Coming soon to a blockchain near you • The Register

Web3, blockchain and decentralized finance (DeFi) technologies, with their famously libertarian users, seem like the last places you’d expect to see a credit scoring system. But money talks, even in a DeFi world.

If you understand a traditional credit score, you understand the point of a web3 credit score: to determine the trustworthiness of individuals trying to transact on blockchains. Their basic operating plan is also not unlike centralized financial credit scores.

Where web3 credit scores differ from their analog progenitor is how they define identity, and how easy it can be to fool them. Web3, cryptocurrency, and DeFi are all about anonymity, which makes it hard to see how credit scoring—a necessarily intrusive concept—could eliminate widespread web3 fraud without upsetting many of its proponents.

But what is a DeFi credit score?

Credit scores in the physical world use a number of calculations to arrive at a picture of a person’s financial condition – payment history, length of credit, debt-to-income ratio and other data points are part of how banks and lenders get an understanding of a person’s risk .

Web3 credit scores will apparently do the same, but for decentralized financial systems.

There is a lot of overlap between the web3 credit score companies’ methods, which typically involve connecting 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 . The owner.

With a score established, the various DeFi credit bureaus issue NFTs that act as a token of creditworthiness. These NFTs can be attached to any blockchain transaction on a system that supports smart contracts, such as Ethereum, and can theoretically be used in place of collateral, which is typically how DeFi transactions and loans are backed.

The problem with DeFi credit: Identity

It could be argued that the reason credit scores work is because of their centrality. Banks and lenders report to which agencies handle credit ratings in a particular country, and these agencies are in turn able to keep an (ideally) accurate record of how lenders are behaving.

Not so with decentralized credit scores, and that appears to be a serious problem, DeFi researcher Chris Blec pointed out in a Twitter exchange with Julian Gay, CEO of Cred Protocol, a company developing a web3 credit scoring system.

Blec discussed the use of multiple wallets, saying that such users can expect a higher level of privacy. In other words, what is stopping them from not connecting multiple wallets to split up their online activities?

Spectral, a web3 credit scoring company that recently announced $23 million in funding from companies including SamsungNext, apparently admits the potential for such abuse in its explanation of the scores, which it said are “created by connecting either a single wallet or a bundle of multiple wallets to Spectral’s app,” the company said.

With web3 credit scores apparently requiring voluntary participation, the success of such systems appears to rely on the hope that the incentive to create a pseudonymous, decentralized online identity will override an individual’s desire to remain anonymous online.

“Web3 wallets include not only financial transactions, but also NFT holdings, gaming transactions, salaries, governance votes, etc. So when a user collects their wallets, they also express their pseudonymous identity,” said Spectral CEO Sishir Varghese 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 is 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 use of decentralized identity constructs and applications, and that hasn’t happened yet,” Litan said The register.

Bird, another web3 credit company, has answered that question by relying on off-chain data sources such as social media and browsing history, as well as traditional bank records, employment status and other data sources it may be able to obtain hands on in the future. “Given the pace at which new sources of data are being created in our daily lives, the sky really is the limit when we envision the potential of Bird’s prediction products,” the company said in a 2021 Litepaper [PDF] about the scoring process.

It sounds a lot like traditional credit scores, only perhaps more invasive. Agencies like Experian and Equifax, for all their faults, typically don’t look at your Internet search history—at least not yet. ®