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Web3, blockchain and decentralized finance (DeFi) technologies, with their famously libertarian users, seem like the last places you would 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: verifying the trustworthiness of people attempting to transact on blockchains. Their basic operating scheme is also not much different from centralized financial credit ratings.

Where web3 credit scores differ from their analog ancestors is in how they define identity and how easy it can be to trick them. Web3, cryptocurrency, and DeFi are all about anonymity, making it hard to see how credit scoring — a necessarily intrusive concept — can weed out rampant Web3 fraud without upsetting many of his supporters.

But what is a DeFi credit score?

Credit scores in the physical world use a variety of metrics to get 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 a person’s risk.

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

There is a lot of overlap between the methods of Web3 credit scoring companies, which usually involve linking one or more wallets to the company’s system and letting an algorithm run through the on-chain (and sometimes off-chain) history of the wallet to create an image of its owner.

With an established score, the various DeFi credit agencies issue NFTs which serve as a pledge of solvency. These 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 typically how transactions and loans DeFi are supported.

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 the bureaus that handle credit ratings in a particular country, and those bureaus are in turn able to keep an (ideally) accurate record of borrower behavior.

That’s not the case with decentralized credit scores, and it seems like a serious problem, DeFi researcher Chris Blec pointed out in a post. Twitter exchange with Julian Gay, CEO of Cred Protocol, a company developing a web3 credit scoring system.

Discussing the use of multiple wallets, Blec said such users can expect a higher degree of privacy. In other words, what’s stopping them from simply not linking additional wallets in order to compartmentalize their online activities?

Spectral, a Web3 credit rating company that recently announced $23 million in funding from companies such as SamsungNext, apparently admits the potential for such abuse in its explanation of its scores, which it says are “created by connecting either a single wallet or a set of multiple wallets to the Spectral app,” the company said.

Since web3 credit scores apparently require voluntary participation, the success of these systems seems to rest on the hope that the incentive to create a pseudonymous, decentralized online identity will outweigh an individual’s desire to remain anonymous online. .

“Web3 wallets include not only financial transactions, but also NFT holdings, game transactions, salaries, governance votes, etc. So when a user aggregates their wallets, they are also expressing their pseudonymous identity,” said Spectral CEO Sishir Varghese. The register.

Avivah Litan, a distinguished Gartner analyst covering AI and blockchain, said much the same thing, but added that the anonymity promised with web3 and blockchain is essentially incompatible with credit ratings because the establishment An online credit score 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 applications and that hasn’t happened yet,” Litan said. The register.

Bird, another Web3 credit company, answered this question by relying on off-chain data sources such as social media and web browsing history, as well as traditional bank statements, status employment and other sources of data that he may be able to obtain. hand in hand in the future. “Given the rate at which new sources of data are created in our daily lives, the sky really is the limit when considering the potential of Bird’s prediction products,” the company said in a 2021 Litepaper [PDF] on its rating process.

It is very similar to traditional credit scores, but perhaps more intrusive. Agencies like Experian and Equifax, for all their flaws, generally don’t look at your internet search history – at least not yet. ®

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