Crowdfunding and peer-to-peer (P2P) lending are two forms of alternative finance that have emerged in recent years to connect investors and borrowers directly without intermediaries such as banks or financial institutions. Both crowdfunding and P2P lending are based on online platforms that enable individuals or businesses to raise funds or borrow money from many people.
However, investors should be aware of some differences between the two models. In this blog post, we will explain what crowdfunding and P2P lending are, how they work, and their advantages and disadvantages in the investment process.
What Is Crowdfunding?
Crowdfunding is a method of raising funds for a project or a cause from many people who contribute small amounts of money, usually via the Internet. Crowdfunding can be used for various purposes, such as launching a new product, supporting a social or environmental cause, or financing a personal or business venture.
There are different types of crowdfunding, depending on the nature of the project and the reward or return offered to the backers. The main types are:
- Donation-based crowdfunding: Backers donate money to support a project or a cause without expecting anything in return except for recognition or gratitude. Examples of donation-based crowdfunding platforms are GoFundMe, Kickstarter, and Indiegogo.
- Reward-based crowdfunding: Backers receive a non-financial reward or incentive in exchange for their contribution, such as a product, a service, or an experience. Examples of reward-based crowdfunding platforms are Kickstarter, Indiegogo, and Patreon.
- Equity-based crowdfunding: This is where backers receive a share or a stake in the project or the business they fund, becoming shareholders or co-owners. Examples of equity-based crowdfunding platforms are Seedrs, Crowdcube, and Fundable.
- Debt-based crowdfunding: This is where backers lend money to the project or the business they fund, expecting to receive interest and principal repayment over time. This type of crowdfunding is also known as crowdlending or P2P lending.
What Is Peer-to-Peer Lending?
Peer-to-peer lending (P2P lending) is a form of debt-based crowdfunding that involves lending money to individuals or businesses through an online platform that matches lenders and borrowers. P2P lending can be used for various purposes, such as personal, business, student, or mortgage loans.
P2P lending platforms typically charge fees to both lenders and borrowers for their services, such as origination fees, servicing fees, or default fees. P2P lending platforms also perform credit checks and risk assessments on borrowers to determine their eligibility and interest rates.
Lenders can choose which loans to fund based on their risk appetite and expected returns.
Some examples of P2P lending platforms are Prosper, LendingClub, Upstart, Funding Circle, and Kiva.
What Are the Advantages and Disadvantages of Crowdfunding and P2P Lending?
Both crowdfunding and P2P lending offer some advantages and disadvantages for investors and borrowers compared to traditional sources of finance. Some of these are:
- Accessibility: Crowdfunding and P2P lending platforms are accessible online 24/7 from any device. They have lower barriers to entry and less stringent requirements than banks or financial institutions. They can provide funding or borrowing opportunities for individuals or businesses not qualifying for conventional loans or investments.
- Affordability: Crowdfunding and P2P lending platforms charge lower fees and interest rates than banks or financial institutions. They also offer more flexibility and transparency regarding repayment terms and conditions. They can reduce the cost of capital for borrowers and increase the returns for investors.
- Diversity: Crowdfunding and P2P lending platforms offer various projects and loans covering multiple sectors, regions, and purposes. They can provide more options and opportunities for investors and borrowers to diversify their portfolios and achieve their goals.
- Social impact: Crowdfunding and P2P lending platforms can have a positive social impact by supporting projects or businesses with a social or environmental mission or benefit. They can also create community and engagement among investors and borrowers who share common interests or values.
- Risk: Crowdfunding and P2P lending platforms involve higher risk than banks or financial institutions. There is no guarantee that the projects or loans will succeed or repay. There is also no protection or insurance for investors or borrowers in case of default or fraud. Investors and borrowers should do their due diligence and research before participating in any crowdfunding or P2P lending platform.
- Regulation: Crowdfunding and P2P lending platforms are subject to different rules depending on their country, state, or jurisdiction. Some regulations may be more strict or lenient than others, affecting the legality, compliance, and taxation of crowdfunding and P2P lending activities. Investors and borrowers should know the rules and regulations that apply to their crowdfunding or P2P lending platform of choice.
- Competition: Crowdfunding and P2P lending platforms face increasing competition from other platforms and banks or financial institutions that are adopting similar models or technologies. This may affect the availability, quality, and profitability of crowdfunding and P2P lending opportunities. Investors and borrowers should compare and evaluate different platforms and options before deciding.
Taking everything into account, crowdfunding and P2P lending are two forms of alternative finance that enable investors and borrowers to connect directly through online platforms without intermediaries such as banks or financial institutions.
Both crowdfunding and P2P lending have advantages and disadvantages for investors and borrowers, depending on their goals, preferences, and risk profiles. Investors and borrowers should understand the differences between the two models, as well as the benefits and drawbacks of each, before participating in any crowdfunding or P2P lending platform.