The fintech industry is going through a global transformation. With the advent of blockchain technology, fintech is being revolutionized. But has this transformation benefited individuals yet?
The answer is no. A major example is the credit scoring model. It is 2022, and financial institutions still use a centralized credit scoring model, making them more vulnerable to hackers and cyberattacks.
Credit scoring is where the transformation needs to happen, and experts say enterprise blockchain technologies are the solution for this issue.
Let's explore credit scoring and how blockchain credit scoring can make it better.
A credit score is a number/value that tells how worthy a person is to earn credit. A higher credit score depicts that the person is highly likely to repay a debt on time; this makes it easier for lenders to offer credit.
Various factors will influence a credit score, like the number of active accounts, the volume of debt, repayment frequency, etc. Credit scores are calculated based on these factors, and the score ranges between 300 to 850.
This is how the traditional credit score models work: Lenders look at the scores to assess the capacity of an individual to repay the credit borrowed. When the score is low, the chances of getting credit from lenders (banks, credit unions, etc.) are also low.
Traditional credit score models used to be effective for calculating credit scores. They eliminated major discrepancies and gave lenders a breath of fresh air. Lenders could speed up the lending process, which resulted in the growth of the commercial loan industry.
Now, the world has digitalized, making traditional credit scoring systems obsolete and prone to cyber-attacks. Here are some of the major issues with the existing structure:
Credit scores are calculated based on historical loan data; what about someone new to credit? How will their credit score be calculated? Due to this issue, more deserving individuals are denied fair credit, and sometimes they will be the ones that need the credit.
Almost anyone can calculate a credit score, and credit bureaus are transparent about it.
While being transparent is good, it also has its downsides; people can easily manipulate their scores and make them look like they are at higher credit risk.
Financial experts and institutes have warned that the major issue with traditional credit scoring methods is the incredible number of errors in credit files and reports.
There is a potential material error in one of five consumer credit files, making them appear riskier than they are. This kind of error might lead to loan rejection altogether.
Another major issue borrowers suffer is the credit trouble they face when migrating to a different country. There are three credit bureaus: Equifax, Experian, and TransUnion. Lenders calculate credit scores depending on these bureaus; due to the disconnect among these bureaus, an individual will have to build their credit from scratch if they move to a different country.
This is an issue of the highest priority. In 2017, Equifax, one of the largest credit reporting agencies, suffered a data breach that exposed the sensitive information of 148 million Americans. Names, phone numbers, addresses, and social security numbers were among the data compromised due to this breach.
This is why the need to switch to a decentralized system like Blockchain has risen; technologies like enterprise blockchain and Hyperledger can be viable solutions to fix these data breach issues. Let’s discuss this further in the following section.
The inception of blockchain technology transformed several industries, particularly the finance industry.
Blockchain technology is not new. The first decentralized application to emerge from blockchain technology was peer-to-peer digital cash (cryptocurrency) like Bitcoin, Ethereum, etc. Cryptocurrency is public; it doesn’t come under enterprise blockchain.
Decentralized finance is the next application of blockchain technology. It has explored the feasibility of conducting financial services through a peer-to-peer (P2P) system, removing the need for a middleman or central authority.
Centralized credit scoring relies on debt payback history information from financial organizations to estimate a borrower's creditworthiness.
In contrast, decentralized credit scoring employs a peer-to-peer network of trustworthy parties and customer data to certify a potential borrower's identity and creditworthiness, resulting in a safe credit scoring system for everyone, regardless of debt history.
Furthermore, a decentralized credit rating eliminates the need for traditional credit bureaus, which have become prone to data breaches.
Long story short, this is how decentralized credit scoring can help individuals:
Unlike a centralized system, sensitive data is not stored in one place. Decentralized scoring is done on enterprise blockchains, where the information is not stored in one place, reducing the chances of theft.
Let’s look at the 2017 Equifax data breach as an example. It happened because all the data was stored in one centralized location, making it a sitting target for cyber attackers.
Permissioned blockchain technology like Hyperledger can eradicate this issue as it won’t store the data in one location and will be accessible only to people with authentication.
A centralized system doesn’t let the borrowers see their actual credit report; at times, you’ve to pay to see your credit report, and even then, only a farce detail is visible to the borrower.
Credit bureaus send two reports, one for the borrower and the other for the lender. The lender gets to see additional reports on the credit score that a borrower can’t see, giving them power over the borrower.
With decentralized credit scoring, the playing field is leveled. Credit scores are available to both the borrower and the lender with the correct authentication.
Now the borrower can access their data by themselves without the help of an external agency. They will have complete control over their data, and if there are errors in their score, they’ll know it and fix those without affecting their credit score.
Blockchain technology has the potential to credit individuals who are at the highest risk.
The volume of unbanked and underbanked individuals is getting high. Traditional lenders cannot offer credit to these individuals due to their lack of credit history.
For example, homeless people cannot get a loan as they might not have a credit history. With blockchain credit scoring, unbanked individuals can obtain credit scores without previous credit history and access lending services through decentralized credit scoring.
Centralized credit scoring is limited to countries due to the disconnection between credit bureaus. This is not the case in a decentralized scoring system because the calculations are not based on geography.
So, individuals can migrate to any country without fearing their credit score might be reset.
Crypto-currency is just the beginning; enterprise blockchain technology has the potential to transform every industry, not just finance. Permissioned blockchain technology like enterprise blockchain and Hyperledger is still unexplored; once the word gets out, we can witness the revolution. Blockchain is all about giving power back to the people from centralized bureaus. Decentralized credit scoring is just the tip of the iceberg; Blockchain technologies offer many possibilities.
