The problem with traditional crypto lending is that you can’t get a loan without more than enough liquid capital to cover it.
By and large, decentralized finance (DeFi) projects offer only collateralized loans to the average consumer. To borrow $1,000, you need to put up $1,250 to $1,500 worth of crypto. The main point is to get liquid capital without selling assets you believe will grow in value over time.
But the “reliance on collateral also limits access to credit to borrowers who are already asset-rich, negating financial inclusion benefits,” the Bank for International Settlement (BIS) wrote in June. While that’s necessary when the borrower’s identity is unknown, it drains the potential to democratize finance and help those on the edges or outside of the traditional economy grow wealth, the BIS said.
That’s where crypto credit scores come in.
A relatively new phenomenon, crypto credit scores are in some ways fairly similar to the 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 uncollateralized loans or lines of credit.
Personal experience led Masa Finance Founder Brendan Playford to launch a crypto credit score firm. Noting that he grew up poor, Playford found himself without a credit score of any kind, despite having made good money in mining crypto.
The problem is that a traditional FICO credit score “doesn’t currently take into account is any of the existing crypto assets that I’ve had for the last seven or eight years. My particular portfolio is weighted towards on-chain assets — I’m thin file off-chain.”
Masa takes that information and adds in data from many other sources — including traditional credit scores — and creates scores “for people that are traditionally unscorable off-chain.”
It’s far from the only firm doing this.
The Credit DeFi Alliance, or CreDA, launched a rating platform in November, using artificial intelligence (AI) to look at transaction histories. It then creates an NFT token with a users’ credit score that can be used by DeFi lenders to assess risk, allowing the smart-contract-managed platforms to offer low- or no-collateral loans with personalized rates and services that are more competitive.
Others are combining online and offline data as well. 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.
Nor are these crypto credit scores only for individuals. Another firm, TrueFi, builds a crypto credit score for its own lending that requires crypto-industry corporate borrowers to provide data on things like compliance, accounting systems, corporate structure — frequently a source of concern in the crypto world — and principles’ experience, combining it with data including loan repayment history, assets under management and exposure to leverage and other risks.
RociFi uses machine learning to review things like decentralized autonomous organization (DAO) governance participation, NFT ownership, and even social media account data to build a score focused on undercollateralized loans.
Who Are You?
Identity is a key problem for uncollateralized crypto lending, and not just for anti-money laundering compliance. Crypto transactions are by their nature pseudonymous — any transaction is open for anyone to see on a blockchain, but the users’ identity is 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 as trusted third parties of the type bitcoin and crypto in general were supposed to make unnecessary. They collect information from people, who must provide identifying data and access to the details of their holdings.
This allows the score issuers to both provide access to credit information without having to see and scrutinize potential borrowers crypto assets and transaction history, and offer a source to collection agencies if a lender defaults.
This is especially important in DeFi lending, where there is no centralized management to do such a review. This can be used as an oracle — providing yes or no information to companies that ask does someone meet these requirements.
The ultimate goal, said CreDA Chief Operating Officer Cassie Zhang, is to “fulfill the promise of blockchain and decentralized finance, providing the trust architecture needed to unlock capital for the billions of people without access to traditional banking.”
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