This is an essay I wrote to conclude my Google Associate Product Manager internship. Enjoy.
Imagine a world where banks are no longer needed and the stock market is no longer the primary vessel for investment returns. Prosper.com has transformed this unlikely vision into a foreseeable future by providing America’s first people-to-people lending system. Prosper offers an online auction website that matches borrowers with lenders (it’s essentially an eBay for loans).
Prosper’s value proposition is to provide borrowers with loans at lower rates than the bank can offer and to provide lenders with higher returns for their money than the bank can offer. In the process, they charge a small fee to both the borrower and lender. Borrowers simply create loan listings by specifying the desired loan amount and the maximum rate they are willing to pay a lender. Lenders can bid in increments of $50 and up to the full size of the loan on many different loan listings, thereby diversifying their risk. Furthermore, once lenders have completed bidding on the full amount of the loan, more lenders can come in and bid the rate down.
Prosper’s value proposition sounds excellent, but it requires high volume and liquidity in order for its marketplace to function successfully. One of the most difficult challenges for Prosper has been in establishing a large and active user base. The company launched in February 2006 and, according to its website, now has over 330,000 registered members. While that may sound like a lot of users, according to quantcast.com, only half of those users are actively using Prosper. If you consider the tremendous volume and liquidity of the stock market, a stock with only roughly 160,000 traders is typically considered illiquid. There tends to be higher volatility associated with these illiquid stocks and they are often considered to be priced away from fair value due to this fact. In Prosper, you might expect only a few hundred lenders to bid on a particular borrower’s listing, so borrowers are not getting rates that are as low as they could be getting in a liquid and fairly priced market. On the other hand, lenders are probably obtaining higher rates of return than they would in a liquid and fairly priced market. In order for Prosper to provide the best user value and experience possible, it needs to find ways to increase its user base.
Prosper can improve both its user experience and thereby increase its user base by partnering with eBay in order to leverage their established user credibility system. Currently on Prosper, borrowers establish credibility through two means: their credit rating and groups. The credit rating is obtained from the borrower’s credit report and the groups system helps borrowers within a credible group lower each group member’s rates. Prosper can partner with eBay by linking Prosper accounts with eBay accounts so that borrowers can utilize their eBay feedback score as another basis of credibility. This will reduce the switching cost for borrowers who wish to establish strong credibility in order to decrease their loan rates. In return, Prosper can offer eBay some form of advertisements or create a special partnership program for loans that result in eBay purchases.
If Prosper grows rapidly and establishes a solid brand image, it could very well change the entire landscape of the financial industry. Currently, most of the loan listings on Prosper are for borrowers to pay off or consolidate their debt. Given the current credit crisis, Prosper has gained many borrowers who are looking for the cheapest way to fix their credit situation. In addition, many investors have decided to move portions of their investments from the stock market to Prosper in order to diversify their portfolio as well as to seek higher returns. One of the appealing aspects to borrowers about Prosper is that even a borrower with a low credit rating is given the opportunity to obtain a loan, given that lenders are willing to take the risk. Borrowers who have defaulted on a loan, however, will never be allowed to borrow again on Prosper. Therefore, many desperate borrowers have the motivation to use Prosper as a stepping stone to reestablish their credit and to change their ways for the better. This single-shot system serves as a filter to ensure the quality of the borrower base, thereby increasing the trust of lenders in the Prosper marketplace. If enough borrowers come to Prosper and establish good credibility, Prosper can expand into and replace the credit card business with person-to-person lending.
Over time, more and more entrepreneurs have flocked to Prosper to obtain loans to launch their businesses. These entrepreneurial borrowers typically have very good credit ratings and have lenders complete the bidding on their loans fairly quickly. Prosper can increase its potential customer base by targeting these entrepreneurs looking for funding by increasing the borrowing limit from $25,000 to a much higher level. An automated system can be devised that raises the limit based on credit rating and Prosper can hire a team to manually examine abnormal cases. While funding entrepreneurs can be risky, these investments can also be very rewarding to lenders. Prosper can stand to gain a lot by branching off to make a separate entrepreneurial loan division that has special rules. For example, one such special rule might be to eliminate the single-shot default loan system, and to provide a different safeguard to account for the risky nature of entrepreneurship. Furthermore, Prosper can add a feature where entrepreneurs can post their business plan for lenders to examine. If Prosper can enter this space with a well-planned system, it can essentially become a marketplace that replaces angel funding and venture capital funding.
With so many directions Prosper can head in to revolutionize the financial industry, it remains to be seen whether their success thus far will be replicated in the future. There are many battles still to be fought, including lawsuits, competitors entering the same space, and potential changes in the law surrounding people-to-people lending. It is exciting, however, to envision a financial world no longer driven by the institutions but by the people.
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