Lending Club recently announced the launch of a new type of credit: auto loans. This is great news,… except for the individual Peer Lending investor, who remains without access to this investment opportunity. Again.

Perhaps this change was inevitable, as technology originally designed to serve the individual investor has evolved to deal with its own success.

Peer-to-Peer as an impetus for change

Napster was the original Peer-to-Peer network, and the idea was revolutionary: let’s get rid of clumsy and overpriced stores, either physical or digital, and let’s have people share their music with each other directly. This spearheaded the digital music revolution, but seventeen years later, Napster has virtually disappeared and hardly anyone directly shares their own music with anyone else.   Instead people either buy music on iTunes or stream it through Spotify. The ‘Peer-to-Peer’ in music has died, and was replaced by commercial platforms that are more reliable, easier to use, and legal.

Peer Lending may soon follow the same trajectory. Lending Club started as a Facebook application, and facilitated lending between ‘friends’. It evolved to connect perfect strangers, which made sense, because by enabling other people actually fund the loans, a marketplace like Lending Club can grow without capital constraints. But ironically, the difficulties in maintaining this system can also hinder future growth.

Compounding difficulties are man-made

Unfortunately, letting Mr. Everybody invest small amounts in a stranger’s loan is awfully difficult. This isn’t true from a technology perspective; 150,000 registered investors and over half a million loans issued every month are big numbers, but they’re nothing compared to 1.71 billions users (Facebook) or 60 billions messages processed in a single day (WhatsApp).

The complexity is entirely regulatory. The SEC has put tons of rules in place to protect ‘normal people’ from being scammed. One may question the efficiency of those rules, but in any case, they make the life of a peer-lending marketplace like Lending Club quite complicated. Every single loan for Lending Club made available for investing by general public has tons of documentation. There’s the original prospectus, a 109-pages explanation of what’s a ‘Member Payment Dependent Notes’, and five supplemental documentations. Then there’s a specific filing. For each. Single. Loan. Take for instance this filing from Prosper, that operates on a similar regulations, for one \$18,000 loan. It’s almost as if those companies were doing IPOs, several hundred times a day…

In this regard, it’s no wonder than when Lending Club tries to originate new types of loans, they don’t make the effort of offering them to retail investors. For example, Lending Club expanded into medical loans and small business loans more than two years ago. Yet neither is accessible to individual investors. And recently Lending Club announced another new vertical: auto refinancing. While it starts as ‘balance sheet lending’, meaning that Lending Club will fund these loans with their own money, the company is proposing to make these loans accessible to institutional investors soon. As for retail…. there’s no plan to make auto loans available for the individual investor yet, if there ever will be.

The progression of the name of this nascent industry is telling. It went from ‘Peer-to-Peer Lending’ to ‘Peer Lending’, then ‘Marketplace Lending’. Today, ‘Alternative Lending’ (alternative meaning it’s made outside of banks or publicly traded bonds) seems the most accurate.

Offering a secondary market, which is a marketplace for investors to trade existing loans is also quite the endeavor. Stocks of companies like Amazon or Apple are traded at what’s called a ‘National Securities Exchange’, such as the NYSE or the NASDAQ. These exchanges won’t trade Peer loans. This requires the marketplace to work with a licensed Broker-Dealer, who himself registers an ‘Alternative Trading System’. The one operating for Lending Club, FolioFn, maintains a completely separate website and database that are hosted within Lending Club’s premises. And even then only the fractional loans are traded. The complexity is such that Lending Club’s main competitor, Prosper, announced recently the closure of their secondary market for loans. Without a secondary market, individual investors simply don’t have liquidity; after all, it requires only a few minutes for an investor to commit to the funding of a loan, but getting the money back may take up to 5 years. Hence the increased appeal of funds, that may offer some redemption before the loan matures.

Of all the marketplaces in the US, only two went through the hoops of an extensive registration with the SEC to become accessible to ‘everyday’ people: Lending Club and Prosper, who were the first marketplaces in the US. A handful of other platforms (Fundrise, Groundfloor and StreetShares) rely on something called ‘RegA+’ of the JOBS Act. While originally designed for startups to raise money, this mechanism allows these platforms to market investment opportunities in loan obligations. But theres a catch…. the maximum amount a platform can raise via this method is only \$50M per 12 months. That’s plenty for a startup who is raising money. Not so much for the main line of business of an origination platform. At 2% origination fees, the maximum revenue caps out at \$1M per year.

The future is trending towards aggregation

The truth is, small investors are no longer necessary. SoFi is another origination platform in the ‘peer lending’ space. Except that investing in SoFi loans directly is impossible, unless you’re an institutional investors with a few million dollars. This does not prevent SoFi from being remarkably successful, having originated over \$12B of loans thus far.

But even in UK, where regulation is significantly more flexible, giving retail investors direct access to loans may not the preferred solution. Zopa, the grandaddy of peer lending, doesn’t let individual investors pick loans; the investor puts their money in a Zopa-managed fund instead. After all, choosing which loans to invest in and which ones to avoid is quite complex, and few people are natural-born credit officers. It is also stressful to see a loan one has invested in being late in payments, then defaulting. Of course, when investing small amounts in hundreds or thousands of different loans, this happens quite often. Average returns may remain excellent, but some investors take it as a personal insult.

So maybe intermediation is more than a necessary evil, but a necessary good. Actual lending that is directly peer-to-peer may be ending, but let’s hope that by shaking things up, peer-to-peer in finance will continue to force intermediary firms to become more agile and cost-effective for their clients. Just as without Napster you would still be paying several dollars for each DRM-encrypted song, without peer-to-peer pioneers, we’d have to make to with 0.85% return on savings accounts.

Peer Lending is dead. Long live Alternative Lending.