The problem with traditional crypto loans is that you cannot get a loan without enough liquid capital to cover it.
By and large, decentralized finance (DeFi) projects only offer secured loans to the average consumer. To borrow $1,000, you need to put up $1,250 to $1,500 worth of crypto. The key is to get liquid capital without selling assets that you believe will increase in value over time.
But the “reliance on collateral also limits access to credit to borrowers who are already asset-rich, negating the benefits of financial inclusion,” the Bank for International Settlements (BIS) wrote in June. . While necessary when the identity of the borrower is unknown, it exhausts the potential of democratizing finance and helping those on the fringes or outside the mainstream economy to get richer, said the BRI.
This is where crypto credit ratings come in.
A relatively new phenomenon, crypto credit scores are in some ways quite similar to traditional credit scores issued by TransUnion, Equifax, and Experian: they take into account your crypto assets, transaction history, spending habits, and asset growth over time. And they can be used by both DeFi lending protocols and FinTech lenders to provide unsecured loans or lines of credit.
Personal experience led Masa Finance founder Brendan Playford to start a crypto credit score company. Noting that he grew up in poverty, Playford found himself with no credit score of any kind, despite making a lot of money mining crypto.
The problem is that a traditional FICO credit score “doesn’t currently take into account any of the existing crypto assets I’ve had for the past seven or eight years. My particular portfolio is focused on on-chain assets — I’m a lightweight off-chain file.
Masa takes this information and adds data from many other sources — including traditional credit scores — and creates ratings “for people who are traditionally not notable off-chain.”
It’s far from the only company to do so.
The Credit DeFi Alliance, or CreDA, launched a scoring platform in November, using artificial intelligence (AI) to review transaction history. It then creates an NFT token with users’ credit score that can be used by DeFi lenders to assess risk, allowing smart contract-powered platforms to offer low- or unsecured loans with personalized rates and more competitive services.
Others also combine online and offline data. TransUnion has partnered with digital identity provider Spring Labs to add its data to the ky0x digital passport. Teller, another crypto lender building its own scores, works with Equifax as well as online data.
These crypto credit scores are also not just for individuals. Another company, TrueFi, builds a crypto credit score for its own loans that requires corporate borrowers from the crypto industry to provide data on things like compliance, accounting systems, corporate structure – often a cause for concern in the crypto world – and experience the principles, combining it with data such as loan repayment history, assets under management and exposure to leverage and other risks.
RociFi uses machine learning to look at things like Decentralized Autonomous Organization (DAO) governance participation, NFT ownership, and even social media account data to create a score focused on under-collateralized loans.
Who are you?
Identity is a key issue for unsecured crypto loans, and not just for AML compliance. Crypto transactions are pseudonymous in nature – any transaction is open to everyone on a blockchain, but users’ identities are hidden behind an alphanumeric wallet address.
See also: Crypto Basics Series: Is Bitcoin Really Anonymous and How Can Law Enforcement Track It?
In many ways, crypto credit score issuers operate like trusted third parties of the type that bitcoin and crypto in general were supposed to render useless. They collect information from individuals, who must provide identification data and access to details of their holdings.
This allows score issuers to both provide access to credit information without having to see and review the crypto assets and transaction history of potential borrowers, and to offer a source for collection agencies in the event of default of a lender.
This is especially important in DeFi lending, where there is no centralized management to perform such review. This can be used as an oracle – providing yes or no information to companies asking if someone meets these requirements.
The ultimate goal, said Cassie Zhang, CreDA’s chief operating officer, is to “deliver on the promise of blockchain and decentralized finance, providing the trust architecture needed to unlock capital for the billions of people.” who do not have access to traditional banking services.
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