Is blockchain a cure for peer-to-peer lending?

The blockchain, a decentralized ledger system, has been considered a revolutionary technology to transform businesses, including the financial markets. As peer-to-peer (P2P) lending is also known for decentralization in the sense that individuals borrow from and lend to each other directly, bypassing traditional banks, we explore the possibility and benefits of blockchains in P2P lending. We first provide an economic analysis of existing P2P lending problems, including herding and platform-borrower collusion, with and without the blockchain mechanism. We note that, compared with the existing markets, blockchain-backed P2P lending is highly effective in privacy preservation and borrower quality distinction. Since the role of intermediaries is eliminated in the blockchain world, the chance of platform-borrower collusion is also minimized. Moreover, we show that borrowers and lenders can expect additional surplus when the origination fee in traditional P2P lending is replaced with a smaller tokenization cost and when borrowers present a more accurate financial incentive in a smart contract. With the smart contract, borrowers are allowed to propose optimal interest rates based on their creditworthiness and capacity of repayment while detailed personal information is not required. Additionally, we demonstrate that small investors’ surplus can be further enhanced due to the elimination of herding.