by Daniel Grossman | June 5, 2021
What is microlending?
Microlending is a charitable system for loaning money to smaller-scale businesses, particularly to provide financially disadvantaged individuals with the necessary funds to run a successful business venture. Rather than using banks or credit unions, microlending typically operates on peer-to-peer technology where loans are issued by benevolent individuals willing to take on additional risk.
Although microlending’s individual approach can be more efficient in providing money where its needed, there tends to be a trade-off of less informational transparency, security vulnerabilities, and high interest rates. These weaknesses ultimately provide fertile ground for exploitative lending practices. There thus exists a need for a secure microlending platform able to manage individual user roles while maintaining data privacy & transparency. This paper proposes a permissioned, blockchain-based system as a solution.
Applications & value proposition
This system offers greater transparency and security than existing peer-to-peer microlending platforms like Kiva. In particular, blockchain’s decentralized nature eliminates the security risk of hosting financial data on a vulnerable, centralized database. Since a microloan’s conditions are embedded directly within the code of a smart contract and then submitted to a blockchain (thus preventing any alterations without the consent of all transacting parties), a donor does not need to “trust” a borrower to fulfill their part of the bargain—a smart contract on the blockchain guarantees it if both parties agree to its conditions.
This keeps borrowers’s funds very safe and accessible. If their project is approved, the money is securely transferred and immediately can be put to use. Borrowers also don’t have to worry about paying interest. Because donors can directly monitor how borrowers use funds via the continually updating project asset, they are incentivized to provide loans without interest since they can be certain the money will eventually be repaid or charitably spent.
This system also enables a charitable organization to manage user roles and interactions using a structure of checks and balances. Only approved participants can join the network, preventing unwanted parties from attacking the system while ensuring the legitimacy of individuals already admitted to the network. This organization can assign roles to users (ie. “borrowers” and “donors”), who are then restricted to specific “channels” so that their project and funding information remains private to just the transacting users and their verifying peers within the channel. This segregation improves network performance, privacy, and scalability.
The system’s pool fund provides additional flexibility, enabling donors to pool their money and provide additional capital to projects that fail to meet their funding needs. Together, these features form a benevolent microlending system that can securely fund the businesses of financially disadvantaged borrowers while not exploiting their needs.
- Increase the efficiency of the funding process by reducing the time taken for borrowers to receive funds.
- Enhance the transparency of fund distribution, fund use, and project progress.
- Ensure the privacy of information shared by users.
- Identify and address security threats.
- The microlending platform is operated by a charity organization.
- The charity should “actively search and verify the identities” of users.
- Individual donors should be motivated to help the borrowers without expecting any monetary returns.
- Loans should be provided at no interest unless donor contributions are insufficient for funding a project.
- If there is insufficient funding, the charity can enroll banks to provide loans at low interest rates.
What is Hyperledger Fabric? Why does this project use it?
Hyperledger Fabric is an open-source framework established by the Linux Foundation for developing blockchain-based applications. It has a modular “plug and play” architecture allowing one to customize their own blockchain system based on the needs of their business or organization. Hyperledger is a useful framework for a peer-to-peer microlending platform because it enables the separation of transaction processing into three distinct phases and the use of “channels” to restrict transaction visibility to different user subsets. This compartmentalization of data ultimately improves network performance, scalability, and privacy—all necessary components for a successful distributed charitable funding platform.
- Borrower = a user that proposes a business project and receives funding from donors; the beneficiary of microlending
- Charity = the microlending platform’s central administrative authority; adds all other actor types to platform; provides infrastructure for/governs transactions
- The charity also manages the pool fund = a collective fund providing additional capital to underfunded projects
- Donor = a user that evaluates borrowers’ project proposals and donates funds to borrowers;
- Premium donor = a donor with good donation history who can vote on project funding
- Bank = a third party that provides funds with interest if prior donations fail to meet the required funding for a project
How it works
- A borrower proposes a business project and its necessary loan amount, kickstarting the donation period.
- Donors contribute funds to fulfill the project’s loan requirements.
- Scenario 1: If donors contribute enough funds to match the proposed loan, the tokens are transferred to the borrower and the repayment cycle begins.
- Scenario 2: If the donated funds fail to match the proposed loan amount, the premium donors vote on whether to use the pool fund to fulfill the rest of the loan.
- If three-fourths or more of the premium donors agree to use the pool fund, the proposal is accepted by the pool fund.
- The remaining necessary funds are transferred from the pool fund to the borrower, beginning the repayment cycle.
- Scenario 3: If the donated funds fail to match the proposed loan amount AND the premium donors reject the use of pool funds, the loan request is forwarded to a bank.
- If one-fourths or more of the premium members disagree with using the pool funds, the proposal is rejected by the pool fund.
- A bank approves the proposed loan and transfers the corresponding tokens to the borrower.
- Scenario 4: If the donated funds fail to match the proposed loan amount, the premium donors reject the use of pool funds, AND the bank rejects the loan proposal, the project is dropped and any donations are reverted.