P2P Financial Systems Conference London

This was a conference very much focused on content quality and, perhaps, less on self-marketing: A relatively tight group of academic researchers, regulators, lawyers, technologists, government officials and entrepreneurs came together for a couple of days to discuss various aspects of P2P financials and of blockchain.

Frankly, from the learning perspective and the depth of the topics, this was the most insightful event of this year. Thank you so much, Kevin, for inviting me!!!

Some of my personal call-outs:

On the evolution of different forms of money:

– Better (more convenient) money prevails;

– Stable currency would always prevail over an unstable one;

– Governments have a tendency to take over successful money instruments.

What does it mean for crypto-currencies? Money have historically evolved  into more abstract forms that are easy to store, send, recognize, use for denomination and pricing, and exchange with minimal costs. At the same time, money must remain rare and scarce and somewhat restricted, otherwise everyone will print their own money. Cryptocurrencies solve these problems quite well or at least are getting there, but what they have not solved yet – money has to be stable to preserve wealth.

Frankly speaking, fiat money on its own isn’t much better – just think about inflations, privatizations, demonetizations and other governmental reforms that have repeatedly eliminated monetary wealth in USSR, India, Latin America and practically everywhere else on the planet at one point or another. Several governments are currently thinking about issuing governmentally sponsored digital currencies, but they have not found practical use cases yet.  If we remember that “governments have a tendency to take over successful monetary instruments”, it could be interpreted that cryptocurrencies are here to stay.

Many participants agreed that a tighter, more focused governmental oversight over crypto-space is long overdue.

P2P lending

I have always heard and adopted a firm conviction that P2P lending is a great instrument and a great invention, because it is cheaper and more accessible than credit card financing, which is why it allows un-banked individuals to get access to credit and it allows people to consolidate and reduce their net debt, pay off expensive credit cards debt and improve their credit ratings.

Listening carefully to Yiuliya Demyanyk from the Federal Reserve Bank of Cleveland, I learned that my aforementioned conviction was a total illusion, completely unsupported by numerical data they gathered. It turns out that in vast majority of cases, borrowers at P2P platform have had access to financial systems, were over-leveraged at the time of borrowing, had excessive credit card and mortgage debt and simply kept borrowing. Their debt did not decrease, their credit rating deteriorated an the number of delinquencies they experienced, were substantially higher than among people who never borrowed via P2P platforms and lived in the same ZIP-codes.

A different, related research by Paolo Guidici, suggested that P2P lending platforms may have an inherent bias to over-estimate the creditworthiness score of their applicants: these platforms do not bear the credit risks themselves, but their remuneration is commissions-based, directly linked to the number and volumes of transactions they generate.

Wisdom of the crowd

One of the most interesting and quite non-intuitive hypotheses was presented by Jiasun Li from George Mason University. He created a model, suggesting that equal profit sharing arrangements without regard to the original proportion of contributions might be the best model to harness the wisdom of the crowd. His idea is based on the following assumptions:

• Alice and Ben know something about the project, its risks and surrounding circumstances. They don’t share this knowledge between themselves.
• Alice and Ben will make their investment decisions based on various factors (risk tolerance, availability of the funds, liquidity constrains, personal preferences), but most likely one of the key factors for them would be – how much they know about the project and how risky they consider this project to be.
• Traditional models (shareholder structure) suggest that if Alice invests 30% into the project and Ben contributes the remaining 70%, this is how they should divide the profits:  30% to Alice and 70% to Ben.

However, the model of Jiasun Li suggests that if the profit split between them will be 50%:50%, irrespective of the initial contribution, this would incentive both of them to invest more and therefore the total pie (to be divided) will become bigger and each of the will earn more of it.  Apparently, the incentive to equally participate in the economic profit of the entity is somehow mathematically triggering to contribute your best, financially and otherwise. This creates the effect of the wisdom of the crowd, when asymmetrical information is shared via the size of optimized contributions.

I personally found this conclusion fascinating. Everyone in the startup environment these days is trying to design the best possible incentive models with vesting periods and cliffs and proportionate stock vesting. Definitely, something to think about.

A big-big thank you to Paolo Taska for organising such a wonderful event!