Blockchain Revolution

REPUTATION: YOU ARE YOUR CREDIT SCORE

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Whether you’re applying for your first credit card or seeking a loan, the bank will
value one number above all else: your credit score. This number is meant to reflect
your creditworthiness and therefore your risk of default. It is the amalgamation of a
number of inputs, from how long you’ve borrowed to your payment track record.
Most retail credit depends on it. But the calculation is deeply flawed. First, it is
incredibly narrow. A young person with no credit history might have a sterling
reputation, a track record of fulfilling commitments, or a rich aunt. None factors into a
credit score. Second, the score creates perverse incentives for individuals.
Increasingly, people use debit cards, that is, the cash in their account. Because they
have no credit score, they get penalized. Yet credit card firms encourage individuals
without resources to apply for credit cards anyway. Third, scores are very laggy: data
inputs can be outdated and have little relevance. A late payment at the age of twenty
has little bearing on one’s credit risk at fifty.
FICO, an American company originally called Fair, Isaac and Company,
dominates the U.S. market for credit scores, yet it doesn’t factor most relevant
information into its analysis. Marc Andreessen said, “PayPal can do a real-time credit
score in milliseconds, based on your eBay purchase history—and it turns out that’s a
better source of information than the stuff used to generate your FICO score.”
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These
factors, combined with transaction and business data and other attributes generated by
blockchain technology, can enable a far more robust algorithm for issuing credit and
managing risk.
What’s your reputation? We all have at least one. Reputation is critical to trust in
business and in everyday life. To date, financial intermediaries have not used
reputation as the basis for establishing trust between individuals and banks. Consider
a small business owner who wants to get a loan. More often than not, the loan officer
will base the decision on the person’s documentation, a one-point perspective of
identity, and their credit score. Of course, a human being is more than the sum of a
Social Security number, place of birth, primary residence, and credit history.
However, the bank does not know, and does not care, whether you’re a reliable
employee, an active volunteer, an engaged citizen, or the coach of your kid’s soccer
team. The loan officer might appreciate your acting with integrity, but the bank’s
scoring system does not. These components of reputation are simply difficult to
formulate, document, and use as social and economic systems are currently
constructed. Most of these are ethereal and ephemeral.
So what do the billions of people do who have no reputation beyond their
immediate social circle? Where financial services are available to the global poor,
many can’t meet the requisite identity thresholds, such as ID cards, proof of residence,
or financial history. This is a problem in the developed world too. In December 2015,
many large U.S. banks rejected the newly formed New York ID cards as a valid

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credential to open a bank account, despite the fact that more than 670,000 people
signed up for them and the banks’ federal regulators had approved their use.
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Blockchain could solve this problem by empowering people to form unique identities
with a variety of attributes, previous transaction history among them, and give them
new alternatives beyond the traditional banking system.
There are still many use cases—particularly in credit—where the blockchain
establishes trust between parties when trust is needed. Blockchain technology not only
works to ensure that loan funds move to the borrower, but also assures that the
borrower repays with interest. It empowers both parties with their own data,
strengthens their privacy, and generates a new kind of persistent economic identity
based on factors such as one’s past economic history on the blockchain and one’s
social capital. Patrick Deegan, CTO at identity start-up Personal BlackBox, said that
individuals will someday “deploy and manage their own identity, and form trusted
connections with other peers and nodes,” thanks to blockchain technology.
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Because
the blockchain records and stores all transactions in an immutable record, every
transaction can count incrementally toward reputation and creditworthiness. Further,
individuals can decide which persona interacts with which institution. Deegan said, “I
can create different personas that represent different sides of myself, and I choose the
persona that interacts with the company.”
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Banks and other companies on the
blockchain ought not ask for and aggregate more information than they need to
provide service.
This model has proven to work. BTCjam is a peer-to-peer lending platform that
uses reputation as the basis for extending credit. Users can link their profile on
BTCjam to Facebook, LinkedIn, eBay, or Coinbase to add more depth and texture.
Friends can volunteer recommendations from Facebook. You can even submit your
actual credit score as one of many attributes. None of this private information is
released. Users start on the platform with a low credit score. But you can quickly
build a reputation by showing you are a reliable borrower. The best strategy is to start
with a “reputation loan” to prove you’re reliable. As a user, you will have to respond
to investor questions during the funding process. Ignoring these questions is a red
flag; the community will hesitate to fund you. With your first loan, start with a
manageable amount, and pay it back on time. Once you have, your quantitative score
will improve, and other members in the community might give you a positive review.
As of September 2015, BTCjam had funded eighteen thousand loans in excess of $14
million.
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Entrepreneur Erik Voorhees called for common sense: “With a reputation-based
system, people who are more likely to be able to afford a house should be able to
purchase one more easily. Those who are less likely should have a harder time getting

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a loan.” To him, this method “will drive down costs for good actors and drive up costs
for our bad actors, which is the proper incentive.”
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In reputation systems, your
creditworthiness is derived not from a FICO score, but from an amalgamation of
attributes that form your identity and inform your ability to repay a loan. Credit
ratings for companies will also change to reflect new information and insight made
possible by blockchain. Imagine tools that can aggregate reputation and track different
reputational aspects, such as financial trustworthiness, vocational competence, and
social consciousness. Imagine getting credit based on shared values, where the people
loaning you money appreciate your role in the community and your goals.