Why has been DeFi credit assessment falling behind — Web 3 Credibility, DID Trilogy (pt.2)

Inerslit

Published in

DoubleSlit

6 min readJul 13, 2022

“Why and how could have been better, DeFi”

TLDR;

A number of possibilities have yet to be refined of DID
Is wallet usage history-based loan viable?
What will be the complete form of Credit based loan

The nation which officially adopted DID- Imagination

Current Financial systems have attempted to increase the reliability of credit ratings by using the information other than data provided by financial institutions, but due to restrictions and regulations on Personal Information, it was difficult to evaluate precise creditworthiness based on meaningful data other than bank account information (e.g. organization contributions and more). That being the case, what will the credit assessment look like on the blockchain ecosystem where all the financial product usage records, all the paths of movement of funds, and further all Internet activities are collectively recorded on a single wallet?

On the blockchain, wallet usage records of not only economic activities but also social activities are freely available for analysis and credit assessment. Therefore, evaluating one’s creditworthiness will not only take place in the financial field but also in the sphere of human daily activities. For example, if the results of the vote or contribution in Dao can be reflected in the identification that can be used anywhere, this record can be regarded not only as an indicator of creditworthiness in financial activities but also as an indicator for personnel evaluation.

In addition, if all of these records representing individuals are published Internet-natively in the form of DID (Decentralized ID), it can be intrinsically aligned with the blockchain’s concept of crossing borders and laws while at the same time providing stability within the blockchain ecosystem as a whole. It is in this regard that the universalization of DID behaves similarly to reputational dynamics in the real world, so if social rewards are given (in anonymity), they can play an effective role in quelling chaos.

Still, a long way to go

However, in order for the financial and social status(credit) created by combining these credits to play its role, it is necessary to expand the use cases themselves, which may lead to benefits or disadvantages depending on their creditworthiness. In addition, a strong compensation system for good credits is required considering that it is possible to create a new wallet at any time and launder old records. Thus the punishment for laundering previous records and strong compensation for maintaining the wallets with good records must be guaranteed at the same time, and for the following reason, the relative disadvantage of low credit ratings must also be fatal.

We never had a clear solution for credit assessment (Even existing institutions)

In terms of credit assessment methodologies as an indicator to the extent that they can be used as a credit-based loan, it’s a whole different story. Generally, two types of loan risk insulation methods exist in current finance: collateral-based loans and credit loans. Except for uncertainties in the sale of collateral, collateralized loans are less risky since both parties of the loan can simply discharge their debt positions through liquidation without needing to pay trust costs.

Credit loans, on the other hand, pose many risks since they are provided without any guarantees and are solely based on the prediction of the future, the “reimbursement capabilities.”

Fortunately, in existing finance, there are many reliable indicators to predict repayment ability as well as the appropriate punishment. Individuals’ financial histories are shared between financial institutions, and the records are used to impose life-affecting penalties, such as restricting the use of loans or credit cards.

Nevertheless, there is still plenty of risk of relying entirely on credit. Therefore it can only work under conservative loan conditions such as low loan limits and high-interest rates.

DeFi, Lacking but Stacking

When it comes to credit-based loans in the DeFi ecosystem, it is not even close to it’s full potential. The usage of credit ratings has not yet been widely adopted enough to compensate for high credit and its negative consequences for low credit. Therefore, the motivation to maintain good credit is low, and some may even refuse to be evaluated for credit. The most fatal flaw is the absence of a reliable model which can predict repayment ability; as a result, all of the current successful credit-based DeFi loan protocols are based on the credit rating of existing finance.

The credit evaluation of a loan is primarily a measure of repayment ability, that is, the assurance of future cash flow. The question “Is repayment ability assured?’ can not be answered based on records of ‘What has been done, while might be able to explain ‘what kind of person this is.’

Future of DeFi credit assessment would be like

Then how could this conundrum be resolved further? Compromise with the existing credit rating system has been discussed several times and concluded with clear limitations. Hence we will consider credit loans in terms of an upcoming fully internet-native society( DAO as an occupation, cash flow in the guarantee of the smart contract). It would be possible for the number of DAO members with promised *cash flow to increase, as well as the formation of more synchronized organizations with strong bonds of solidarity between their members and long-term objectives despite the fact that they are mostly small teams of TFs at this point of time.

*(Cash flow does not refer only to regular salaries but also to those cash flows that are currently non-fluid but are guaranteed to be paid in the future, such as tokens at stake and vested assets.)*

Furthermore, it would be ideal to evaluate the cash flow and financial solvency of the DAO itself. Thus, DAO members’ credit will be evaluated alongside DAO credit, enabling recursive evaluation of DAO’s credit based on DAO members’ credit. By achieving this level of development, DeFi would have already established a high degree of reliability in its evaluation criteria for repayment ability for both individuals and organizations.

Having repayment ability verified, the remaining human variables can be easily resolved by utilizing the inherent advantages of the crypto ecosystem. Due to the fact that DeFi can be accessed by anyone without border restrictions, it can reduce the overall protocol risk by dispersing loans and above all, can force interest repayments into codes. While existing credit loans are considered for only evaluation, the credit loans of DeFi may also include additional follow-up measures.

The Trustless-Trust ecosystem will exceed the capability of the current financial system once the Trust mechanism is built on top of it.