Digital Finances Unit 3

Alternative online financing: P2P lending, crowdfunding and ICO's

Fintech

new technology (like the internet and large-scale data) applied to financial services such as online payment systems, online banking, digital wallets

Online alternative finance

technology that leverages online channels or platforms acting as intermediaries between the demand and supply of financing for individuals and businesses outside the traditional financial system

What are the two online systems in online alternative finance

Balance sheet non-bank online lending and marketplace/P2P/Crowdfunding

BS Non-bank online lending

an online entity (platform) directly grants a loan to a consumer or business

Marketplace/P2P/Crowdfunding

the collective pooling of individual investors (the crowd or peers) who provide funds, with the platform serving solely as an intermediary

Online alternative finance is distinct from alternative finance, how?

alternative finance: finance provided by financial institutions other than banks such as private debt placements funded by institutional investors, venture capital, investment funds, shadow banking activities, or microcredit

How big is alternative financing and how does it compare to bank-financing?

Banks provide half of funding, alternative provides a very large portion of the financing that doesn’t go through banks and it’s growing

How is the financial landscape changing away from the banks? What is alternative financing growth due to?

1. banks are having big problems with increased regulation - especially after 2008 crisis

2. technology allows a wider spread reach

3. number of small and medium sized companies has increased a lot in the economy relative to the number of very large companies

   1. large companies need to go to the banks and capital markets

   2. smaller and medium sized funds are more attractive to smaller investors

Debt based models of alt finance

P2P/Marketplace lending, Balance sheet lending, invoice trading, debt-based securities, mini-bonds, consumer financeE

Equity based models

real estate crowdfunding, revenue/profit sharing

non-investment models (no financial return)

Reward-based crowdfunding, donation-based crowdfunding, crowd-led microfinance

What regulation did the JOBS Act to allow firms to remain private while having greater access to funding?

1. increased number of shareholders a company can have before being required to comply with SEC regulations and become a publicly traded firm—up to 500 non accredited shareholders or 2,000 shareholders in total

2. exemption from the requirement to register public offerings with the SEC, imposing an aggregate annual cap on the amount each individual can invest in such offerings of $2,000 for non-accredited investors

What requirements does the SEC impose for accredited investors in P2P lending and crowdfunding

1. a minimum annual gross income of $70,000 and a minimum net worth of $70,000

2. net worth exemption: if an individual’s net worth is at least $250,000, no mimum annual income needed

What has regulation in the US led to?

highly institutionalized market with few individual investors

What is the correlation between social trust and volume of online alternative financing per capita?

positive! people with more trust will engage in alternative online lending more

What is a debt contract?

an agreement where a borrower receives funds and promises to repay a fixed amount (principal + interest) regardless of project performance

why use a debt contract?

it provides predictable payments to investors, reduces the need to monitor firm performance, protects lenders with fixed claims

What is special about a debt contract?

it is optimal when it is costly for investors to verify cash flows

Why is debt optimal when verification is costly?

investors only check performance in default, avoid constant monitoring costs, minimized info/verification costs

If external funding is needed, why is debt preferred over equity?

debt requires less info disclosure, fixed payments are easier to enforce, investors only intervene if default occurs

Bonds (debt contract)

tradeable fixed-income securities purchased by financial investors

• only large, publicly traded firms issue bonds

• they are rated by credit rating agencies

  • they can be purchased by retail investors

Loans (debt contract)

fixed-income instruments (typically non-tradeable) held by banks and/or other financial intermediaries

financial intermediary

an entity that provides services to help individuals or firms invest or obtain funding (commercial bank, investment bank, investment fund)

commercial bank

a financial intermediary that accepts deposits and grants loans using its own funds

P2P lending

borrowers obtain loans through platforms that match them with individual investors willing to lend their own money

What is the business model of P2P lending

capturing a portion of the traditional banking system’s profits by exploiting the spread between “deposit” rates (typically 1-2%) and the rates at which banks lend those same funds (8-20%)

• by bypassing banks and directly connecting investors with borrowers, the goal is to offer attractive rates to both parties

  • the P2P model represents between 1% and 2% of consumer loans

Platforms generate revenue from fees charged to both borrowers and lenders, how?

1. Borrowers submit loan requests for specific amounts, typically for:

• debt consolidation, credit card debt consolidation, home renovations

2. Platforms sets the interest rate and provides credit ratings

3. lenders express interest in financing the loan

4. funds are only disbursed to the borrower if the loan is fully funded (“filled”) - most applicants never receive the loans