Lending Club Blog

Microfinance, Crowdfunding, and Peer-to-peer Lending Explained

Whenever I get the chance to speak at an event about peer-to-peer investing and personal loans, I consistently get the following questions: “isn’t the concept the same as Kiva?”, “are you not the same as Grameen Bank, but in the US?”,”it sounds like Kickstarter or Indiegogo, no?”.

The answer to all three questions is “No”.  Even though peer-to-peer lending, crowdfunding and microfinance share the same core concept, they are very different in their purposes and implementation.  Here is an attempt to untangle your brains:

CrowdsourcingCrowdsourcing refers to the idea that a group of people can accomplish something that would otherwise be impossible for an individual to do alone.  It involves turning to the general public or group of experts to address a need for ideas or work.  The concept is based on the philosophy that the “collective” is wiser than any one person.

Arguably, the most successful web-based example of crowdsourcing is Wikipedia, which has become a legend, taking on traditional encyclopedias (both physical books and e-versions) by enlisting collaborative content sourcing and reviewing.  Another pioneer in this space is 99Designs, which enables crowdsourcing of visual design work online.  Matt Mickiewicz, co-founder of 99Designs, explains that his company “is all about providing opportunities to designers to build their portfolios, find work, build client relationships, hone their skills, and have fun. On the other hand, we bring affordable, high-quality graphic design to start-ups and small businesses who in the past simply couldn’t afford it.”

Crowdsourcing is also to outsource work to the masses, independent of location.  Amazon’s Mechanical Turk is one of the better known brands in this area, but two more recent web-based crowdsourcing marketplaces are making the concept more popular nowadays: oDesk and CrowdFlower.

My favorite application of the crowdsourcing concept is the process of collecting ideas from users to improve a product or service.  Check out UserVoice and Get Satisfaction for ways to create more intimate and effective product feedback loops with your customers.

crowd fundingCrowdfunding describes how the collective pools together money to support an initiative or project. Crowdfunding has historically been used for political campaigns, disaster relief (charitable donations), government support (taxes anyone?), and public projects.  Anti Hannula, entrepreneur from Finland, argues that the pedestal where the Statue of the Liberty is placed today was crowfunded.

More recently, crowdfunding has seen a resurgence on the Internet on sites like Kickstarter or Indiegogo, where artists, entrepreneurs, and communities  seek support for their ideas and projects from the “4F Bank”: fans, friends, family and fools.  The individual seeking monetary support typically offers something in return for a donation, such as an autographed CD, discount on a art piece, or free access to a service.

MicrofinanceMicrofinance consists in providing of financial help to low-income families or individuals who traditionally lack access to banking and loans (a.k.a. the “unbanked”).  The concept was pioneered by Muhammad Yunus, economist and Nobel Peace Prize recipient from Bangladesh, who devised a model to extend loans to entrepreneurs who were too poor or lacked the sufficient credit history to qualify for traditional bank loans.  He put his model to work by creating Grameen Bank: banking for the poor.

Kiva is probably the most known of a myriad of web-based microfinance institutions and facilitators. Premal Shah, president of Kiva, describes microfinance as ” the way to empower others to lift themselves out of poverty.”

Peer-to-peer lendingPeer-to-peer Lending or Investing is defined by wikipedia as for-profit financial transactions occurring directly between individuals or “peers” without the intermediation of a traditional financial institution.  When you look at it carefully, you will realize that this is how lending was done centuries ago, before banks emerged and became the norm: communities borrowed and invested directly in its members.  The Internet has now made this concept available to virtually anyone, offering an opportunity for borrowers to get better rates, and investors to earn better returns.

Zopa was the first peer-to-peer lending network, opening its Internet doors 5 years ago in the UK, and growing very rapidly in the last couple of years.  Giles Andrews, General Manager of Zopa, describes his company as “a marketplace where people can lend and borrow money to and from each other, sidestepping banks”.

Lending Club is the US-based leader in the space, having issued more than $170M in personal loans since its inception in 2007, and growing at a record-breaking pace.   Last month, Lending Club announced that it had payed out more than $12M in interest to its investors.

So there you have it.  Peer-to-peer lending, crowdfunding and microfinance are like triplet sisters: even though they look alike from the distance, they are quite different in purpose and in how they work.

Would you define any of these in a different way?  Leave us a comment below.

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Images courtesy of James Cridland, configmanager, Lewis Scott/New York Times, and Daniel Marsula/Post-Gazette.

Friday, October 22nd, 2010 at 4:00 am

Comments (11)

  1. It’s a long discussion, that probably is still in the making. But
    I’ve often argued that to classify the different initiatives we
    should consider both: the methods and the goals. This is why I have
    been defending that p2pventure is concerned with the goals and that
    the method (p2plending and crowdfunding) can both be used to
    achieved the goal: help a project receive necessary financing and
    support. So I’m not really helping in the definitions here, just
    mentioning that all these categories are the expression of
    something that is probably much wider in term of changes for the
    financial system.

    October 22nd, 2010 at 7:00 am

  2. The understanding of Microfinance is also witnessing an evolution
    in itself. Several people are advocating for the use of the word of
    “financial inclusion” instead. I’m definitely in favor for one
    thing that understanding of Microfinance should evolve from the
    simple case of microlending to include microsaving and
    micro-insurance, because both can prove to be as beneficial to help
    people grow out of poverty.

    October 22nd, 2010 at 7:05 am

  3. Jenny M:

    Awesome article. Love how you break it down with sample companies
    we all know. So what’s next? P2P Insurance? P2P mortgages? The sky
    is the limit!

    October 22nd, 2010 at 12:52 pm

  4. Lara:

    The good news is that now, you can send your audience to this post
    before the ask you the same basic questions again ;-) good post.

    October 22nd, 2010 at 1:05 pm

  5. Great distinctions Rob. I really think the P2P space will continue
    to grow in the coming years, beyond even just P2P investing. There
    is just no need for a middle-man bank or insurance agency in many
    cases. Keep up the good work!

    October 22nd, 2010 at 2:45 pm

  6. Matt:

    Nice article Rob! Great job explaining the core ideas and roots of
    p2p lending. I like to think of it a “power 2 the people!”

    October 22nd, 2010 at 4:24 pm

  7. GREAT! It took me a minute to understand why you distinguish
    between microfinance and p2p-lending… but I got it now, you are
    absolutely right. All of these p2p initiatives are making a big
    impact, which is a good thing as we are seeing a true
    democratization of the financial world. It´s about the people again
    and not about big institutions. We are hoping to launch a platform
    in Germany that is going to offer crowd funding for start-ups. Well
    it is more like crowd investing. The crowd will act as a group of
    “mini”-business angels and provide seed capital to start-up
    projects they like. In doing so they become shareholders of the
    young companies (just like “real” business angels).

    October 26th, 2010 at 10:38 am

  8. [...] of Product Strategy at Lending Club. This post was originally
    written for Lending Club’s blog. Rob can also be found on [...]

    October 27th, 2010 at 12:55 am

  9. Yeah oDesk and Mechanical Turk ftw! Although MT is only for
    Americans I believe. Then there’s also elance.com, which is what I
    use for most of my outsourcing. And btw, the good thing about
    99designs is that you only have to pay to the winner (you get to
    choose the most appropriate design from a vast variety of bidders).

    October 27th, 2010 at 2:47 am

  10. Ari Lest:

    The idea of microfinancing is a way to get to real people, help
    them make easy on payments, or doing services, with small amount of
    money, providing rates at fair price less than banking system. In
    Africa I know someone who has done an amazing project with little
    amounts of money. Goes a long way.

    November 2nd, 2010 at 6:45 am

  11. [...] peer to peer lending, such as crowdfunding, crowdsourcing and
    microfinance, here is an excellent tutorial of the difference among
    these terms. Scan the QR code to the left with your smart phone to
    [...]

    June 7th, 2011 at 1:28 pm

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