Crowdfunding and peer-to-peer lending are often confused with one another and the newer, broader term marketplace lending creating more confusion. Here we’ve put together a brief definition of each term and how they’re different to add clarification and highlight the potential for each space.
Definition of Crowdfunding
Crowdfunding is the process of raising small amounts of money for a project or venture by a large number of people typically through an online platform. Popular platforms include Kickstarter, Indiegogo and Crowdrise. Projects range widely from product creation such as developing a new product, arts such as movies, books or music, to non-profit endeavors. There are three core types of crowdfunding: reward crowdfunding, equity crowd funding, and debt crowdfunding.
Rewards based platforms typically provide something in return for the money provided such as the first versions or exclusive limited editions of the product or service being funded. Equity based platforms provide backers with shares of a company in exchange for the money pledged. The 2012 JOBS Act in the United States allowed firms to raise more funds from small investors with fewer restrictions, creating more interest in crowdfunding.
Debt crowdfunding, the funding of debt from individuals and other organizations, has grown rapidly and has moved into its own category more commonly known as peer-to-peer lending (P2P lending).
Definition of Peer-to-Peer Lending
Peer-to-peer lending is the practice of matching borrowers and lenders through online platforms. Borrowers are often able to gain access to funds quickly and typically at lower interest rates than banks, making it an attractive loan alternative to banks. The loans issued are often comprised of many different investors ranging from individuals to institutional investors.
Individual and professional investors benefit by being able to lend money at a range of interest rates based on proprietary credit scores assigned by each platform. Since investors typically fund only a portion of a loan and spread the amount they loan across many buyers, investors can potentially receive steady, attractive returns while spreading risk across multiple borrowers.
P2P lending has experienced rapid growth as borrowers look for alternatives to banks. As a result, the largest P2P lending platform in the US, Lending Club went public in December 2014 with a successful IPO. The number two US platform, Prosper may also file an initial public offering in 2015.
Definition of Marketplace Lending
Marketplace Lending is a term that has recently come into play. The term is synonymous with P2P Lending and encompasses all of the forms of p2p lending on various platforms. Suggested by Renaud Lalplanche, CEO of Lending Club at the Lendit conference last year, he felt that the term “marketplace lending” could be less confusing to some that don’t understand the definition of p2p lending.
“Peer-to-peer lending and marketplace lending are essentially synonymous. Many mistakenly believe that “peer” means small retail investor, and they cried foul when large institutions entered the space. In IT networking lingo, a “Peer” is simply an end user, regardless of size, that has equal access to a distributed application architecture network”, says Don Davis of Prime Meridian Capital Management.
Foundation Capital, a venture capital firm specializing in financial technology and marketplace lending opportunities, believes that “Marketplace Lending…is fundamentally about creating platforms to connect borrowers with lenders” with technology making it possible for “…third part(ies) to match idle supply and demand.”1
The marketplace lending space
It is important to keep in mind that these new entities are generally not government regulated in the way banks are. While it creates potentially more risk, it also makes them potentially more nimble, enables them to operate at lower costs by not having to follow all of the same compliance and regulatory requirements, and to innovate with technology at its core.
Prime Meridian Capital Management manages a p2p consumer lending fund, Prime Meridian Income Fund, and a p2p small business lending fund, Prime Meridian Small Business Fund, which purchases large volumes of loans on marketplace lending platforms.
1 Foundation Capital, Whitepaper: “A Trillion Dollar Market By the People, For the People: How Marketplace Lending Will Remake Banking As We Know It”;