Why does a decentralized credit score make sense?
What is a credit score?
Individuals sometimes look to extend their funding capacity beyond a salary or recurring source of income. Typically, they will borrow credit instruments like mortgages, car loans and/or student loans.
In order to be eligible for these forms of credit, banks and financial institutions will look to establish the entity’s ability to repay them at a given expiration date, plus interest. Credit scores are an essential part of the credit-approval process and savvy individuals will have worked hard to establish a high score. Using credit cards and paying down the balances on time can significantly help to ensure a good score.
Credit scores are also very important for securing a place to live, i.e. an annual rental unit, as landlords like to ensure their future tenants will pay rent on time. A good credit score makes for a satisfied landlord.
Large third parties like Equifax, Experian and TransUnion are frequently called upon to provide an entity’s credit score.
Centralized credit verification can present risks and challenges
Data usage and validity
Centralized institutions like Experian use proprietary methods by which to establish credit scores. The data being used to establish individual scores is usually processed behind walled gardens. The average individual rarely has access to the data or the methods used by these third parties. Equifax itself admits that credit bureaus do not seek out information, rather they only use information that is available to them. Often times, credit reports can contain incorrect information resulting in an inaccurate score. It is the individual’s responsibility to reactively correct the data.
Data reliability
In terms of reliability, there is very little guarantee on how credit bureaus package and present data to the general public. In 2008, the world faced the biggest ever global financial crisis to have hit markets. Analysts would soon discover that this was the result of faulty, complex financial instruments being sold to the public. In simpler terms, banks, lenders and financial institutions had packaged up bad credit instruments with C, D or lower ratings into new major classes. They convinced credit bureaus to re-rate these newly-packaged instruments and assign them A+ or higher ratings so that they could sell them.
According to the Royal Bank of Australia, what resulted was “falling US house prices and a rising number of borrowers unable to repay their loans.”
The inability of previously-trusted credit scoring agencies to reflect data with integrity represents a huge gap in the market that decentralized credit scoring can close.
Data security
Centralized institutions are depots for hordes of sensitive information. Equifax was hacked and hundreds of millions of people were compromised in the attack. Vulnerabilities like this and a lack of transparency in what data is used (and how) simply do not signal trust in the marketplace. In fact, Inc.com wrote an exposé piece on how credit bureaus aggregate information and sell it back to lenders to turn a profit. Personal information is not safe and people’s identities are being stolen without consequence.
Not universally available
Moreover, there are unbanked or underbanked individuals who do not fall within the usual parameters of the traditional financial system. They cannot get access to credit cards, much less establish credit scores and be approved for loans in spite of healthy financial patterns, smart saving habits and ethical behaviour with cash-based transactions. With no access to a bank account, the unbanked and underbanked have no real identity anywhere in the world. There is nothing to validate their day-to-day existence.
Therefore, whether you have government-issued identity and rely on traditional financial systems or not, the present structure is simply unsafe, unreliable and does not champion the individual’s needs.
Blockchain technology at the intersection of credit and identity
Blockchain technology has made it possible for individuals to partake in peer-to-peer (P2P) transactions. In these networks, like Bitcoin and Ethereum, individuals can transact with each other without the need for an intermediary or third party like a bank or government. Specifically, Bitcoin demonstrates important validation for P2P transactions and Ethereum, the validation for the issuance of tokens on a P2P network.
All exchanges of value are tracked and validated directly on the blockchain and in real time. This creates an incredible opportunity to develop reputation systems that can vouch for both identity and credit; each of which currently require proof delivered by a third party, like a birth certificate or credit report respectively.
Additionally, as the blockchain industry matures, we have seen some questionable behaviour by participants. Credibility in the industry is still a gap that is asking to be addressed. We see a number of new decentralized applications (dApps) being created and corresponding tokens issued. However, usage for blockchain dApps is staggeringly low and this nullifies the value of related tokens. Not to mention, fraudulent projects that do not deliver on their promises and leave backers in trouble.
Instead of value generation, we see token dumps in exchange for fiat and markets all round are taking a hit. There is simply no way for investors to establish the validity and longevity of a blockchain project before they invest millions of dollars. This makes for a toxic and unhealthy environment within which, growth is not possible.
Additionally, when coins offer anonymity (like Bitcoin used to do before regulators caught on) we see an increased opportunity for crime to proliferate. Money laundering and nefarious activity can continue unchecked with privacy coins. Darknets present an increasingly difficult challenge for cybersecurity experts to contend with.
However, the situation could be remedied with the availability of decentralized credit scoring.
Funding made available on meritocracy and validated by a network in a managed-risk environment
The advantage of decentralized credit scoring comes from the fact that an entire network of validators can prove identity and establish someone as financially viable or reputable. As such, individuals acting on behalf of themselves or institutions are less likely to defraud one another. Trustless takes on a whole new meaning.
Additionally, with a centralized market that presents risks, entities are not as heavily reliant on banks, lenders and credit bureaus to secure desperately-needed funding.
Any information inaccuracies are quickly eradicated with access to live data that evolves at pace with activity taking place on a blockchain.
Decentralized credit scoring is also bolstered by the fact that information of the borrower (and lender) can remain protected. The need for trust can be minimized to the individual’s financial capacity to make good on their end of a deal. No further identifying information need be provided beyond this. Therefore, the way that credit bureaus and financial institutions presently make use of personally identifying information can be circumvented and slowed. People’s personal data would no longer be subject to the same extreme risk that was presented by the Equifax hack (and so many others).
This is not to say that centralized financial institutions have no value. They provide an essential set of functions to a majority of the world’s population and are still extremely important to the daily operating of people’s lives.
Enter NUTS Finance — An enabler of decentralized financial applications
As such, at NUTS Finance, we believe that centralized and decentralized processes can co-exist in financial services applications. Transparency issues and counterparty risks caused by asymmetric information have presented a major hurdle that can be overcome through decentralization. Our mission is to provide the necessary technology modules to support that decentralized component.
NUTS Finance is the first enabler of a truly decentralized credit system, based entirely on the blockchain. The NUTS decentralized credit protocol is designed to measure the credibility of public keys, strictly using on-chain data.
Credibility is the most critical element in every transaction that involves a counterparty, regardless of consumer or institutional transactions. At NUTS Finance, we believe that decentralized credit scores can validate financial identity (reliability) on a blockchain. It can additionally provide an uncontaminated assessment on a transaction participant’s historical and future behaviour when it comes to crucial financial transactions.
As such, decentralized credit scoring can have a very important impact in speeding up the time to acquisition and delivery of credit instruments, reliably and securely.
Building with NUTS Finance
NUTS Finance is building an open technology framework to support the issuance of diversified financial instruments on the blockchain. Our vision is to enable an open, inclusive and transparent financial system by simplifying the issuance process of financial instruments; reducing the barriers to entry in financial services markets for all participants.
