As part of our ongoing series of posts related to crowdfunding and microfinance, we are pleased to re-post the following article from out colleagues at AboutMicrofinance. For more about crowdsourcing and international development, see our paper "Crowdsourcing Applications for Agricultural Development in Africa." You can also access more of our work on this topic here.

AboutMicrofinance is an aggregator and disseminator of current and authoritative information and resources on all aspects of the microfinance industry.

One of the latest developments to affect the ever-changing world of capital allocation is the increasingly popular phenomenon known as peer-to-peer lending (P2P). In P2P lending debt financing is distributed via the internet either directly, or semi-directly, from a lender to a borrower. The specifics notwithstanding, the lender can be just about anybody from anywhere -the same of which can be said regarding the borrower. The entire transaction can be handled independent of the financial institutions, which traditionally would handle either the underwriting or be the ultimate providers of the debt capital. This method poses both benefits, as it reduces borrowing costs associated with bank lending, as well as risks, as it hinders unbanked populations from entering more formal financial markets.

The world of microfinance has not been immune to these trends and a number of interesting portals have emerged. One of the most well-known such organization is Kiva, which has been bringing together would-be individual lenders and borrowers since 2005. According to their original framework, borrowers are displayed on the website and lenders are given the opportunity to choose a recipient to receive their microloan from amongst those displayed.

Lenders can ‘invest' as little as US$ 25 and either receive payment back (without interest) or reinvest their funds in another borrower. After KIVA receives the capital it passes it off to a microfinance institution or non-profit which then transfers the funds to the client whose information they previously provided to Kiva. In this way Kiva serves as a fundraiser for a variety of institutions who in turn fundraise for specific clients and projects. To date, KIVA has distributed over US$475 million in loans to over 1.0 million micro-entrepreneurs in 70 countries.

Kiva recently also initiated a pilot program known as Kiva Zip, whereby lenders and borrowers are put into direct contact without the use of a formal microfinance intermediary. Lending, which is limited to borrowers in Kenya and the United States, has grown rapidly and as of the end of August 2013 roughly 1,400 lenders had lent to nearly 15,000 borrowers.

If Kiva was the trailblazer of bringing microfinancial institutions to the rank and file, Zidisha trail blazed the idea of putting non-institutional lenders and borrowers into direct contact. Founded in 2009, Zidisha has raised roughly $1.5 million using a direct P2P model that cuts out all financial intermediaries with the goal of minimizing operational costs.

Similar to Kiva and Zidisha are Mentors International which focuses on providing business assistance to its borrowers, World Vision Micro, which prefunds its loans and then recoups the money from the microlenders, Babyloan, which provides interest free loans, and Namaste Direct, which focuses on women.

While exciting, these platforms are not without risks. For one, lenders are often provided limited or nonexistent collateral, and to forestall the challenges of "the original sin" - the concept that dollarized loans have proven extremely destructive to emerging markets in the event of local currency devaluation - loans are often made in the local tender. (In other words, the lenders are assuming all of the foreign exchange rate risk.)

There are also issues of transparency to consider. While eliminating banks from the equation may have reduced operational costs, it also is likely to have decreased the level of diligence used to vet the borrowers, which may increase the probability of fraud and/or result in the inflation of borrower credit worthiness. (Although in the Kiva model the partner MFIs presumably provide vetting services.) Borrowers, on the other hand, may be vulnerable to fraudulent activity if too much of their personal information is posted online or provided to potential lenders.

Another issue is regarding regulations. The world of P2P lending is extremely nascent and it remains to be seen how the market will change if/when various regulatory authorities increase their footprint; not to mention how new regulations will interact as the capital flows across borders. (For more information please see Chapman and Cutler LLP's paper on the regulatory environment.)

These challenges notwithstanding, the world of P2P lending may be poised for continued growth. China, for example, with its large poor population and longstanding struggle to provide financing to small businesses, may prove fertile ground. The research firm Celent recently predicted that P2P lending in China will likely grow from roughly $1 billion per annum in 2012 to nearly $8 billion by 2015.

Similar to P2P lending is the idea of crowdfunding. Whereas in P2P funding individual lenders provide a small loan to their desired entrepreneur, in crowdfunding a large group of people pool money together for the sake of a given cause, which could be anything from helping an artist fund their latest project to supporting a provocative research project.

Catapult has decided to bring the idea of crowdfunding to the world of development and provides users the opportunity to help fund a variety of projects ranging from building new schools for girls in LDCs to providing new mothers with better medical care. A list of available projects is provided on the organization's website and users can donate money however they desire, with the donations being held until a given project is 100% funded. In the event that a project isn't fully funded within 150 days of being posted, donations are returned in the form of a credit which can be used elsewhere.

Both P2P lending and crowdfunding are noteworthy innovations which may fundamentally alter the way that microfinance institutions, entrepreneurs, and NGOs raise funds and have proven remarkably effective at facilitating interaction between socially conscious individuals and the developing world.