Two of the most talked-about topics in the world of financial technology are marketplace lending and cryptographic currencies. As we have explored in depth on this blog, marketplace lending is growing rapidly and democratizing access to capital for consumers and businesses around the globe. Cryptographic currencies such as bitcoin offer the potential for a monetary system not controlled by central banks or governments, as well as the promise of decreased transaction costs and simplified cross-border commerce.
Recently, some companies have endeavored to combine these two powerful concepts, the largest of which is BTCjam, a bitcoin-based lending marketplace that has processed $4 million in loans since 2012. Using data available in the BTCjam API, we can explore the characteristics of loans offered for investment and also consider how bitcoin-based lending differs from more familiar approaches.
For this analysis, we used a dataset of available listings downloaded from the BTCjam API on July 27, 2014. At the time of retrieval, there were 201 listings, representing a total requested amount of $1,109 bitcoin.
As bitcoin is not dependent on any particular government, cross-border transactions are no more complex than those between 2 immediately adjacent neighbors. As such, the BTCjam marketplace has attracted borrowers and investors from all over the world. In the graph below, we see the distribution of active listings by borrower country. While 38% of listings come from within the United States, 40 distinct nations are represented in the current dataset.
The average requested amount for listings available on the platform today is 5.5 BTC, an amount roughly equivalent to $3,282 at current exchange rates. Below is a distribution of requested loan amounts in BTC, followed by the equivalent distribution expressed in dollars. As we can see, the majority of loans offered on the platform are for less than $2,500, suggesting perhaps that the borrower profile, loan structure, or loan purpose differs from what we’ve seen on the larger marketplace lending platforms or, perhaps, that more performance history needs to be established before investors are comfortable funding larger loans, particularly in a currency that is not as broadly understood.
Currency & Exchange-Rate Risk
While we are accustomed to evaluating marketplace lending investments on the basis of credit risk, changes in the value of a currency also have the potential to affect returns. When loans are denominated in a generally stable currency, such as the Dollar, Euro, or Pound, this risk may be considered relatively minor. However, given the significant fluctuation in the price of bitcoin, exchange-rate risk may in this case present an even greater potential to impact returns than the underlying credit risk of the borrower!
As we can see from the graph above, based on the Coinbase API, the price of bitcoin in dollars has shifted massively over the past year, from a low of $92.13 one year ago, to a high of $1,126.82, to $595.07 today. This volatility poses a major risk to borrowers on either side of the transaction and is one of the most common concerns in any discussion of bitcoin-denominated lending.
Fortunately, BTCjam offers 2 distinct types of loans, one of which is directly aimed at mitigating currency risk.
- “Bitcoin loans” are made in BTC and repaid in BTC. Both borrower and investor are exposed to changes in the value of bitcoin. Investors who predict that bitcoin will rise in value would expect to benefit from funding these loans. Borrowers who predict that bitcoin will decrease in value would theoretically benefit from borrowing under this structure, particularly if they receive their income in a fiat (i.e. government-issued) currency.
- “Linked loans”, also known as “Bitstamp USD”, are made and repaid in BTC but are indexed to the bitcoin-dollar exchange rate on the date of loan origination. For example, if a loan is made for a sum of bitcoin equal in value to $5,000, the payments on the loan will be based on the $5,000 initial value, regardless of any change in the value of bitcoin. In this way, bitcoin serves only as the medium of exchange, and both borrower and investor are insulated from the exchange-rate risk.
In the graph below, we see the breakdown between the 2 types of loans, further segmented by the geographic location of the borrower. As one might expect, BTCjam customers tend to opt for the dollar-linked loans, particularly those from the United States.
A quick look at the data reveals a massive proportion of BTCjam loans to be for the stated purpose of “business”, with a relatively low number for debt consolidation.
As business and other are both very broad categories, they merit some more detailed examination. In reading through the borrower-provided loan titles and descriptions, a large number of loans appear to be for the purpose of either bitcoin mining or trading/arbitrage. While these are not broken out as distinct categories, we can perform some text analysis of the loan information to draw our own inference. As we can see from the graph below, a significant number of borrowers are obtaining loans in order to engage in mining – that is, to invest in the computational hardware needed to run the complex algorithms needed to “discover” new bitcoin.
In addition, many borrowers appear to be obtaining funding for the purpose of trading in the bitcoin exchange markets.
While we have become accustomed to 3 or 5 year term loans on the mainstream consumer lending marketplaces, BTCjam loans tend to be of shorter and more varied duration, with terms ranging from 7 days to 1 year. In addition, payment frequency is not necessarily monthly, with available payment cycle intervals of 1, 3, 7 or 30 days.
Risk and Interest Rates
As with other marketplace lending originators, BTCjam assigns borrowers an alphabetic score ranging from A+ to E. This score is based on a variety of factors, including traditional credit data as well as identity verification and social graph information. For this analysis, we don’t have access to performance data, so we will simply show the credit grade distribution, along with associated interest rates.
Alternative Data and Verification
One unique aspect of BTCjam is its use of alternative data for identity verification and risk-assessment purposes. The site encourages its members to link their Facebook, LinkedIn, ebay, and PayPal accounts and then makes aspects of this data available to prospective investors. While its hard to know exactly how these attributes affect credit ratings or interest rates, the information itself is somewhat interesting.
Traditional economic theory teaches that money has 3 main functions: a medium of exchange, a unit of account, and a store of value. Cryptographic currencies such as bitcoin challenge some of these notions. For instance, earlier this year, the IRS ruled that bitcoin would be taxed like property, rather than like currency. Fiat-linked loan options like BTCjam’s BitstampUSD also challenge traditional thinking, utilizing bitcoin as a medium of exchange and unit of account, but preserving the U.S. dollar as a stable store of value. Clearly, cryptographic currencies still represent a bleeding-edge technology and remain the province of early adopters. It is not yet clear if, or how, they will influence the evolution of our banking system. Regardless of one’s feelings surrounding bitcoin as a currency, the promise of a more flexible transaction protocol that lowers costs and facilitates cross-border transactions is extremely compelling, and we are excited to see its impact on the world of marketplace lending.