Following on from the two posts that explain equity and reward based crowdfunding, we move on to debt-based crowdlending, also known as Peer to Peer (P2P) lending, sometimes Market Place lending and in FCA speak as debt based investing. For brevity I’ll use P2P, although this is somewhat confusing as some of the borrowers are businesses, or P2B. A newcomer to alternative finance, whether it be through conversation or news, is more likely to have heard of crowdfunding, largely due to press interest in that specific area of FinTech and in particular the innovative crowd raises that businesses and individuals have employed. Yet in the UK, the P2P lending industry is worth just under £4.5 billion, compared to £132.5 million cumulative total raised through crowdfunding. Borrowers are attracted by a less clunky process that is competitively priced and easy to use. The vast range of alternative finance solutions available means that both businesses and consumers can find a loan tailored to their needs. Lenders, meanwhile, are drawn to the sweet spot of statistically lower risk investment at interest rates that go beyond the bounds of anything offered by a bank.
The P2P lending sphere can be broadly broken down into three categories: P2P consumer loans, P2P business loans and invoice financing. The biggest player in the consumer loans market is Zopa, who are the oldest and arguably the biggest alternative finance company in the world. They have lent over £1 billion to consumers at an average loan size of £7,500, offering investors a return of 5%. Every consumer loans company is only as good as their borrowers; Zopa have reported 0.04% actual defaults so far this year, a figure which is made even lower by the Zopa Safeguard Trust which helps pay-out in case of bad debts. The fund is taken from the fee that each borrower pays when their loan is approved. Another of the major P2P consumer lenders, RateSetter, have their own provision fund to help bail out lenders to borrowers who have defaulted. RateSetter operate a platform that allows lenders and borrowers to pair up through a process of bidding, over four set term lengths. The model has proved very popular with both individuals who appreciate the transparency of the loan structure and lenders enjoy decent interest rates. RateSetter also offer business loans in the region of £25k to £1 million.
The business lending market is diverse for both investors and borrowers; loan size, terms, length, funding and structure vary from platform to platform. Just dipping a toe into the water in terms of range and variety, you can facilitate finance for property loans through Assetz Capital, Wellesley have their own listed bond that offer lenders 4.75% per annum over three years or 5.5% per annum over five, Folk to Folk specialise in regional lending in the South-West, Landbay secure lenders’ money against residential mortgages, MarketInvoice and Platform Black allow investors to access funds in outstanding invoices and factoring. The list goes one: the Best place to explore the full array of P2P operators and the services they provide is on the AltFi news website. The banks do not appear to have the will or resources to compete, despite their own admission that most of the platforms are supplying an updated version of services that they have provided for years.
Mitigate the risks and P2P Lending is a fantastic way to save wisely whilst helping SMEs and consumers drive UK economic growth. The incoming Alternative Finance ISA will bring in a whole host of new lenders; it is crucial that the industry is properly regulated and that platforms adapt sufficiently to ensure that the optimism continues.
I am aware that there are other cryptocurrencies available on the web, but for the purpose of keeping this article short I have decided to focus on P2P platforms that use Bitcoins. The leading cryptocurrency in terms of worldwide market value, it has been a rocky ride to say the least in its short life to date.
What is Bitcoin? Bitcoin defines itself on its website as “the first decentralized digital currency, directly transferred from person to person without going through a bank.” Advantages include very low processing fees, no frozen bank accounts and worldwide payments. The currency is secured by a group of individuals called miners, who verify transactions in return for newly generated bitcoins. Traditionally, currency valuation is based upon confidence; the assurance that the central bank is good for the money and promises to pay the bearer on demand. The miner system has been exploited in the past; cybercriminals have a very well-established, tested, and long-operating mechanism to perform marginal-cost distributed computing in the form of botnets, which are undermining the currency’s value by enabling them to produce illegal bitcoins.
This week, Bitcoin broke through the 215 support level – declining almost 9% in a day.
Another major downside to date has been the currency’s volatility. In its initial stages, bitcoin was still classed as an asset that received bad press due to its link with illegal websites such as The Silk Road. As its reputation and distribution has grown, it has been affected by factors similar to all fiat currencies, as fluctuating perceptions of how to correctly value the currency continue. In the near term, much of the volatility will be driven by investor perception of the ability of gateways to provide a reliable store to secure individual holdings.This week, Bitcoin broke through the 215 support level – declining almost 9% in a day.
Are the risks greater for a potential investor using P2P bitcoin lending platforms?
Bitcoin P2P platforms themselves do not pose more risk than a traditional P2P platform. However, the USP for the P2P lenders to use bitcoin is the ease (both in terms of time and cost) at which money can be transferred overseas. It is here that the risks inevitably begin to stack up. Lending money to borrowers in other countries makes AML and KYC checks nay on impossible. If time is indeed money, then the value saved by cutting out expensive bank fees needs to balance out the time-consuming and ultimately expensive process of vetting potential borrowers. Beware of interest rates that seem too good to be true… they usually are.
A lack of awareness to the risks involved for a potential investor is as dangerous a territory for all unregulated platforms as it is for the investor. P2P lending websites will always be judged by the worst platforms as much as they will the best. The clean, modern P2P cryptocurrency websites do not guarantee clean, modern loans. The regulatory-enforced investment warning signs that adorn the websites of British P2P and B2B lenders are notable in their absence on Bitcoin P2P lending websites. The risks of lending money abroad to markets with conventionally weak currencies should not be understated. If you are borrowing in a highly unstable currency and do not generate revenues in that currency then you create another risk: the exchange rate risk that the cost of the loan, which is unknown to the lender, cannot be met. So what’s the attraction for lenders? Unless they are Bitcoin based, then they are lending to receive an unknown return, which is likely to be less than they expect. To me this is unattractive.
Which platforms should investors be wary of?
Bitbond, based in Germany with offices in the UK and across Europe, specialise in facilitating bitcoin loans to small online business owners to secure funding to increase their inventories and/or revenue. Bitbond launched in July 2013. In its first year of trading it funded more than 180 loans worth over €36,000 ($48,000) to date, and has a user base of approximately 4,100 people from over 100 countries. The website claims that lenders receive an average interest rate of 13%. The loans available on their platform range from a 36 month, bitcoin equivalent to 156 USD loan at 21.3% to a Venezuelan borrower aiming to buy mining equipment, to Bitcoin-equivalent USD10000 loan to a German Borrower purchasing stock for his shop. Bitbond relies on debt collectors and prioritizes the creditworthiness of the applicant and the purpose of the loan, yet there are numerous questionable borrowers that still escape the net and make it to the platform.
BitLendingClub offer a similar service. The majority of their borrowers come from countries with a severely damaged economy, such as Venezuela or Argentina. The service is an alternative source of funding for individuals who don’t have bank accounts but have mobile telephones and are used to making mobile payments. Investors offer competing interests rates from which the borrower can choose to fund the project. A potential lender is left with the complex task of assessing loans where the risks are not homogenised. There doesn’t seem to be any regulation of what is posted on the platform, and the rudimentary risk calculations are very much a guideline rather than a science.
It would take a huge amount of luck to invest frequently and completely avoid a dud borrower. Interestingly, their statistics are given as raw data from which an investor must carry out an independent analysis. In short, these platforms are for experienced, tech-savvy investors, or somebody with few pennies going spare willing to help out an individual in another country, with the hope of seeing some sort of return.
The Bitbond model has been heralded by Cryptocoins News as the most secure way yet of avoiding some of the horror stories that have plagued sights such as BTCjam. The San Francisco-based company specialise in offering personal loans starting from 6.7% percent APR, yet in the same digital “breath” suspiciously offer lenders up to 19.3% APR on their loan. Once again, be wary of offers that seem too good to be true. Their mission statement to “make credit affordable and accessible” is based upon the “accepted wisdom” that interest rates for personal loans in developing countries can exceed 200% per year, choosing Brazil as an example. Brazil, along with India, has certainly been the poster boy for extortionate interest rates in the past, although the issue is certainly being addressed. BankFacil are at the forefront of a new generation of Brazilian financiers that offer secure finance to Brazilians, but still at rates of between 20-30%.
There are horror stories aplenty on internet forums that slate BTCJam: those alone should deter all but the most reckless investor. In an age where borrowing money through unconventional online platforms is more and more common, BTCjam certainly can command even more of a share of the market than they already have. By the end of 2014, BTCjam had facilitated bitcoin loans in excess of $10 million with 100,000 users in over 200 countries… a bold claim considering there are only 196 recognised countries in the world. Such minor discrepancies are important: transparency should be guaranteed, but in the convoluted world of cryptocurrency market places, a fine tooth comb and plenty of due diligence is necessary to enjoy any success as an investor. I for one would avoid them like the plague, impressive as the technology is. One of the good things about loans is that you know what you need to repay. Uncertainty is always unattractive to investors (equity and/or debt). The old maxim that as long as markets are moving somebody is making a profit is true, but only if you can go long and short and do so quickly. A true and perfect market simply doesn’t exist for bitcoin-based crowd loans… so invest at your peril.
Equity crowdfunding is the provision of finance to up-and-coming businesses from a crowd of investors who in return are rewarded with company equity. UK equity-based platforms include CrowdCube, Seedrs and SydicateRoom. Equity crowdfunding presents the next step up the investment ladder from reward-based crowdfunding for pledgers, as they are able to fully buy into the lifespan of a project rather than solely receive a limited reward.
The two highest profile UK equity raises are arguably two alcoholic beverage company: Chapel Down Group (through Seedrs) and BrewDog (through CrowdCube). The former is a UK listed company that turned to equity crowdfunding in order to raise at least £1 million to grow the English wine-making business. It became the largest equity crowdfunding campaign in history when it finished with just under £4 million, unsurprising given the pedigree of the company and the attractively transparent terms and conditions. Following an initial £670k raise from several institutional and High Net Worth Individual investors, the crowd was offered the same terms for the subsequent raise and were able to invest in a high-growth business that stands out from any other equity raise prior or since. Moreover, Chapel Down is listed on the ICAP Securities & Derivatives Exchange, allowing contributors to trade their shares on the ICAP Exchange. This gives investors a freedom not normally possible in an equity raise; no wonder it has been heralded by AltFi as an “unprecedented success”.
So far, so good… invest in the nascent stages of a fireproof company alongside other savvy individuals, sit back and watch as the company receives more and more finance and gives out more and more equity, allowing it to develop and grow into an international behemoth. However, equity-crowdfunding can be high-risk, unknown reward. The stark reality is that the majority of the start-ups are destined to fail (see the warning signs on the equity crowdfunding websites themselves, such as CrowdCube). Yet according to Nesta, an innovation charity, about £84m was raised on equity crowdfunding platforms in 2014, triple the previous year’s amount. Seven months ago, the Financial Conduct Agency, the UK’s financial regulator, gave the following warning to anyone considering investing in equity crowdfunding: “It is very likely that you will lose all your money.” And it is not always just as simple as a company going into liquidation.
Equity crowdfunding is something that takes time and effort in order to see success. It takes sound research and reading of the small print to reveal the princesses from the frogs. Take the example of how the equity crowdfunding industry’s latest phenomenon, BrewDog, has been able to raise a huge amount of money in exchange for very little equity. For a blow by blow breakdown of the story, this comprehensive article written by the industry’s own news service, AltFi, is a must read. http://www.altfi.com/article/1077_death_to_the_fat_cats_if_brew_dog_represents_the_future_then_lets_hope_not
Here equity- and reward-based crowd funding have been merged to form a writhing, dissident beast of £25 million pounds. The small brewery from Aberdeenshire have used an impressive array of marketing techniques to build themselves up as ground-breaking and anti-establishment, offering investors an alternative to over commercialised breweries that will not connect with their drinkers. Their rewards scheme is legitimate; invest a certain amount, receive a certain amount of beer for free. Yet the equity raised is in the form of B-Shares, which account to only 8% of the overall equity of the company. Moreover, investors receive no voting rights and so are unable to prevent the dilution of the shares when the company grows and receives a higher valuation. BrewDog may not represent the “death to Fat Cats”, rather a predatory business that takes advantage of investors drunk on inventive marketing tools. BrewDog’s hawkish equity raise could end up biting them on the behind the future as the Crowd realise that the story wasn’t quite as revolutionary as portrayed.
However, that isn’t to say that there are no diamonds in the rough, or indeed that one shouldn’t invest in companies through crowd funding. A mixture of reward and equity based crowdfunding appeals to an investor with a vested interest in a start-up; supporting growth in small businesses will help the economy to grow and inspire regular people to invest their hard-earned cash in more innovative ways. My next post on demystifying crowdlending to small businesses will highlight the benefits of debt-based peer to peer lending and shed some light on why works for so many businesses and lenders.
Crowdfunding: a form of alternative finance where a project or venture is funded by raising monetary contributions from a crowd of people or institutions.
Peer to Peer Lending (P2P Lending): also known as crowdlending, is the practice of lending money to individuals through a crowd, cutting out traditional financial intermediaries such as banks. Business to Business Lending (B2B Lending) is the practice of a crowd of businesses (and High Net Worth Individuals) lending money to businesses.
In the first of three blogs intended to define and distinguish the various subdivisions of Peer to Peer (P2P) lending and crowdfunding, reward- and donation-based crowdfunding seems the most logical place to start. Platforms that facilitate such services include Crowdfunder, Kickstarter, Indiegogo, Crowdrise, Quirky and Tilt. The industry continues to swell, especially in America; 2014 alone saw donation- and reward-based crowdfunding grow by 45% and 94% respectively, according to Market Wired.
Whilst the nomenclature bears the hallmarks of 21st Century dotcom business jargon, the concept of crowdfunding is by no means new- the Statue of Liberty was itself crowdfunded by 160,000 people raising $100,000. The “reward” in that case was a sense of national identity fuelled by patriotism- and the promise of publisher Joseph Pulitzer to publish the name of every donor in a national newspaper. Today’s rewards are a mixture of the material and the moral: crowds have funded anything and everything from innovative gadgets on Kickstarter to treatment for cancer patients on Standbuy. In the former, the crowd was rewarded with the promise a cooler of their own, although the overwhelming popularity of the “Coolest Cooler” (https://www.kickstarter.com/projects/ryangrepper/coolest-cooler-21st-century-cooler-thats-actually) has meant the company owner has had to restructure his business and outsource his manufacturer to China in order to meet the burgeoning demand.
A means of differentiating the two would be to state that donation-based crowdfunding is philanthropy, whilst reward-based crowdfunding ostensibly offers a tangible reward for the crowd. Yet often projects that offer incentives to pledgers fall into a grey area between the two concepts, as in some cases enthusiasts are willing to back an idea without the guarantee of tangible result. Subsequently, “All or Nothing” campaigns statistically tend to perform better than “Flexible Funding” campaigns that will take on whatever money they receive, regardless of whether it is sufficient to successfully complete the project.
Reward-based crowdfunding, in particular, has opened up huge investment potential for budding entrepreneurs and small businesses that previously was at best sluggish and restrictive and at worst entirely unavailable. Having “investors” that are closer to “supporters” has seen some staggering success stories; the video game Star Citizen, for instance, aimed to raise $500k but through almost a million backers finished up with $87,363,775. In the next instalment, I will demystify equity crowdfunding, exploring its differences (and indeed similarities…) with reward-based crowdfunding, and reveal some of the industry’s more uncomfortable truths.
Star Citizen’s logo for their game: the project attracted over a million gaming enthusiasts as backers.
