Monday, August 6, 2007

How to use the 'wisdom of the crowds' on Prosper

In The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations, James Surowiecki argues that groups make decisions that are often better than could have been made by any single member of the group.

I've been wanting to write a post about this for awhile and an article in the Boston Globe yesterday further encouraged me. In Sharing the Wealth, the Boston Globe discusses how financial social networks may help people make better financial decisions. Here's an excerpt:

Social-investment sites take the sheen off "expert," allowing people to compare their investments or trade advice and opinions. Social-lending companies let people appeal to other people, rather than their banks, when they need a loan. And financial-advice sites that employ social-networking tools act like Weight Watchers for money: People choose goals, such as buying an iPhone or paying off a credit card, then move toward them while others with the same goals trade encouragement and strategies.

"I know a lot about the mistakes people make at a young age, and I think it's a great concept," said Cary Carbonaro, president of Family Financial, a traditional financial planning firm based in New York and Florida. "If I'm in debt, I can go talk to other people in debt or ask someone who is my peer and not embarrass myself."

But there are obvious questions, ranging from privacy and security risks to the dubious benefits of leveraging the financial "expertise" of the masses. The wisdom of the crowd may be a fine way to discover the most amusing YouTube video, but Wikipedia has been vilified for inaccuracies, and the online world hardly has a reputation as a trustworthy source. Start-ups need to gain the trust of users, assuring them that the software is hacker-proof and that their detailed financial information won't end up in the hands of marketers.

...Social finance should have 2 million users by the end of next year, and 16 million within 10 years, according to Online Banking Report, an industry newsletter.

In addition to Prosper, Zopa and Lending Club, some of the social finance sites that the Boston Glove features include:
  • Geezeo/Wesabe - similar to an online version of Quicken where expense information and advice is shared among users
  • Covestor - launched this summer, tracks its members' investment records, allowing people to judge their portfolio's performance against the crowd
  • Zecco - web brokerage with blog and social-sharing features that allow people to share tips and trades
  • Wikinvest - bills itself as a Wikipedia for investments, promising to be a constantly updated resource that reflects more than just a single expert's opinion of a certain company

Is the wisdom of the crowds really wise? Sometimes crowds can make very poor decisions because people tend to emulate others and conform. I've seen posts on the Prosper forums where people said they bid on loans simply because they were mostly funded using this reasoning, "how can 30-40 other investors be wrong?" Of course, maybe they just followed the same reasoning you did. Surowiecki argues the best groups have the following attributes:

  • Diversity of opinion - Each person should have private information even if it's just an eccentric interpretation of the known facts.
  • Independence - People's opinions aren't determined by the opinions of those around them.
  • Decentralization - People are able to specialize and draw on local knowledge.
  • Aggregation - Some mechanism exists for turning private judgments into a collective decision.

While group behavior may cause some poor decisions to be made on Prosper, I think there are plenty of examples in the forums where the collective intelligence of the group contributes to better decision making. What do you think? Would any changes in the website structure or technology help facilitate better decision making?

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