To say that the credit scoring system today is a flawed and messy one is modest at best. At worst, it’s taking away opportunities from those who need it the most – but blockchain platforms might have a solution.
Credit scores, which CNBC reports can range from 300-900 in the US, measure the possibility that a borrower will default. In that sense, credit scores affect a person’s participation in the financial system – be it loans, mortgage approvals, interest rates, or insurance premiums. It can determine whether individuals can secure tenure in apartments or if they can obtain credit cards. In the larger economy, it can also impact producers and entrepreneurs, especially small and medium enterprises, in terms of expanding and building capital.
One huge problem, however, is how it’s actually measured. The process itself relies heavily on loan repayments, which presents an obvious difficulty for younger generations. In an article by Petal Card on the flaws of credit scoring for those starting out their financial journey, it reveals that over 10 million adults under the age of 25 haven’t started building their credit – and that’s just the tip of the iceberg. Even millennials or those who are aged 25 to 40 today have seen their credit scores take a hit. Data from consumer credit reporting think tank Experian shows that millennials and the younger generation have the lowest credit score. And it’s worse for the 1.7 billion adults around the world who remain unbanked – without a credit history, there’s no realistic scoring or easy access to other financial products.
That’s why banks and financial institutions are increasingly investing in blockchain-based credit scoring.
The decentralized solution
The similarity between the immutability of data and transparency in blockchain technology and financial services has long been recognized. From trade financing and foreign exchange to initiatives like the China-led International Cooperation Forum of Blockchain and Digital Finance, blockchain is increasingly seen as the key to the future of financial services.
One key application of these decentralized ledger technologies is in revolutionizing credit scoring. Blockchain based scoring leverages the decentralized architecture of the technology to consider non-traditional factors as well. These can include shopping habits, telecom bills, and social media activity – most of which are paid for in cash or outside the formal financial economy. As a result, this will greatly benefit those without credit history and even those with complicated payment relationships – enabling them to have a level of control over their credit scores.
Another key advantage, however, is data security. Following the Equifax hack in 2018, blockchain-based scoring platform Bloom saw its user signup go through the roof. The decentralized app lets users securely create a global identity which lenders can verify and base their credit scores on.
On the other hand, another platform called INVIOU allows creditors to provide businesses with credit and for businesses to seek credit from lenders. This lets small businesses log and verify their financial documents – showing the lenders their creditworthiness. As it’s made through the blockchain, it minimizes if not obliterates chances of fraud and boosts credibility.
With the rollout of new FICO scores in the US – which experts note will heavily penalize the unbanked engaging in personal loans – more and more organizations and lenders will likely lean to blockchain based scoring platforms. And as these platforms develop to include more alternative data and provide a clearer insight to users’ financial health, it will prove to be a useful substitute to current scoring systems.