Incidentally, I am a Prosper lender to the tune of $300. The dirt on this story could fill a small book, or a large forum (http://www.prospers.org)
The long and short of it: Prosper really wanted to be a technology play like Paypal which disintermediated banks and then got to take a small slice off each transaction. However, their model required that they, in effect, take on a lot of banklike aspects -- including investigating borrowers and collecting on deadbeats. They were woefully unprepared for both of them, thinking at the beginning that the lending peers would crowdsource it, before they realized that this would be very, very illegal.
(Privacy/harassment laws + telling 50 pissed people the identity of a single mom late on her payments + Google + lawyer = you tell me how this story ends.)
Anyhow, Prosper expected that despite the complete lack underwriting and neigh-total lack of fraud checking they would get default rates roughly similar to that of banks. Then, BEFORE the financial crisis started, reality set in and lenders started losing lots of money. This made Prosper's claimed rates of return ("Hey, if you loan money at 20% and only 5% default that means you make 15% APR!"[1]) extraordinarily rosy. Rather than accepting the data and revising the claimed rates of return downward, they instead started slicing it in smaller and smaller pieces (creating, for example, a Prosper Select Index filled with their best quality borrowers -- are we hearing the word "tranches" yet?) to claim that the rate was still exceptionally positive.
Representative ad:
[Edit: Thank you to commenter who pointed out my URL was borked. I'll TinyURL it: http://tinyurl.com/63em2c ]
Funny, "Earn 8.00% to 12.00% rates of return" looks like a security, it sounds like a security, it feels like a security... except if it were an actual security, well, the accountant who approved those numbers would be locked up. (Seriously. I liked the company, but the math is THAT bad. The average rate of return lenders of size were actually achieving was, at the time, closer to 3%. About 25% were losing money. Only about 10% every achieved the rates that were claimed in 36 pt font. And for what its worth, although my $300 doesn't make me a large lender by any stretch of the imagination, up until my first late payment a few weeks ago I was earning close to 18%.)
[1] Despite two years of trying to educate them about how math works via their forum and their email, we lenders were unable to penetrate their ignorance about high school math. Seriously. Three years after opening they still thought 25% interest and 20% defaults meant a 5% return. Even if the defaults were almost instantaneous, as most defaults on the platform are.