Well, you're not lending all your money to a single person. You can make loan amounts to multiple people for a blended return (you can loan out at $25 increments)... so your risk is probably pretty close to that of a mutual fund. On Prosper's website they claimed that everyone who loans 100 units (minimum $2500) has had positive returns. Note that they state that loans made from Nov. 2005-June 2009, had a blended loss of 6%... so you can lose money, just like any other investment.
I think peer to peer lending makes a lot of sense as part of someone's portfolio, and like anything you should diversify.