Crypto Native Credit Score: Between Financial Inclusion and Predatory Lending

Abstract

Decentralized Credit Scoring has surfaced as a new approach in the ever-evolving consumer credit space. While drawing parallels to traditional credit scoring, decentralized credit scoring sets itself apart by evaluating the financial activity and behavior of users within the blockchain ecosystem. Blockchain technology has been fueling this transformation and serving as the backbone for a diverse range of financial products and services collectively known as Decentralized Finance (DeFi). DeFi lending, in particular, has been thriving in recent years. However, the pseudonymous nature of blockchain, coupled with the inherent volatility of crypto assets result in the absence of reliable risk assessment means for DeFi loan processing. As a result, a common practice of relying on overcollateralized loans emerged, limiting access to DeFi loans only to those with substantial collateral.

In the face of this challenge, enterprising DeFi lending protocols sought a transformative solution and introduced Crypto Native credit Scoring. By tapping into blockchain data, Crypto Native credit scoring aims to bridge the gap in risk assessment, rendering DeFi lending more robust and inclusive. While decentralized credit scoring has been touted as safer, more trustworthy, and equitable, we find that it may not be as promising as it is made out to be.

This Article demonstrates how DeFi loans were heavily promoted to the same disadvantaged populations that have experienced exclusion and bias in the traditional finance system and sought out a more equitable alternative. It argues that Crypto Native credit models, which currently operate without regulatory oversight and are met with slow regulatory responses, present new fairness, accountability, and transparency harms that have yet to be identified and addressed by legal commentary. These harms include potential predatory practices by DeFi lending protocols requiring borrowers to over-collateralize their loans to build credit history. This Article further underscores the crucial role of the Consumer Financial Protection Bureau (CFPB) in overseeing decentralized credit scores and the involvement of financial influencers. These influencers, which have been operating without much regulatory attention, are increasingly shaping investment choices, particularly among underprivileged and financially excluded populations.