When thinking about the P2P I always draw parallels to the financial crisis 2008.

In 2000 David X Li came up with a mathematical formula, most famous as “the formula that caused the financial crisis 2008”. Prior David X Li´s formula the trade with CDOs was very limited due to the complexity to calculate value & risk. CDO stands for Collateral Debt Obligations and is a structured financial product which is a mix of loans, bonds and mortgages. When Li published the formula, it was received with open arms by investors, it was an elegant and perfect mathematical formula to get a measurement of value & risk of CDOs. The trade with CDOs exploded and 5 years after the formulas was released, the trade with CDOs was worth billions of dollars.

Unfortunately, as it showed later, the formula was incomplete. The formula didn´t take into account the fact that defaults in the real world happens due to changes in the market which affect many at the same time. When house pricing declined in 2007 it did so for a lot of people at the same time resulting in CDO market crashing. One of the banks that had extremely overvalued the CDOs was Lehman brothers which later went bankrupt.

In P2P lending the interest is what you get in return, but foremost a measurement of risk. Just like with Lis formula and CDOs, diversifying across multiple lenders does not take into account risks of market changes which affects multiple borrowers. This risk is real and need to be priced as well as a part if the interest rate. There is no perfect formula for how much but it´s definitely not 0%.

Doing this is especially important now since we have an extremely low interest market which may at some point change to increased interest rates leading to higher cost of debt leading to more defaults and so on.

In Oct 2015 Swedens biggest P2P lender Trustbuddy went bankrupt, this risk will of course never be priced in by the P2P lending company, but it´s also there and it´s real.