Decentralized finance (DeFi) requires a more reliable credit scoring system, however, we need to be cautious, according to Ontology (ONT) Founder, Li Jun.
Jun explains that credit scores have been “a cornerstone of risk evaluation in the global banking systems for decades.”
He adds that they allow banking institutions to determine who may qualify or is eligible to receive a loan, at what interest rate, and what the credit limits might be for an individual or business. Lenders use these scores to assess or evaluate the “likelihood that the borrower will fulfill their obligations and repay their loan,” Jun explained.
He also mentioned that the global lending and payments market managed to reach $6.7 trillion last year. It may be on track to reach $7.6 trillion this year, Jun revealed. He also noted that if you’ve applied for a bank loan, then you’ll know that these traditional credit-scoring systems and ID verification processes “work together.” He added that these include proof of address and a copy of a passport (or some other form of official identification).
Jun further noted that Europe’s Open Banking initiative, PSD2, is expected to streamline credit scoring. It will “make it possible for lenders and borrowers to access a full picture of an individual’s financial history in real-time,” Jun added while noting that its introduction into financial services systems will “revolutionize the loan process.” It will “increase speed, accuracy, and more importantly, financial inclusion,” Jun predicts.
He also mentioned:
“In comparison to this highly sophisticated system, lending and borrowing in the DeFi industry is still in its [early stages of development.] However, as we know, over the past 12 months it’s grown at an incredible rate. Total Value Locked (TVL) in DeFi as of March 2021 stands at $39.7 billion, according to DeFi Pulse. What’s more, it is lending that makes up for the largest segment of that market. The DeFi lending market sits at $17.8 billion. Decentralized exchanges follow closely behind at $15.6 billion.”
“What the DeFi industry has been missing is a credit scoring system that provides a full picture of an individual’s varied crypto assets across different wallets and chains. To increase trust and reputation when it comes to lending and borrowing through DeFi, we need a system that supports cross-chain interaction and verifiable credentials. By connecting user identities with personal accounts, users can bind their digital assets and contact addresses making it easy for the correct due diligence to take place.”
Jun further noted that crypto credit scores will allow lenders to look at or review the borrower’s eligibility or creditworthiness. They should also help them with avoiding “over-collateralization when looking to borrow assets,” Jun explained while adding that they’ll “have the ability to put their positive credit scores to use and to access more rewarding opportunities.”
He also noted:
“As the DeFi industry progresses to merge with traditional financial systems, there will need to be an evaluation of on-chain and off-chain assets. To create a trusted merger between these two worlds, a full picture of traditional and digital holdings and history needs to be made available. This will further bolster the benefits of legislation like Europe’s PSD2. It will provide a more rounded, integrated look at asset holdings and histories, including crypto assets, in real-time.”
But he also pointed out that as we have now seen with any new technology that “deals with highly sensitive data, we must be cautious.”
He also mentioned that any decentralized credit scoring system “applied to DeFi lending and borrowing needs to put user privacy and security first.” Jun also believes we “cannot ask individuals to give up their data sovereignty in exchange for a well-working DeFi lending system.”
“Decentralized digital identity systems can help immensely here. By coupling decentralized credit scoring with a decentralized digital identity system, no one party will hold full control over an individual’s financial data. The buck will stop with the individual. The World Economic Forum has been promoting these kinds of digital identity solutions for a long time. In addition, the UK Government endorsed their use universally as the cornerstone of future economies.”
“If DeFi is serious about going mainstream and further nurturing relationships with institutional players, a reliable means for evaluating risk in a timely, accurate manner while permitting the same level of due diligence is integral. In addition, [if]the DeFi industry wants to win the trust of mainstream finance, it … [must] avoid the mistakes many disruptors in big tech have made in recent years.”