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LendingClub is setting out to transform the banking world. To get there, it's following a playbook popularized by some of the world's biggest tech companies.
Like Apple, Google and Facebook as well as Microsoft and Salesforce.com, LendingClub's mission is to not only be the biggest player in a massive market—in this case, online lending—but to create something with so much potential value that outside developers race to build services on top. It's the holy grail of technology: becoming a platform.
"This is the most efficient way to spur more innovation that will eventually benefit our customers," LendingClub founder and Chief Executive Officer Renaud Laplanche said in an email. The company's IPO prospectus uses the word platform 93 times.
Any true comparison between LendingClub and the world's most valuable tech companies is premature, of course.
The company, which over seven years ago started developing software to algorithmically underwrite consumer loans and match individual borrowers with lenders, is set to sell shares to the public Wednesday night. At the top end of its pricing range, $14 a share, LendingClub would be valued at close to $6.5 billion on a fully diluted basis, less than one-thirtieth the size of Apple, Google or Facebook.
Fostering a true platform takes a lot work, and requires serious investment, with no guarantee that it will succeed. Apple, for example, did it by coming up with a model for taking 30 percent of the revenue generated by developers, a concept emulated by Google and Facebook. Each company had to build a payment system to make it work.
Still, LendingClub provides obvious allure for outside developers. In the first three quarters of this year, LendingClub issued $3 billion in loans, more than double the amount from a year earlier. That's a big number, except when you consider the $3.3 trillion in U.S. consumer debt outstanding and that a bank like Wells Fargo had more than $825 billion of loans on the books at the end of 2013. In other words, there's plenty of potential upside for technology to displace brick-and-mortar banking.
It's not just LendingClub. Other Web-based lenders like Prosper, education loan provider SoFi and small-business lender Funding Circle are luring borrowers seeking lower rates than they can get from credit cards and banks. The capital is coming from individuals and institutions that are lending money on these sites because of the lofty returns, which on a percentage basis can reach into the high single and even low double digits annually.
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"One of the big reasons we exist is because we were able to build on top of the LendingClub stack," said Matt Burton, CEO of Orchard, which provides investors on LendingClub and other sites with strategy, trade execution, back-office reporting and analytics tools to track their portfolio. The ecosystem "allows people to start businesses and specialize in something in their part of the value chain and not necessarily have to do everything soup to nuts."
Start-ups like New York-based Orchard are betting that additional services will be needed by borrowers looking to find the most attractive loans and for investors buying the debt. Portfolio management, credit modeling, investing advice and trading tools are areas where entrepreneurs are building software and, in some cases, raising good chunks of venture capital.
It's the same reason developers create games, photo-sharing apps and meal delivery services for Apple- and Google-powered devices, and why emerging enterprise software businesses build on top of Salesforce.
Not all platforms end up spawning big companies. Twitter curtailed the development of third-party apps on its network by limiting their ability to make money. LendingClub got its start as one of the first apps on Facebook in 2007, but didn't turn into a big business until much later, when it was no longer counting on the social network for users.
Here's what former Google CEO Eric Schmidt wrote in the book he co-authored "How Google Works," published in September: "The most successful leaders in the Internet century will be the ones who understand how to create and quickly grow platforms."
(Coincidentally, or not, Google is an investor in LendingClub. And Burton was an early employee at AdMeld, which was acquired by Google.)
In October, New York-based Orchard raised $12 million in venture funding. Canaan Partners, an early LendingClub backer helped lead the round, and was joined by former Morgan Stanley CEO John Mack, a LendingClub board member.
Fundera, also located in New York, raised $3.4 million in February to help businesses like restaurants and dry cleaners find the right loans from Web-based services including Funding Circle and LendingClub. First Round Capital and Khosla Ventures are among Fundera's investors.
Even with the influx of capital, there's no guarantee that a Google-like ecosystem can be created on top of LendingClub. The biggest issue is that the lenders have to prove they can weather economic swings and rising interest rates, as they've all grown up during an economic upswing with record low rates.
Beyond that, there's the regulatory hassle of operating in financial services, where the lines between providing technology services and offering financial guidance can get blurry. At what point does a software developer need to become a registered investment advisor?
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Nickel Steamroller is working through those issues now. The two-person company, which was started as a hobby, provides software that allows investors to automate their buying on LendingClub and Prosper and get better returns than if they were picking loans themselves.
Right now, the service is free and used by people lending a few thousand dollars, to those investing millions. Michael Phillips and Rocco Galgano, the two partners running Nickel Steamroller, still have their day jobs as software developers. Galgano said that it's taken a while to clear the regulatory hurdle, but they're getting close. He declined to provide specifics.
Galgano, who's based near Washington, D.C., is convinced that Nickel Steamroller's work will pay off, because there's plenty of demand from investors using the software to inform their buying.
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"Having a third-party platform that can help you with that and manage and it is obviously very helpful," said Galgano. "Our largest-paying customers are going to be institutional investors and funds."
P2P-Picks was also started by a hobbyist. Bryce Mason, a career data scientist, got excited about LendingClub and Prosper because both companies make available to the public granular data on every loan they issue. For hundreds of thousands of loans, any geek can look for patterns based on loan size, purpose and status.
"This is the first time in the history of mankind that companies have provided that level of detail about their core business," said Mason, who's based in the Los Angeles area. "I live and breathe stats and mathematical modeling."
Mason started a newsletter in 2012, discussing investment strategies derived from the data. He built a following and in 2013 launched a website. Now, institutions are coming to him—and paying him—for his ability to pick investments (via algorithms) and for his credit modeling.
He sees it as a critical piece of the ecosystem, because the lending companies are incentivized to boost their own bottom lines, not to look out for the average investor.
"The longevity of this industry is going to require an independent review process like what exists in stocks and bonds," Mason said.
Fundera co-founder and CEO Jared Hecht became intrigued with online lending after finding out that his cousin in Ohio couldn't get a bank loan for his restaurant. Rather than trying to compete as a lender, Hecht opted to create software that would allow small businesses to shop around and apply for loans from a single place.
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Hecht describes Fundera as Kayak for loans. There are two dozen or so online lenders that Fundera accesses, with technology-based platforms like LendingClub and Funding Circle driving the growth.
"Our service wouldn't exist had it not been for the proliferation of nonbank alternative lenders," said Hecht, who previously co-founded the texting service GroupMe, which Skype acquired in 2011. "LendingClub and Funding Circle offer some of the most competitively priced loans and are extremely intelligent companies."
According to Prosper CEO Aaron Vermut, tech start-ups are a small but growing piece of the overall ecosystem. Financial companies, meanwhile, have been aggressively seeking ways to be part of it for two years. Big institutional money managers have created funds to invest specifically in these new types of loans, banks are providing leverage to help them juice their returns, credit agencies are rating the debt and public mutual funds are on the way.
"It's interesting to me that personal loans are the hottest thing on Wall Street right now," said Vermut, who sold his previous company to Wells Fargo. "Ten years ago people would've laughed at you if you said that would be the case."
Correction: An earlier version of this story misspelled Fundera's name.