DeFi credit scores: Coming soon to a blockchain near you
- Reference: 1661427852
- News link: https://www.theregister.co.uk/2022/08/25/defi_credit_scores_blockchain/
- Source link:
If you understand a traditional credit score, you understand the point of a web3 credit score: to ascertain trustworthiness of individuals trying to transact on blockchains. Their basic scheme of operation isn't too dissimilar from centralized finance credit scores either.
Where web3 credit scores differ from their analog ancestor is in how they define identity, and how easy it may be to fool them. Web3, cryptocurrency, and DeFi are all about anonymity, which makes it tough to see how credit scoring – a necessarily intrusive concept – can eliminate rampant web3 [1]fraud without upsetting many of its advocates.
But what is a DeFi credit score?
Credit scores in the physical world use a variety of metrics to arrive at a picture of an individual's financial state – payment history, length of credit, debt-to-income ratios, and other data points are part of how banks and lenders gain an understanding of the risk a person presents.
Web3 credit scores would ostensibly do the same thing, but for decentralized financial systems.
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There's a lot of overlap between web3 credit score companies' methods, which generally involve linking one or more wallets to the company's system and letting an algorithm dig through the wallet's on-chain (and sometimes off-chain) history to build a picture of its owner.
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With a score established, the various DeFi credit agencies issue NFTs that serve as a token 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 lenders behave.
Not so with decentralized credit scores, and that appears to be a serious problem, DeFi researcher Chris Blec pointed out in a [5]Twitter exchange with Julian Gay, CEO of Cred Protocol, a company developing a web3 credit scoring system.
[6]Charges filed over $300m 'textbook pyramid and Ponzi scheme' crypto startup
[7]Crypto exchange Kraken reportedly hunted by the Feds for alleged sanctions busting
[8]Martin Shkreli, out of prison for running a Ponzi scheme, now pushes Web3 thing
[9]Ex-Coinbase manager charged in first-ever crypto insider trading case
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 [10]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.
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"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," Spectral CEO Sishir Varghese told The Register.
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," Litan told The Register.
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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 [13]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 – [14]at least not yet . ®
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[1] https://www.theregister.com/2021/12/16/cryptocurrency_rug_pulls/
[2] https://pubads.g.doubleclick.net/gampad/jump?co=1&iu=/6978/reg_onprem/networks&sz=300x50%7C300x100%7C300x250%7C300x251%7C300x252%7C300x600%7C300x601&tile=2&c=2YwecpAXtlgD7TZvklq-2zQAAAM4&t=ct%3Dns%26unitnum%3D2%26raptor%3Dcondor%26pos%3Dtop%26test%3D0
[3] https://pubads.g.doubleclick.net/gampad/jump?co=1&iu=/6978/reg_onprem/networks&sz=300x50%7C300x100%7C300x250%7C300x251%7C300x252%7C300x600%7C300x601&tile=4&c=44YwecpAXtlgD7TZvklq-2zQAAAM4&t=ct%3Dns%26unitnum%3D4%26raptor%3Dfalcon%26pos%3Dmid%26test%3D0
[4] https://pubads.g.doubleclick.net/gampad/jump?co=1&iu=/6978/reg_onprem/networks&sz=300x50%7C300x100%7C300x250%7C300x251%7C300x252%7C300x600%7C300x601&tile=3&c=33YwecpAXtlgD7TZvklq-2zQAAAM4&t=ct%3Dns%26unitnum%3D3%26raptor%3Deagle%26pos%3Dmid%26test%3D0
[5] https://twitter.com/ChrisBlec/status/1547746195153375234?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1547746195153375234%7Ctwgr%5Ec4234cebc4d00ec2ca048ce548ea1329cef9a5b2%7Ctwcon%5Es1_&ref_url=https%3A%2F%2Fcointelegraph.com%2Fnews%2Fcred-protocol-unveils-its-first-decentralized-credit-scores
[6] https://www.theregister.com/2022/08/02/sec_smacks_fraudsters_in_alleged/
[7] https://www.theregister.com/2022/07/26/us_government_kraken/
[8] https://www.theregister.com/2022/07/26/martin_shkreli_out_of_prison/
[9] https://www.theregister.com/2022/07/21/coinbase_crypto_insider_trading/
[10] https://blog.spectral.finance/introduction-to-macro-score/
[11] https://pubads.g.doubleclick.net/gampad/jump?co=1&iu=/6978/reg_onprem/networks&sz=300x50%7C300x100%7C300x250%7C300x251%7C300x252%7C300x600%7C300x601&tile=4&c=44YwecpAXtlgD7TZvklq-2zQAAAM4&t=ct%3Dns%26unitnum%3D4%26raptor%3Dfalcon%26pos%3Dmid%26test%3D0
[12] https://pubads.g.doubleclick.net/gampad/jump?co=1&iu=/6978/reg_onprem/networks&sz=300x50%7C300x100%7C300x250%7C300x251%7C300x252%7C300x600%7C300x601&tile=3&c=33YwecpAXtlgD7TZvklq-2zQAAAM4&t=ct%3Dns%26unitnum%3D3%26raptor%3Deagle%26pos%3Dmid%26test%3D0
[13] https://bird.money/static/bird-new/pdfs/litepaper.pdf
[14] https://www.theregister.com/2020/12/18/web_search_history_credit_ratings/
[15] https://whitepapers.theregister.com/
I wouldn't phase that quite so absolutely. What it seems blockchain is entirely unnecessary for is a financial system with all the same functions as the existing system we are already accustomed to.
However, if you're prepared to go without all the safeguards and regulations of the existing financtial system, and live in a financial Wild West, there are most certainly use cases not readily available in the current system - the rise of ransomware has shown such to be true. However most people, most businesses, and especially most governments, are not prepared to go without the safety nets.
"What it seems blockchain is entirely unnecessary for is a financial system with all the same functions as the existing system we are already accustomed to"
Except that the existing financial system is not ideal and can be improved, while existing blockchain-based financial systems can certainly be improved with safety nets from traditional finance.
2 main issues with current model - a central currency issuing agency like a central bank can, and does, create currency at will, resulting in inflation that devalues everyone else's holdings. For the Keynsian model, a government is free to print as much money as it wants without consequence, which is clearly nonsense, since inflation devalues everyone else's income and savings. A pre-defined and unchangeable rate of currency issuing, as in the bitcoin model that limits mining, guarantees that the value of savings and investments cannot be inflated away. Some say that governments cannot work this way as it ties their hands too much. According to me this is highly desirable exactly because it limits government spending.
Second main issue is the centrality of financial intermediaries who are both custodians and gatekeepers. On the one hand, having custodians of your money is a good idea unless we want to be walking about with huge amounts of cash, either physically or digitally. It's good that we can deposit money in a bank (physical or digital) where it is convenient and safe. But the custodian should have just one role - identifying the account owner, who can then move their money at will at their own discretion and without hindrance. If the custodian is also acting as a gatekeeper beyond these basics it can be a problem. Banks and/or governments can, and do, freeze people's accounts without the knowledge/consent of account holders, even when the account holders have done nothing wrong - eg banks in Cyprus and Greece in the last crisis. For those who say 'only in emergencies / extreme cases' - that's exactly when people need access to their money.
Inflation
A small amount of inflation is a *good thing* in an economy. Inflation discourages hoarding of cash assets (because they loose relative value) over investment in businesses; encourages buying today over the future (when prices will be higher); and reduces the absolute value of debt. An economy with no inflation - or even worse, deflation, which is what many cryptocurrencies are aiming for - is a dead economy.
Good point. I should have written "... offers nothing legal ...". Obviously it has been a godsend for the criminal community.
@Ian Johnston - Exactly
After all this time, blockchain technology is still a solution searching for a problem to solve.
monetizing bundles
So, the New-Finance credit-scoring companies want to monetize your transactions, by analyzing "bundles" of your wallets and their histories.
The traditional financial system knows this scheme intimately. Selling bundles of financial transactions and corresponding derivatives is big on Wall Street.
See the film "The Big Short" for further details.
"Bundle default swaps" is coming to a Web3 website near you soon!
Pointless "Safeguards"
There is no valid reason for having any kind of cryptocurrency "credit score". Cryptocoins are not like a personal check -- once the coins are spent, the spender can't cancel the transaction or grab the coins back. Some people will object, "But what if the coins were stolen?". Well, what happens when cash is stolen? Do merchants refuse cash if the spender doesn't show you his/her credit rating? Of course not. Similarly, the objection, "But what about ransomware?" is pointless -- you already know the ransomware people are untrustworthy scum.
This whole idea looks like an attempt to (1) de-anonymize cryptocoin users, and (2) for the personal-data-industry to grab even more personal data.
Disclaimer: I have no financial interests in the cryptocoin craze, nor have I ever traded in cryptocoins.
It could be argued that the reason why credit scores work is because of their centrality.
Indeed it could. Most powerfully by people whose job is in centrally providing credit scores.
The real reason credit scores work is identity(of course). Is the person seeking credit, the same person listed on the various elements of a credit score ? And that has as much to do with "centrality" as it does the font you use.
And the inconvenient truth is central credit scoring isn't perfect to start with anyway.
All of which being said, if one of the selling points of the cryptobros is anonymity, then credit scoring is the least of their worries.
In fact credit scoring is an early example of trading privacy for utility.
So this will be yet another centralised point of control for "not actually decentralised at all" finance (notDeFi).
LOL
So, as usual, blockchain offers nothing which can't be done better, faster and cheaper by existing technology.