Equifax, TransUnion, Experian FICO Scores Grow Increasingly Inaccurate with Wider Crypto Adoption
The total amount of Americans with cryptocurrency holdings doubled from 7.95% in 2018 to 14.4% in 2019. Equifax, TransUnion, Experian FICO Scores Grow Increasingly Inaccurate with Wider Crypto Adoption
Today, 59.1 million Americans (28 percent of the adult population) own some form of crypto. At the same time, employees around the world increasingly select cryptocurrency as an alternative to fiat compensation, including prominent athletes in the CEBL, NBA, NFL and Nascar.
Decentralized finance (DeFi) loans are also showing tremendous growth. Lenders like Genesis saw an increase in DeFi lending of 400% from $465 million in Q4 2020 to $2.4 billion in Q1 of 2021. MasterCard and Visa have also announced cryptocurrency support. When you consider that cryptocurrency did not exist a decade ago, and yet is currently worth $1.56 trillion, you begin to appreciate why crypto and decentralized finance are now essential asset classes in the modern finance landscape.
Every sector of the modern financial system has acknowledged the resilience of decentralized finance as an inescapable component of our financial future, with one egregious omission: FICO credit scores. FICO credit scores have long been the tool of choice in Institutional finance for quickly evaluating a prospective lender’s creditworthiness. It excels at being a quick, portable, and complete summary of a borrower’s financial capability.
However, the inherently anonymous nature of DeFi presents a unique challenge to this type of system that relies heavily on identity verification. To date, none of the “Big Three” credit bureaus, TransUnion, Equifax, or Experian have produced a solution to this problem. This failure means as crypto gains more and more user adoption, FICO credit ratings will become progressively inaccurate as a tool for financial assessment.
Big Problem; Big Opportunity
The anonymous nature of cryptocurrency presents the most obvious problem for FICO scores. A borrower’s financial commitments — positive or negative — are invisible to the Bureaus. Credit utilization obfuscation is a less obvious challenge presented as a result of the proliferation of DeFi, — specifically Crypto loans. This threat is illustrated perfectly in an excerpt from an article published by BlockFi entitled, “Will a Crypto Loan Affect my Credit Score?”
Carrying significant balances across your credit cards can drag down your credit score. ‘Credit utilization’ is dictated by those carried balances and is calculated by taking your statement balances and dividing it by your credit limits. This calculation makes up 30% of your credit score. The lower the utilization, the better. Typically utilization at around 25% of total credit card limits starts to hurt your score.
Some BlockFi clients use their loan to pay down those outstanding balances. This can go a long way towards improving your FICO and credit scores.
Because of the significance FICO scores give to credit utilization, obfuscation has the potential to significantly invalidate the score.
For many, the catalyst for the departure from decentralized finance has more to do with opportunity than obfuscation.
Solving the DeFi/FICO problem will not only improve the accuracy of the FICO scores, it will help give insight for developing more compelling products for those underserved by traditional financial products.
Utilization obfuscation is a critical problem for both DeFi and FICO credit rating agencies. Those who pioneer innovations that solve this issue will undoubtedly create new opportunities in the other.
The Solution: How LedgerScore Solves FICO’s DeFi problem With LedgerScore GhostIdentity
Introducing LedgerScore GhostIdentity
Wallet addresses are like bank accounts. The accuracy of any DeFi transaction history is directly proportional to the completeness of each user’s decentralized financial identity — that is, across as many financial properties (wallets, loans, tokens etc.) as possible. LedgerScore GhostIdentity was created as a secure, anonymous, and easy way to associate your financial identity across the entire DeFi landscape.
While LedgerScore GhostIDs are anonymous by design, they provide a user with the portability to leverage their DeFi identity in traditional finance. LedgerScore envisions a future where a user has the choice to have their LedgerSore GhostIdentity verified by a bank via our partner API and utilize a favorable DeFi transaction history to secure a loan in traditional finance.
Similar to Bank API access, FICO bureaus will have the ability to allow users to associate their LedgerScore GhostIdentity with their FICO credit ratings.
Beyond LedgerScore GhostIdentity
LedgerScore GhostIdentity Is Just One Of Three (3) Core Technologies That Combine To Solve Some Of The Toughest Problems Plaguing Defi Lending. Here Are The Other Two:
* LedgerScore Defi Credit Score
* LedgerScore GhostSignature
LedgerScore Credit Score
LedgerScore scores are calculated by a proprietary scoring engine produced in collaboration with some of the largest DeFi lenders. LedgerScores are generated by a combination of deterministic and intelligent systems. The deterministic layer of the score is calculated by evaluating a variety of on-chain behaviors to extrapolate key markers such as transactional activity, preferred token mix, combined balance across all wallets and locked tokens (or utilization).
LedgerScore GhostIdentity also opens up a unique opportunity to extract intelligence across a combined crypto identity — that is, spanning several wallets and currencies to create the most accurate image of the borrower.
The second layer of the score is calculated based on our Artificially Intelligent Risk Inference engine, A.R.I.. On a very high-level, A.R.I. ingests detailed transactional data across several wallets and compares them against prototypical data models from successfully executed loan agreements. In essence, with the help of our DeFi Lending partners, A.R.I. is able to extract high and low risk patterns.
The best part about A.R.I. is, with each loan execution it becomes more accurate. A.R.I. is part of LedgerScore’s big plays towards finally meeting the Industry goal of automated, DeFi loan risk assessment. We believe it is one of the final pieces necessary to realize the full disruptive potential of decentralized finance.
The primary goal of LedgerScore is to provide our users with the most competitive loan rates, and for our DeFi loan partners, the best tools to evaluate prospective borrower risk. LedgerScore GhostSignatures were created as an optional, supplementary risk mitigation protocol for DeFi lenders.
At a very high level, LedgerScore GhostSignatures allow a LedgerScore user to collateralize their verified KYC in the form of a double-blind smart contract. When a borrower successfully repays a loan initiated with a GhostSignature it closes the smart contract and the borrower’s KYC is never revealed. The borrower’s GhostIdentity is updated to reflect the successful repayment of the loan, and a score bonus is applied.
In the event of a default, the borrower’s KYC will become available to the Lender. This enables traditional, legal forms of collection, significantly increasing the probability of recovery.
Blockchain technology presents a unique opportunity to completely disrupt traditional finance systems. LedgerScore is fully invested in realizing the full potential of the decentralized finance future, and are committed to building the tools to make it possible.
FICO Score’s Hold On The Credit Market Is Slipping
Three-digit number has been linchpin of consumer-credit decisions, but banks are increasingly relying on their own scores.
For decades, nearly every consumer credit decision revolved around a three-digit number—the FICO credit score. That is changing.
FICO has long dominated the market for consumer credit, providing scores for some 200 million U.S. consumers that are used by a whole host of lenders to evaluate credit-card, auto-loan and mortgage applicants. For borrowers, higher scores can mean bigger loans and lower interest rates.
But powerful forces are aligning to challenge its dominance.
Big lenders are moving away from FICO, according to people familiar with the matter. Capital One Financial Corp. and Synchrony Financial don’t use its scores for most consumer-lending decisions. They are becoming a smaller factor in some underwriting decisions at JPMorgan Chase & Co. and Bank of America Corp.
A key financial regulator, meanwhile, is encouraging banks to de-emphasize credit scores in an effort to expand access to affordable credit. And housing-finance giants Fannie Mae and Freddie Mac are considering allowing lenders to use other scores when evaluating mortgage applicants.
There are a few reasons for the shift. Many lenders now review a wealth of new data and use it to refine their own proprietary scores that they say are better able to predict who will repay and who won’t. Regulators are concerned that FICO leaves too many Americans behind, limiting them to payday loans and other costly forms of credit. Some 53 million U.S. adults lack traditional FICO scores because they have thin or nonexistent borrowing histories.
“FICO scores are good, but they’re not perfect,” said Roger Hochschild, chief executive of Discover Financial Services. The company relies less on FICO scores when evaluating existing or prior customers and more when applicants are brand-new to Discover, he said.
‘FICO scores are good, but they’re not perfect.’
— Roger Hochschild, Discover Financial Services CEO
FICO’s waning influence could become a problem for the roughly $16 billion company behind it: Fair Isaac Corp. FICO scores account for about 40% of the company’s revenue but nearly all of its profits, according to people familiar with the matter.
The company has increased its price for traditional FICO scores significantly in recent years, to around 25 cents apiece for underwriting purposes from 15 cents to 18 cents, eliciting complaints from some big lenders, according to people familiar with the matter. In recent months, it has offered lenders free access to two newer credit scores meant to boost loan approvals among applicants with slim credit histories, other people said.
“We see no evidence in our business to indicate the marketplace is using the FICO score less,” said a FICO spokeswoman. “We realize lenders use, and in fact encourage lenders to use, the FICO score in conjunction with proprietary data and models to make the best decision possible.” The spokeswoman said that FICO didn’t materially increase the price of FICO scores for 25 years after the score’s introduction. “After decades of inflation, the real price of the FICO score effectively decreased,” she said.
FICO scores, which range from 300 to 850, are calculated using the information in people’s credit reports, such as payment history, credit-card debt relative to spending limits and recent credit applications.
Borrowers often check their FICO scores before they apply for credit. But the guessing game is getting harder. Big banks are increasingly approving applicants with low FICO scores or rejecting those with high scores if alternative metrics point in a different direction, lending executives said.
Still, the scores are a mainstay in many consumer credit decisions. The company sold more than 10 billion FICO scores in the past 12 months, a figure that has remained steady during the last few years.
Lenders’ efforts to rely less on FICO scores accelerated during the pandemic. The scores don’t reflect deferment and forbearance programs, making it harder for lenders to evaluate borrowers. Some 48% of lenders feel less confident making consumer lending decisions based on traditional credit scores and reports compared with a year prior, according to a recent Aite Group survey of more than 20 lenders including banks, credit unions and financial-technology firms.
Bank credit executives say their own internal data and proprietary scores are more reliable. They factor in information from credit reports, deposit balances and overdrafts and their own prior lending relationships with applicants.
“There are many other sources of data that can indicate a person’s creditworthiness that weren’t available before,” said Will Graylin, a board member at Synchrony, the largest issuer of store credit cards in the U.S., and chief executive of payments startup OV Loop.
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