A new form of digital credit financing on the blockchain has similarities to old-school credit criteria, yet there are some specific distinguishing features. Let’s review how a credit score is implemented in traditional financial systems, briefly focusing on the existing issues and highlight new opportunities in the world of decentralized finance (DeFi).
Classic Credit Score
Historically, a credit score or a credit rating is a pattern of someone’s credit history and includes several principal factors. This rating helps prospective lenders evaluate a person’s ability to pay his or her debts. In other words, a credit record is a footprint lending institutions use to decide whether to give you a credit card, a loan, or a mortgage, as well as what kinds of loans you can get. They use this to go back through your history to see if you pay your bills regularly. If your credit background looks risky, a lender will not lend to you.
There are five major factors that determine the score, and they all have varying levels of importance.
1. Payment history
Payment history is the most important on a credit profile. It accounts for roughly a third of the score. If a person acted accountable in the past, they will probably behave the same way in the future. Therefore, one is advised to avoid late payments.
2. Credit utilization rate
Credit utilization rate is the second most important factor. It also accounts for about a third of your score. A good credit score doesn’t mean you don’t borrow. An intense credit record demonstrates the ability to handle a reasonable amount of debt without any negative implications. When you don’t use your credit capacity, it might be even worse than using a series of credit sources.
3. Credit history
Credit history is also considered in a credit score and counts for approximately one seventh of a credit rating. The longer you’ve been borrowing the better. A good or excellent credit history is key to a wider range of credit types and new credit opportunities.
4. Credit type
Credit type accounts for about one tenth of the total credit score. This includes how many sources of borrowing you use; diversity works in your favor for this measure.
5. Credit frequency
Credit frequency accounts for about one tenth of the score. It considers how often you take on credit. Consider how many credit cards you keep and think twice before signing up for another credit card.
To achieve a great credit score, you must consider the implications and act accordingly.
In recent decades, traditional credit scores have generated considerable concern. It is already clear that the practice may significantly restrict minority and low income consumers from obtaining loans or renting an apartment. That’s because a person’s credit history becomes permanent, so a past mistake can be held against someone for a long-time, which creates a negative feedback loop. Moreover, because traditional credit data is centralized with a select few companies, this sensitive data is at risk from hacks. The Equifax data breach in 2017, for example, was one of the largest examples of identity theft in history, exposing the private records of nearly 150 million Americans along with 15 million British citizens and nearly 20,000 Canadians citizens.
In other words, the classic credit score is static and is formed by a fixed algorithm that is centralized and therefore risks being abused. CreDA’s score, on the other hand, is decentralized and dynamic, based on real-time activity on a person’s wallet and updated every 24 hours. CreDA’s credit score reflects the current situation and makes it possible to assess the real current creditworthiness of the user without having to give away your identity.
The Crypto Approach to Credit Scoring
We will review the factors that influence a user’s credit score in the world of decentralized finance (DeFi) and correlate them with the traditional credit score mentioned above.
On-chain data analysis is used to determine users’ credit scores. As soon as a user gets a decentralized ID (DID), a new story is initiated automatically. All previous on-chain actions, and activities contribute to the modeling process and result in a user’s current credit rating value.
Below is a list of the most common criteria normally considered for credit score assessment in DeFi.
Behavioral performance reflects a user’s on-chain activity level and their trading preferences. It includes the scope of in and out transactions within crypto wallets, metaverse activity, and other actions associated with a specific user’s DID. It also includes engagement in DeFi projects and amounts funded in on-chain transactions and trading networks.
Asset flow includes total assets across all blockchains, which are associated with a specific user’s DID. The system records the time period a user holds certain assets and estimates asset volumes to produce an accurate credit score. The types of assets matter too, taking into account the volatility of coins and tokens.
Engagement in DeFi depicts a user’s on-chain behavior, such as participation in DeFi activities, including various loan programs. A user’s credit rating may also be modified according to time spent on such programs, the collateral value, and the rate of loan repayments during high market volatility periods.
Compliance and default statistics mirror a user’s balance of positive and negative log entries. These describe the whole statistical picture, which affects an individual’s credit score.
Trading platforms and network participation activity rates show a user’s engagement in trading and purchasing processes on DeFi platforms.
A user’s off-chain social data is linked to everyday off-chain activities that influence a user’s decentralized credit score as well. This is the traditional way of assessing a user’s credit rating.
The final credit rating value calculated by the modeling process is a relative score. It is based on evaluation of a user’s past behaviors, activity on credit platforms, and real-time credit rating relative to everyone else’s score.
Recently, CreDA has established partnerships with two progressive projects: CyberConnect for on-chain social graph data and Project Galaxy for off-chain social data.
These partnerships were initially based on mutual benefits. CyberConnect and Galaxy users will get more DeFi options and possibilities on CreDA. Meanwhile, CreDA users can improve their credit scores if they share their social data details with one or both of the friendly platforms.
Such collaborations are useful for development of CreDA’s Credit Oracle. The more social data, the better. With a bigger database, CreDA will be more successful in upgrading its Credit Oracle. On-chain social graph data and off-chain social data will be used by the Credit Oracle to determine credit scores.
This merging of off-chain and on-chain data is significant in constructing a solid link between standard and digital approaches.
CreDA’s Crypto Credit Score creates the trust architecture for DeFi and Web 3.0 as a whole and provides platforms with the opportunity to offer a number of exclusive tools, such as: non-collateralized, leveraged and peer lending, as well as targeted offers, unique content and exclusive access based on specific risk factors or credit profiles.
For further information, please check out our whitepaper, visit our website, follow us on Twitter and join our growing community on Discord.
