Peer-to-Peer Finance
Whilst decentralised finance (DeFi) is the new kid on the block in Web3, a type of decentralised finance was alive and well back in the 2000s. Except back then, it wasn't called decentralised finance, it was peer to peer (P2P) finance.
Peer to peer networks exploded at the turn of the millennium with the launch of the Napster music file-sharing network. We all saw how Napster and other file-sharing networks wreaked havoc on the music industry with musicians and artists ultimately taking the hit.
These peer to peer networks were decentralised networks made up of thousands of nodes running around the world, that couldn't be shut down. However, unlike the blockchain networks of Web3, there was no distributed ledger component, these nodes were used for sharing files between users of the network.
We saw a new type of financial platform emerge during this time, one that incorporated the phrase peer to peer into its namesake. However, these platforms were not in any way decentralised like today's Web3 protocols, they were really marketplaces for financial products where the peer to peer was in reference to the fact that these platforms matched lenders with borrowers. Hence they were described as peer to peer lending platforms. They could just have easily been called decentralised back then, but thankfully they weren't as DeFi sounds a lot cooler than P2P lending!
The P2P lending platforms started emerging in the mid-2000s with Zopa and then Funding Circle in the UK, and Prosper and LendingClub in the US. When these platforms first emerged they were considered revolutionary with the potential to open up entire new segments of the lending industries to serve less creditworthy individuals and small businesses that often failed to secure loans from more established banks and other lending institutions.
Much like DeFi and crypto now, investors flocked to them due to the yields that they could generate. Yields of over 10% were not uncommon. This was significant considering at the time most conventional asset yields such as bonds had suffered significantly following the global financial crisis.
Naturally, such yields caught the attention of the regulators, such as the SEC and FCA who in time created legislation that any lenders had to adhere to. This was exacerbated by the fact that some P2P lenders' risk models were inadequate, which resulted in far higher default rates for their borrowers than expected. This resulted in investors losing money, and in some instances the platforms going out of business.
In its heyday, it certainly was a wild west but over time, with increased competition and regulation, the P2P lending space grew less attractive as the return provided to investors reduced to a more mundane figure.
P2P lending also marked the birth of what we now call fintech — the financial technology created to improve and automate our existing financial services. Whist blockchain and DeFi are bundled under the broader banner of fintech now, back in the 2010s, off the back of P2P lending and fresh from the global financial crisis, whole new businesses such as neobanks emerged intending to disrupt the financial status quo.
If we want to look to the future to think about how Web3 and DeFi can impact finance, I believe it's important to take heed of what's happened in the last 15 plus years of fintech innovation. As mentioned above, P2P lending was focused on opening up new parts of the financial markets, empowering retail investors to become lenders to borrowers who couldn't previously obtain credit. There are certainly parallels with parts of the DeFi market insomuch as it now offers a wide range of attractive yield opportunities via lending and staking of crypto-assets and stablecoins, with varying degrees of platform risk and asset risk associated with them.
The DeFi markets have yet to be regulated but when they are, we'll likely see DeFi split between regulated protocols that enforce KYC, sanctions and anti-money laundering requirements, versus unregulated DeFi which has no restrictions on who can use it.
It’s also helpful to consider the emergence of neobanks during the past decade. These 100% digital, online-only banks, were viewed as a significant threat to the incumbents of the retail banking industry. The demise of the high-street banks was touted as near, with ambitious, well-funded start-ups building banks from scratch, unencumbered by the legacy technology stacks of the incumbents. This has parallels with the current narrative of DeFi rebuilding our financial ecosystems.
Unfortunately for many of the neobanks, the solution wasn't simply technology alone, the complexity of regulation and existing banking networks couldn't be ignored, which while resulting in leaps forward in mobile-first user experiences, wasn't enough to make a successful land grab of the retail market.
Meanwhile, the incumbents, with their healthy profits and customer bases were able to start investing heavily in new digital platform initiatives, in many instances, reinvigorating their offers to their customers.
This isn't the case with all banks, some have remained dinosaurs, but many have seized the opportunity and continued to thrive against the backdrop of adversarial competition. Many of the neobanks have had to resort to the financial staples of subscription accounts and lending products to generate revenue. It's not just the neobanks we've seen this happen to, other parts of retail finance such as share dealing and home loans have continued to evolve.
When we recast our gaze to Web3, it's not hard to see how things could play out. While cryptocurrency and DeFi do provide entirely new financial plumbing that could replace many aspects of what we have in place now, the regulatory frameworks would need to be broadly supportive of such an approach.
In many parts of the world, regulators are unlikely to be so idealistic, which is why there's a likely need to be some middle ground which connects what we have now with the future. This doesn't mean that the amazing work of the DeFi ecosystem is all in vain, it's that we need to ensure the rails are built to bridge our existing TradeFi (traditional finance) infrastructure with the new.
This is where some of the leading centralised cryptocurrency exchanges such as FTX are making great headway in finding new solutions to existing problems. What's interesting is that the uptake of such initiatives by incumbents right now is slow. If it remains slow, then the opportunity for Web3 companies and platforms to step into the mix to service the burgeoning demand, and do so in a manner that regulators can get on board with is significant - As it becomes increasingly more expensive to play catchup as the DeFi landscape matures.
We're still relatively early in the evolution of Web3 and DeFi. However, much like the P2P lending products all those years ago, DeFi yields are going to get less attractive over time. Hence the real opportunity is finding ways to onboard TradFi to Web3 as seamlessly as possible, and that is what will facilitate the widespread adoption of decentralised finance over the coming years.
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