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Can crypto spring reshape social lending?

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The rising cryptocurrency market influences peer-to-peer lending with higher loan requests and amounts, benefiting tech-savvy investors but raising concerns about inequality, a new study finds

By Putro Harnowo, Senior Content Manager, China Business Knowledge @ CUHK

Amid the predominantly controversial news surrounding cryptocurrency and peer-to-peer (P2P) lending in the past few years, many still believe that technology will redefine the financial landscape. As concerns regarding volatility, security, and illicit activities have dominated the headlines, regulators are actively considering new laws to safeguard the public interest.

Financial technology, or fintech in general, is expected to experience significant growth in the coming years, with cryptocurrency and P2P platforms potentially gaining more reach among unbanked or underbanked populations. Therefore, gaining insight into the dynamic relationship between the two is crucial for uncovering opportunities for businesses and individuals.

To investigate these effects in-depth, a new study examined how the rise of cryptocurrency markets has influenced the makeup and behaviour of borrowers and investors in P2P lending. The results suggest that active cryptocurrency markets bring economic gains to the P2P lending market. The transfer of funds from P2P lending to cryptocurrency markets, particularly by highly creditworthy and tech-savvy investors, also provokes increased inequality in access to P2P lending markets.

cryptocurrency
Active cryptocurrency markets benefit the P2P lending market economically but also contribute to increased inequality in access to funding.

“Contrary to their original intent and purpose, technology-enabled fintech markets may penalise, rather than benefit, many people and firms who are at a disadvantage in accessing financial resources,” says Kim Keongtae, Associate Professor in the Department of Decisions, Operations and Technology at The Chinese University of Hong Kong (CUHK) Business School.

“Understanding the interdependence of fintech platforms is important to assess the implications of their expansion and sustainability.”

Crypto and P2P lending interactions

In the research paper, Interdependence between online peer-to-peer lending and cryptocurrency markets and its effects on financial inclusion, Professor Kim along with Professor Chung Sunghun of George Washington University and in collaboration with Professor Oh Wonseok and Professor Lee Chul Ho of the Korea Advanced Institute of Science and Technology, shows that growth in cryptocurrency markets is associated with increased loan requests and larger loan amounts in P2P markets.

The researchers matched data from California-based peer-to-peer lending platform, Prosper, with aggregate data from a price-tracking website for crypto assets, CoinMarketCap, from January 2017 to February 2019. They also investigated positive and negative market shocks in cryptocurrency markets that affect borrowers’ incentives for using P2P lending markets.

The positive shocks were Goldman Sachs’ announcement on 2 May 2018 to open a Bitcoin trading operation and the International Monetary Fund’s statement on 2 October 2017 that cryptocurrency could be the future, which led to sudden and huge increases in Bitcoin prices. Two negative shocks occurred on 13 September 2017, when JPMorgan’s CEO warned that Bitcoin is a fraud, and on 15 January 2018, when China escalated cracking down on cryptocurrency.

During the sample period, the researchers found that high-creditworthy borrowers increased their demands in bullish markets, while low-creditworthy borrowers changed insignificantly. This influx came mostly from borrowers with good credit ratings and high-skilled occupations seeking loans related to cryptocurrency.

“High-creditworthy and tech-savvy borrowers increased their demands in P2P lending when the cryptocurrency market was in a good situation.”

Professor Kim Keongtae

The researchers then examined whether credit rating and occupation affected borrower responses to positive shocks and found that high-creditworthy borrowers largely drove increases in loan amounts. High-creditworthy borrowers increased the requested amount of loans by about US$930 after the positive shock from Goldman Sachs, which corresponds to 7.01 per cent of the average loan amount during the 10-day window.

In contrast, low-creditworthy borrowers generally responded negatively to positive shocks. This implies that growth in the cryptocurrency market induced high-creditworthy borrowers to use P2P borrowing more aggressively. The increase was more positive for borrowers in occupations like investors, computer programmers, executives, professionals, and analysts, who are likely to have more familiarity with and have better access to the cryptocurrency market.

“High-creditworthy and tech-savvy borrowers increased their demands for P2P lending when the cryptocurrency market was in a good situation,” says Professor Kim. “In contrast, low-creditworthy and low-skilled borrowers showed the opposite behaviours, although statistically weaker.”

Identifying the main opportunistic actors

Additional analyses showed that in the following week after the positive shocks, the borrowing and the daily unique number on the P2P lending platform increased, implying that hot cryptocurrency markets attract new borrowers. Economically, for a per cent increase in the market capitalisation of the cryptocurrency market, a daily listing amount on the P2P lending market increases on average by 0.12 per cent.

cryptocurrency
Hot cryptocurrency markets motivate creditworthy and tech-savvy borrowers to borrow more actively and in large amounts.

After breaking down the type of borrowers, the analyses showed that hot cryptocurrency markets are more positively associated with high-credit and tech-savvy borrowers, but had no significant association with low-credit borrowers. “High-credit and tech-savvy borrowers were more responsive to hot cryptocurrency markets,” says Professor Kim.

Given their advantageous condition traditionally in terms of access to credit, high-credit and tech-savvy borrowers are more likely to apply for loans through P2P lending to seize new investment opportunities.

In terms of risk, the study found that better cryptocurrency market conditions are associated with lower default rates and lower interest rates in the P2P lending market. On average, a per cent increase in capitalisation of the cryptocurrency market is associated with a 0.003 per cent decrease in borrower interest rates and a 3.03 per cent decrease in default rates, indicating that as the cryptocurrency market became hot, this led to lower default rates and borrower interest rates at the market level. “This result should not be surprising because hot cryptocurrency markets attracted proportionally more high-credit borrowers,” says Professor Kim.

Consideration for fintech platforms

Overall, the research findings suggest that hot cryptocurrency markets motivate creditworthy and tech-savvy borrowers to borrow more actively and in large amounts. This further implies that financially disadvantaged borrowers have difficulty accessing fintech markets, thereby diminishing financial inclusion, at least in the short run.

“Despite the possible short-term gains derived from the influx of additional loan requests from high-quality borrowers, the increased inequality in access to fintech platforms originating from service to certain groups may hurt the long-term sustainability of P2P lending,” says Professor Kim.

As creditworthy and tech-savvy investors are more inclined to use P2P lending to invest in cryptocurrency, the study suggests that fintech strategies should focus on protecting the investors while ensuring financial inclusion. On the other hand, policymakers should consider the potential impact of cryptocurrency markets on P2P lending and financial inclusion when developing regulations related to fintech.

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Fintech: Friend or foe to financial stability?

This double-edged sword of fintech platforms should be approached with caution, especially for individuals with limited credit scores and technological proficiency, to maintain sustainable practices. For instance, policymakers can offer relevant technological training to individuals and businesses with poor credit ratings and limited technological understanding to bolster financial inclusion.

From an individual standpoint, people need to embrace rapidly evolving financial technologies and actively seek potential opportunities within fintech platforms while possessing a comprehensive understanding of these modern technologies.