How Web 3 Agencies Check Credit Worthiness Of A Customer In DeFi & Misuse Blockchain Rating System?

2 min read

How Web 3 Projects Check Credit Worthiness Of A Customer In DeFi & Misuse Blockchain Rating System?

With their libertarian users, Web3, blockchain, and decentralized finance (DeFi) seem like the last places you’d expect a credit-scoring system to appear. The truth is, even in the world of DeFi, money talks.

Web3 credit scores are similar to traditional credit scores in that they assess trustworthiness of individuals trying to transact on blockchains. The basic principles of their operation are similar to those of centralized finance credit scores as well.

The main difference between web3 credit scores and their analog ancestor is the way they define identity and how easily they can be fooled. As web3, cryptocurrency, and DeFi are all about anonymity, it’s hard to see how credit scoring, a necessarily intrusive concept, could eliminate rampant web3 fraud without upsetting its supporters.  

How DeFi Credit Agencies Determine Score & Issue NFTs as Proof-of-Credit Worthiness?

Banks and lenders use a variety of metrics to determine an individual’s financial state when it comes to credit scores – payment history, credit length, debt-to-income ratios, and other data points are some examples of how they determine the risk someone presents.

Web3 credit scores would ostensibly do the same thing, but for decentralized financial systems.

A lot of web3 credit score companies use similar methods, which typically involve linking one or more wallets to the company’s system and letting an algorithm analyze the wallet’s on-chain (and sometimes off-chain) history to build a picture of the owner.

After the score has been established, the different DeFi credit agencies issue NFTs as proof of creditworthiness. Those NFTs can be attached to any blockchain transaction on a system that supports smart contracts, like Ethereum, and could theoretically be used in place of collateral, which is commonly how DeFi transactions and loans are backed.

The problem with DeFi credit: Identity

It could be argued that the reason why credit scores work is because of their centrality. Banks and lenders report to whichever bureaus handle credit ratings in a particular country, and those bureaus in turn are able to keep an (ideally) accurate record of how borrowers behave.

Not so with decentralized credit scores, and that appears to be a serious problem, DeFi researcher Chris Blec pointed out in a Twitter exchange with Julian Gay, CEO of Cred Protocol, a company developing a web3 credit scoring system.

Discussing the use of multiple wallets, Blec said such users may be expecting a higher degree of privacy. In other words, what’s to stop them from simply not linking additional wallets in order to compartmentalize their online activities?

Spectral, a web3 credit score company that recently announced $23 million in funding from companies including SamsungNext, seemingly admits the potential for such abuse in its explanation of its scores, which it said are “created by connecting either a single wallet or a bundle of several wallets to Spectral’s App,” the company said. 

With web3 credit scores apparently requiring voluntary participation, the success of such systems seem to rely on the hope that the incentive to create a pseudonymous, decentralized online identity will overrule an individual’s desire to remain anonymous online. 

Web3 wallets include not only financial transactions, but also NFT holdings, gaming transactions, salaries, governance votes etc. So when a user bundles their wallets they are also expressing their pseudonymous identity.

Sishir Varghese, Spectral CEO

Avivah Litan, Gartner distinguished VP analyst covering AI and blockchain, said much the same, but added that the anonymity promised with web3 and blockchain are essentially incompatible with credit scores because establishing a credit score online requires some sort of decentralized identity system, Litan told us.

Before we get reliable credit scores in Web3, we need more adoption of decentralized identity constructs and application and that hasn’t happened yet.

Avivah Litan, VP Analyst Gartner

Bird, another web3 credit company, has answered that question by relying on off-chain data sources such as social media and web browsing history, as well as traditional banking records, employment status, and other sources of data it might be able to get its hands on in the future. “Given the pace at which new data sources are being created in our daily lives, the sky is truly the limit when envisioning the potential of Bird’s prediction products,” the company said in a 2021 Litepaper [PDF] about its scoring process.

That sounds an awful lot like traditional credit scores, only perhaps more invasive. Agencies like Experian and Equifax, for all their faults, don’t typically look at your internet search history – at least not yet.

Via this site

Stay on top of Crypto Trends

Subcribe to our newsletter to get the latest crypto news in your inbox

Have A Story? Get Featured On Nexofly Plus 100+ More Exclusive Crypto News Sites