Time and time again, the impact of blockchain technology has been brought up in multiple fields. The features it provides and its innovative functionality is gradually changing pre-existing systems. Now, we can add credit scores to that list.
The conventional model of the credit score as we know it was created by the Fair Isaac Corporation. Since its creation, it would go on to be a popular model that financial institutions continue to use. There are plenty of other credit-scoring systems, but the FICO score is by far the most common and recognizable.
A credit score is a statistical number that gauges a consumer’s overall ‘creditworthiness’. To determine this, it draws from the consumer’s credit history. Lenders will utilize credit scores as a way to evaluate the probability of an individual repaying their debts. The typical range of someone’s credit score is from 300 to 850. The higher the score is, the more financially trustworthy a person is in the eyes of lenders.
Every creditor will define their own ranges for credit scores. However, the average FICO score range is the following:
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
The system uses mathematical methods to determine a rating. The person’s (or organization’s) personal data, credit history, and statistics on borrowers with similar conditions are parameters for these calculations. It is inevitable for services estimating the risks to use big data, especially when working with a specific borrower. This is how credit scoring systems and credit history agencies would become the largest operators of personal data. Therefore, it only makes sense that they end up working closely together.
With this comes a notable concern: safe storage.
The straightforward definition of blockchain is that it is a shared database. It records transactions that occur between two parties and puts them into an immutable ledger.
The easiest way to describe the structure of blockchain is in the name itself. The “blocks” are pieces of data and the “chain” is the public ledger they go on. A block will contain pieces of information about the time in which the transaction occurs. Moreover, it has information pertaining to previous transactions and details about the transaction. Upon being recorded as a block, the order of the transactions is chronological and it’s impossible to alter them.
This technology has been lauded for an array of qualities, with one of them being its system of privacy.
A core aspect of privacy in this technology is the use of ‘private keys’ and ‘public keys’. Blockchain systems use asymmetric cryptography as a means to secure transactions between users. In these systems, each user possesses a public and private key, which are random strings of numbers. What’s more, they are cryptographically related. From a mathematical perspective, it is impossible for a user to guess another user’s private key from their public key. This effectively provides a considerable increase in security and thus, protects users from potential hacks.
Other elements that correlate with blockchain and privacy protection are peer-to-peer networks and zero-knowledge proofs. The former is essentially a distributed application architecture that divides tasks or workloads between peers. The latter is a consensus decision-making protocol. Basically, one party proves to another party that something is true without revealing any information.
All in all, blockchain technology leaves a mark when it comes to privacy protection. With this in mind, it becomes unsurprising that the subject of credit scores would come up.
The question of reliable storage for credit score data
For most agencies, credit scoring systems and credit history agencies collaborating are quite convenient. The same cannot be said from the perspective of the users. In the areas where there is a heavy focus on personal data, the matter of safe storage is very urgent.
There was an incident in 2017 that would leave a lot of people in doubt concerning the safety of their information. Between May and July of that year, hackers stole up to 145 million Americans’ Social Security numbers. On top of that, they were also successful in stealing birthdays, driver’s license numbers, and addresses from Equifax. This company is one of the three largest credit reporting agencies in the U.S., making the hack all the more devastating.
The additional data has the potential to make it easier for hackers to open credit lines. Alternatively, they could go on to exploit the identities of the victims. The theft of tax ID numbers is one that raises an extensive amount of concern. This is because it may boost the risk of fraudulent tax filings.
Storage that is centralized is completely vulnerable and will be a constant target for hackers. The large-scale hack of users’ database at Equifax is all the confirmation that this belief needs. This fiasco is not an annoying misfortune; hackers continue to attack, making it much more than an unfortunate event. Thus, there is a sense of powerlessness on the part of the industry.
Blockchain and cryptographic technologies alike have the capability of providing much better protection for vital information. In addition, credit scoring is an easily solvable issue for such systems. Moreover, there are companies out there in which credit issuance also fully operates on the blockchain.
Access to data
There are a wide variety of organizations that have an interest in studying the financial condition of future customers. In order to properly carry this out, they need data. Luckily for them, credit agencies compile, store, provide upon request, and sell user data to these organizations.
Generally speaking, laws oblige to provide credit history reports upon official requests of citizens. Regardless, one can obtain this service free of charge, but only for a limited number of times. There are a few noteworthy examples of this time limit. In the U.S., it is once a year. Russia has it set for twice a year. In India, it is also once a year, as is the limit in Australia. As it turns out, the users’ data – which is personal and obviously very important – is a commodity that is tradable. Specifically, by companies that collect it and put it into storage, often quite carelessly.
On its own, blockchain is admittedly not a thorough solution to this problem. In the traditional distributed ledger, records are typically open to all users to see. What’s more, all communications, transactions, and member relationships are susceptible to tracking. However, with the assistance of blockchain technology and cryptographic technologies, there is a solution that can come to fruition. It is entirely possible to construct a system where digital identity systems provide data access safely, as well as flexible.
The questionable complexity of loans
The relationship between a borrower – whether potential or recurring – and credit organizations a significant aspect of credit scores and loans. Oftentimes, they are the defining feature of an individual’s trustworthiness. Without it, how can one’s reliability on paying back be determined? Algorithms specifically for calculating the rating of scoring systems take the history of this particular relationship into account. Such pieces of information include the size of loans and payment schedules compliance among others.
There are various reasons as to why a client may not have credits. Maybe they live in an area where they were inaccessible or perhaps they didn’t have a need. Moreover, they are probably not old enough. Whatever the reason may be, the scoring system will lower their assessment. There are times when a recommendation to take out another loan accompanies the refusal. To elaborate, a loan that is smaller so that you can restore your credit history with positive actions.
Evidently, there is little to no rationality in this practice. It doesn’t make sense for a store to deny the sale of a product to someone who has never before purchased such goods. More contemporary computing systems combine an array of factors. These include machine learning technologies, peer-to-peer communications, smart contracts, and of course, blockchain. With this assembly, they can calculate the borrower’s rating. Furthermore, they can do so without lowering it due to the lack of credit history.
What comes from moving
People that move across borders – province or state – are not out of the ordinary. However, traditional credit rating agencies and scoring companies don’t view foreign borrowers’ data as pertinent to the current situation. People just have to accept that a good credit history resets to zero following migration. Moreover, everything needs to start from scratch. In this particular case, blockchain technologies prove themselves to be the better system. Generally speaking, there are little to no boundaries for them. This is because the movement of an individual across the world does not affect the overall credit rating.
There is something important that one should keep in mind regarding a client of the blockchain credit scoring system. That being in a new location, banking infrastructure that is sufficiently developed will likely not be present. It won’t be an issue if cryptocurrency payment systems develop. The bank offices will end up losing significance for the availability of credit products.
“I don’t have a bank account”
‘Unbanked’ is a term that is used to describe people who do not have a bank account of their own. Moreover, those who do not use loans in microfinance institutions. Overall, there are roughly 1.7 billion unbanked adults worldwide. In terms of the banking system, these people are out of reach.
A majority of those who are unbanked are people who live in developing countries. From a realistic perspective, the foundation of credit institutions will not expand there quickly enough. The reason for this being that it is as expensive as it is inefficient. People that have low income will not be able to receive credit products. This is due to them failing to meet the requirements of banks. Furthermore, scoring systems will typically not assign them a rating that is satisfactory enough.
Meanwhile, adults who are unbanked can potentially bring in up to “$380 billion in new revenues.” All that needs to be done is finding a way to make loan products affordable for these people. In the U.S. alone, 14% of the population falls into the category of “credit invisibility.” This is because they do not have a personal rating in scoring systems. With this in mind, it becomes apparent that there is great potential even for developed countries.
Blockchain projects could in all likelihood benefit from this potential as well.
From here, let’s quickly go over some projects and companies that are incorporating blockchain into their systems. They are already developing products specifically for the credit scoring market and credit histories.
- Colendi – This is a project that aims to provide credit products to people who don’t have access to the banking system. The proprietary development of the company is an array of algorithms that are able to calculate the Colendi Score.
- Bloom – This project’s primary goal is to facilitate the receipt of loan financing. Specifically, for those who have difficulties with accessing any kind of banking product. An additional intent of theirs is to provide a blockchain-based digital identity system that is modern, trustworthy, and secure.
- POINTS & Ontology – The POINTS project is in collaboration with the Ontology Network and hopes to meet the needs of the Chinese market. The main objective of the company is to provide services for the cooperation of financial market participants. These include a variety of companies and institutions, as well as individuals, that vary in size and structure.
With blockchain leaving its impact on various fields, it should come as no surprise that it will do the same thing with credit scoring. There are a lot of factors that are effectively tipping the scales towards the side of the crypto community. With the devastation of various database hackings, an excessive amount of unbanked citizens worldwide, and the benefit of the implementation, who would argue otherwise?
Of course, there are some issues that are stemming from the gradual increase of blockchain credit rating agencies. A large number of these problems are thankfully already being addressed. Still, though, public opinion is what matters, and plenty of people are in full support of the blockchain revolution. Because of this, financial institutions and authorities have no excuse in disputing the need for change. To do so would be almost imbecilic. 🙂