I think there have been three general difficulties with P2P lending that haven't fully been solved:
1. Ordinary investors tend to underestimate the risks involved. That means that if investors are allowed to set the rates freely through an auction, naive investors will be willing to bid the rates below what more risk-aware investors would be willing to accept. They will win the auctions and shut the sophisticated investors out of the market, but they will then get burned when there are more defaults than they expected and they lose money. The Prosper experience has been that when investors lose money this way, most won't attribute their losses to their own deficiencies. They won't come back again to try a more sophisticated approach. Instead, they will attribute their losses to the platform. They'll walk away and they'll never come back. Some of them may sue.
2. A P2P outfit has to provide a lot more services to help prevent and alleviate the risks than was anticipated. These services include giving investors much more guidance about what rates are reasonable given the risks, and performing much more aggressive collections to try to prevent lates from becoming charge-offs. These services cost money, requiring the P2P outfit to charge a larger spread than previously anticipated to support them. This makes the P2P outfit more like a bank, with a hand in the transaction and a relationship with the parties at all times, than like an eBay which simply momentarily connects a buyer and a seller.
3. The spread between what fully-informed investors should rationally accept to make money (as distinct from what naive investors will initially accept) and what borrowers find competitive given their alternatives is narrower than first appeared, and may be negative for some credit groups. Because P2P debt is both unsecured and risky, and perhaps because of current economic conditions, investors' proper comparator given the risks involved is not bank deposits as previously believed by many, or even high-grade corporate debt, but lower-grade or junk debt. And given the current ultra-low underlying interest rate climate this recession has engendered, excellent-credit borrowers have opportunities to get lower rates through credit unions and similar competitors who pay interest at ultra-low federally guaranteed deposit rates. This reduces the competitive viability of the P2P lending niche.
