“Too many people spend money they haven’t earned, to buy things they don’t want, to impress people that they don’t like.” ― Will Rogers
A Brief History
There are a lot of confusing and contradictory theories about what credit is and why it exists. Some people think credit is necessary for an individual and an economy. Some people believe credit is an evil tool used by predators to extract other’s wealth.
Although the economic and philosophical debate will continue, the fact remains that borrowers and lenders are concepts that have existed and will continue to exist for the foreseeable future. Credit is an ancient and simple concept. The lender provides money to the borrower, and the borrower gets the funds that they need to do things they otherwise could not without the funds.
The details and terms are where credit gets complicated. The rules have changed dramatically depending on who you are, where you live, what year it is, and how you plan to use the loan. Lenders in the past could provide you with no-interest loans out of charity, or they could use violence to intimidate you into taking loans and paying them back with predatory terms. Generally speaking, access to lending was more about who you knew and what culture you identified with rather than your objective “creditworthiness.”
In the latter half of the 20th century, many societies implemented fundamental civil reforms in lending. These reforms criminalized abusive debt collection practices, required lenders to disclose loan terms to borrowers, standardized credit agencies, and prevented the practice of discrimination against protected classes.
These laws dramatically changed the practices of lending and borrowing. Lenders found themselves regulated by the government, but they also had access to an enormous market, where they could sell a variety of products to anyone.
A New Industry is Born
“It’s not overblown to call the credit score one of the most important financial metrics that we now live with.” ― John Ulzheimer
With so many borrowers and so many products to sell to them, the lending industry quickly realized a need for a standard model to judge an individual’s creditworthiness. Many firms were already experimenting with their models by providing “reliable” borrowers access to new products and more favorable terms on loans. These practices continue to this day, but they are labor-intensive and require invasive background checks. Lenders determined that more universal and straightforward metrics would be needed to process the massive amount of mortgages, credit card applications, and personal loans sold by the industry.
In a short amount of time, several sectors emerged that allowed this simplified system to exist. These companies were a mix of startups, old companies, new companies, and government institutions.
One sector to emerge were those who created the scoring systems. The scoring system has to be simplified and give lenders an accurate picture of an individual or institution’s creditworthiness. The scoring system works best when it becomes standardized. If a borrower can ignore their score and go to another bank and get a loan, it doesn’t work as well. An excellent example of this is FICO in the United States.
A second sector emerged of organizations that specialized in compiling all the data for creditworthiness evaluations. Data gathering and storage is a very labor-intensive process, as the organizations need to continually update countless pieces of information regarding payment history, accounts, and personal information. These organizations pioneered the computerization of data and built pathways and relationships with lenders. The organizations have dozens of names depending on what county they operate in, but they’re generally considered Credit Bureaus. An excellent example of this is Equifax, a corporation with global reach in dozens of markets.
Another sector that emerged relatively recently is the personal finance company. These organizations help consumers understand their credit scores and give them tools to improve and maintain them. An excellent example of this is Credit Karma.
The credit industry’s original players, lenders, needed to cooperate with this system by sending information to credit bureaus and using the standardized scoring system. This system has generally worked because everyone in the system has been able to profit. Most of those profits are earned by selling the massive amount of consumer data collected, selling credit products, and collecting fees from those using the system.
The new credit evaluation systems developed in the 20th century revolutionized lending and borrowing across the world. By the end of the century, these systems had become the standard model (with some variations) to evaluate individuals’ creditworthiness in most countries.
Mistakes Were Made
“A security freeze is one step you can take to help prevent access to your Equifax credit report to open credit accounts.” ― Equifax Security Freeze Website
Unfortunately, there were some deficiencies in the systems designed to evaluate individual creditworthiness, and some serious negative side-effects from the emergence of the credit evaluation industry.
It is possible to classify the majority of these problems into two distinct significant criticisms.
The first major criticism is that the system is highly centralized. Centralization is a common theme throughout the industry.
Credit Bureaus store tremendous amounts of personal data and are in a constant battle with data thieves attempting to steal it. Linking accounts using sensitive personal information like unique identification numbers and addresses has been the standard for almost every bureau since the beginning. It has come to the point where it’s better to freeze your ability to apply for credit when you don’t need it. Someone can easily impersonate you and use your information to open loans, credit cards, and even take out a mortgage in your name. This threat has become an existential threat to anyone who even seeks to have a credit score.
It often takes a long time for reportable actions to come up on your credit reports. It can be months before someone realizes that they are a victim of identity theft. It can also be months before you get access to credit after taking positive steps to improve your creditworthiness. The time delay has led to the rise of personal finance companies and credit monitoring, resulting in companies accumulating more data in centralized storage.
Many people feel the credit evaluation industry is an oligopoly. Very few corporations control the entire system. They set policy and have enough money and resources to weaken government actions on consumer protection. Credit scoring agencies, credit bureaus, and personal finance companies are all criticized for negatively influencing the credit evaluation process to maximize their profits.
The second major criticism is that the credit evaluation systems built in the 20th-century help solve past problems but do not adapt to future financial systems.
Even though each country has a standardized credit evaluation system, those standards change from country to country. Having good credit in one country does not guarantee good credit in another. This regulatory conflict causes problems not only for individuals who find themself in a new country but for businesses that wish to conduct international business.
Although credit scores are sophisticated algorithms, they are limited by the type of data they can track. Usually, this is simple data such as the age of your accounts, number of accounts, payment history, whether you have applied for credit recently, or whether you have derogatory marks. Credit scores do not include other important factors, such as salary, employment, child support, or whether you are in credit counseling. Unfortunately, it is possible to have an excellent income, no debt, practice responsible spending habits, and yet have little to no credit access.
Limited credit access also affects younger people. They are often subject to low scores due to having few accounts, minimal credit history, and no credit access before they reach legal adult age.
Although traditional credit scoring systems often work for traditional credit types like mortgages and credit cards, they have limitations. Credit fundamentally requires “Know Your Customer” (KYC) checks, which expose people’s identities.
Finally, traditional credit scoring systems are not easily integrated into Decentralized Finance (DeFi). DeFi systems rely on anonymity and a public ledger to function, rather than personal information and credit bureaus. The systems are fundamentally incompatible.
The ZORA Score: A New Algorithm
“If crypto succeeds, it’s not because it empowers better people. It’s because it empowers better institutions.” ― Vitalik Buterin
Zoracles is a cryptocurrency project launched in May 2020. The Zoracles developers specialize in two things: oracles and privacy tools. Their name is a portmanteau of “Z” and “oracles.” The “Z” represents privacy tools like ZKPs and zkSNARKs. “Oracles” represent devices or entities that connect deterministic blockchains with off-chain data.
The Zoracles team found itself in a unique position with the emergence of DeFi this past summer. The developers’ skillsets allowed them to build a wide variety of oracle projects with privacy features. These products include specialized price feeds, derivative platforms, and many others. One of the most promising products is a solution for evaluating the creditworthiness of a cryptocurrency wallet. This product requires both privacy technology and oracles to work seamlessly.
The Zoracles team decided to immediately pursue building a credit platform, primarily due to the lack of DeFi-based credit evaluation systems and uncollateralized lending.
They created and implemented the Zoracles On-chain Reputation Assessment Score or the ZORA Score for short. You can preview your score at https://zora.cc.
The ZORA Score is based on an algorithm that scores a blockchain wallet on its creditworthiness, similar to how FICO scores a person on their creditworthiness. However, instead of using centralized data stored by credit bureaus, the ZORA Score draws its data from publically available blockchains. There are a long list of factors that are compiled into signals informing the algorithm of an individuals creditworthiness.
A distinguishing feature of The ZORA Score v.s. FICO is that it does not require personal information. The algorithm always reflects the most updated information on the blockchain. It can be used by any person in any country and can be easily integrated into the larger DeFi ecosystem. It can also provide various scoring assessments to existing and future DeFi protocols by leveraging an API being built by Zoracles.
Over time, the development team plans to strengthen their algorithm with more sophisticated signals and data pulled using oracles. Although currently built on Ethereum, Zoracle credit platform can be ported to different chains in the future.
The ZORA score can be used for a myriad of other tasks, aside from evaluating creditworthiness. Some of these tasks include reputation assessment, decentralized identity and screening for malicious activity.
The cryptocurrency community now has a tool for evaluating creditworthiness. Zoracles and the ZORA Score can help empower more robust lending protocols as well as their uncollateralized credit lines that are scheduled to launch sometime in Q3 of 2021.
“Human beings, viewed as behaving systems, are quite simple. The apparent complexity of our behavior over time is largely a reflection of the complexity of the environment in which we find ourselves.” ― Herbert A. Simon
To many, it feels as though the emergence of cryptocurrencies and decentralized finance couldn’t come at a better time in history. Almost everyone has a financial horror story from traditional finance: identity theft, the subprime mortgage crisis, increasing national debts, currency devaluation, the credit bureau hacks, discrimination, and countless others.
Inevitably, there has been a breakdown of trust between the people and the traditional credit evaluation systems. These traditional systems were designed in the past when humans had less complexity to manage.
Not everything that the traditional financial system created was bad. Credit bureaus helped pioneer the computerization of data, but were not prepared for the consequences of centralizing personal information. Personal finance companies significantly increased consumer education regarding credit evaluation systems, yet eventually became driven by the same need to sell credit products as the lenders themselves. Although credit scoring agencies did their best to create accurate scoring systems, they were limited in what they could evaluate.
Ultimately, new technology had to be developed to mitigate the problems of the traditional credit evaluation systems. Blockchain technology is the technology that solves the critical flaw of centralization. Decentralized finance is the new system that is being built on blockchain technology and Zoracles Protocol is building the future of DeFi credit with their unique algorithm.
Zoracles partners with DeFi projects using zero-knowledge proofs to provide confidential data to smart contracts. Our product lines include confidential credit, price feeds and a “Snarks-As-A-Service” software platform.