.) on blockchain technology helps build a wall against unauthorized access and prevents fraud. Blockchain helps maintains transparency between entities; it could be between buyer and seller, business and employee, or customers and investor.
A World Economic Forum report predicts that, by 2025, 10% of GDP will be stored on blockchains. Amalgamating blockchain and alternative lending has not only a technical appeal but is business common sense. Online finance decentralized lending allows savers to directly fund borrowers; they took away the middlemen, traditional banks, who otherwise used to take the major benefit away from the transaction. Now, it is the alternative lending sectors’ turn to leverage the power of decentralization via blockchain.
The Benefits of a Decentralized Distributed Ledger
Currently, alternative lenders hold their complete data centrally, in either their own servers or on Amazon Web Services-type cloud structures. This is a honey pot for hackers. In 2017, an Equifax data breach collected 145.5 million users’ data. The breach was caused by a software flaw that allowed the hackers to take over the company’s website.
Lenders have access to extremely sensitive data such as bank account numbers, social security numbers, and other personal identification information. Losing control of that data can compromise the entire financial history of an individual or a business. Blockchain eliminates the risk by storing information on a decentralized ledger. So a massive data hack would never be possible because it will be practically impossible for the hackers to have access to each and every part of the distributed record.
A distributed ledger also provides transparency and allows that all transactions are recorded are on the blockchain in an immutable manner. Thus, backdating of contracts is not possible under any circumstance (Re: Lending Club backdating loans scandal). Corporate governance improves across the board, and investors and regulators can breathe easy knowing that the data they are seeing is the absolute truth.
Digital loans can be tokenized via blockchain and be constructed as a tradeable security. This, in effect, allows securitization for loans; so lenders don’t need to wait until they are unicorns. Othera, a blockchain lending platform, is doing just that. It has created an online marketplace where lenders can tokenize their cashflow by putting the loan on the blockchain and selling it to investors.
Apart from this, blockchain technology is more user-friendly as it is open to the public with no authentication or permission issues. It is scalable and cost efficient for businesses to incorporate into their existing systems and allows for all stakeholders to easily extract relevant information about their transactions without risking the entire system’s database.
Digital identity verification
Identity theft is one of the biggest reasons for online lending fraud. That is exacerbated by the fact that the lender and the borrower usually never meet in real life. The old traditional way was to go through the lengthy and costly process of physical verification. But in the age of blockchain, by merging identity verification with decentralized blockchain principles, a tamper proof digital-id can be used as the digital signature for recording and validating all transactions.
How Blockchains Are Revolutionizing Lending
Alternate lending has seen many iterations and pivots since inception. From being a pure peer-to-peer platform, the sector has metamorphosed into one dominated by balance sheet lenders and institutional investors. Now, the era of Alt Lending 2.0 is emerging, which is going to be dominated by players who have co-opted blockchain as an integral part of their business processes.
Here is a brief description of some companies that are doing innovative work in the field.
The ERP giant is experimenting with blockchain on an enterprise level. One of its applications is focused on KYC. The distributed ledger solution is to store a customer’s ID and link it to their personal documents, which are not stored on the blockchain. Once the transaction is cleared, the link is established and the documents are accessed to prove identity and the onboarding process continues. In this, SAP provides a solution to KYC issues, with running proof of identity. Thus, there is a single source of truth for all parties.
WishFinance is a Singapore- and Honk Kong-focused lender to merchants and small businesses. It is keeping its entire loan portfolio on a public blockchain to push transparency for investors. The investors can evaluate the performance of a loan at anytime (the data is anonymized so no identifiable borrower information is shared).
SALT is reversing the model by allowing crytpocurrency holders to cash out without actually selling their crypto assets. It allows loans for Bitcoin. The borrower can redeem his crypto assets once the loan is paid.
These are by no means the only use cases. Almost daily, at least weekly, a new P2P or marketplace lending model is announced usig blockchain or DLT as the backbone or underlying technology. It is probable that more blockchain-based alternative lending companies will raise their heads at various places around the globe.
Blockchain has the power to allow alternative lending companies to scale effortlessly and solve fraud and KYC issues haunting the industry. Lenders who are able to get their blockchain game right should see renewed investor interest and benefit from higher unit economics.
Written by Heena Dhir.