By Serafin Lion Engel is Founder and CEO of DataWallet
In reaction to a data breach affecting a reported 143 million Americans, the New York Times published an article suggesting the government to take over Equifax’s job. In the light of advancements in blockchain technology, the question arises: why not let the people take over?
Equifax recently suffered an unprecedented data breach affecting 143 million people. Compromised data includes Social Security Numbers and driver's licenses, and their associated credit history. Writing to the CEO of Equifax on September 11, 2017, US Senator Brian Schatz said:
“The impact [on affected Equifax customers] is potentially devastating… They could suffer long-lasting damage to their credit… they could be denied loans, mortgages, employment, or even rental housing... they will likely spend months, if not years, trying to resolve resulting errors and problems with their financial records.”
The Cost of the Central System
While it’s hard to pinpoint the exact implications of this breach, take a look at the following example:
According to the US Census Bureau’s 2016 data, 70.58% of all houses were bought through “traditional financing,” which includes all mortgages that aren’t secured by a government agency like the Federal Housing Administration (FHA). The average sale price was $407,500. With a 30-year loan, 20% down, and 4% interest, the average homeowner has total interest payments of $232,856.
If a hacking victim’s interest rate is raised from 4% to 5%, those total interest payments become $302,150 – a 29.76% increase. With 143 million Americans affected, this breach could cause the housing market to decrease by about $35.5 billion.
How is Equifax capable of doing this much damage?
The Role of CRAs
Equifax is one of the largest consumer credit reporting agencies (CRAs) in the world. CRAs provide data on people’s borrowing and bill-paying behaviors, which creditors have long used to screen potential borrowers and avoid “high risk” loans. People with bad credit-repayment histories or court adjudicated debt obligations (like tax liens or bankruptcies) will pay higher interest rates than consumers who don't. By supplying this data, CRA’s like Equifax have become the mediators of the credit ecosystem.
When it was founded in 1899, Equifax’s expertise in aggregating payment histories was valuable; it required significant manual labor. But now that its data is generated digitally by us, Equifax’s only value is its historical position as a trusted third party. So why does the credit market still rely so heavily on CRAs?
The answer is because currently the internet is centralized. We create data mostly in walled gardens, making it hard to extract and use, and self-reported data can’t be easily verified. CRAs verify and share information among these gardens, skimming off billions in the process.
But with recent advancements in blockchain based smart contract technology, the internet is starting to become decentralized, finally giving a way for the centralized credit ecosystem to change and with only one person being in charge of their data: the user.
A Blockchain-Based Credit Ecosystem
The blockchain’s core features of transparency and immutability, and resulting potential for scalable disintermediation and trustless exchanges, make it the perfect technology to disrupt the centralized credit ecosystem.
One’s credit score measures past transactional behavior to predict future transactional behavior. The blockchain is designed to insure transactional integrity online, so it’s easy to find blockchain equivalents for the types of transactions used to calculate traditional credit scores:
Blockchain-based transactions are publicly available, so standardized data can be pulled in real-time. Each account can be accessed in its entirety, removing applicants’ ability to selectively submit data or hide relationships among accounts. These accounts can be collated in a self-sovereign wallet, which the user can share with prospective borrowers.
Blockchain-based equivalents to the credit ecosystem are not limited to credit scoring. Smart contracts can secure the decentralized lending ecosystem: borrowers could be required to stake currency, which could be crowdsourced from multiple accounts, to collateralize loans. Another possibility is reputation staking, where accounts associated with – but not owned by – the borrower are flagged in case of default. These flags can be incorporated into a blockchain-based credit score.
Most importantly, a decentralized blockchain-based credit ecosystem opens the door for expressive user consent, allowing customers to leverage new types of data to demonstrate creditworthiness. This can be achieved by linking non-traditional data sources to one’s self-sovereign wallet. Social media data, for instance, can aid in identity and employment verification. Another powerful data source is online purchases: AliFinance, which provides loans for Chinese companies, uses payment information from customers’ AliBaba profiles, with default rates reported at less than 1%.
Such loan underwriting allows institutions to assess the creditworthiness of individuals who don’t have a credit history. According to the Department of Consumer Finance, there are 26 million American “credit invisibles,” with another 19 million considered “unscorable” because their credit file is insufficient to generate a credit score – this disproportionately affects Black, Hispanic, low-income, and young adults. In emerging markets, the number is even greater: about 3 billion have been deemed “credit invisibles.” Non-traditional data sources can remedy this problem, and the transparency of the blockchain can overcome any adverse selection risks associated with our current online ecosystem. These two features combined stand to provide access to fair credit to individuals in developing nations (representing around 22% of global GDP). And by means of the blockchain, funds can travel directly to intended recipients, eliminating the risk of exploitation by corrupt middlemen.
Credit reporting agencies are an integral part of our financial systems. Historically, they were a necessary evil. But with the advent of the blockchain and disintermediated peer-to-peer transactions, we see that their highly-centralized models are outdated. A decentralized credit ecosystem can be realized by users leveraging a self-sovereign wallet to manage their data, whose value can be assessed via blockchain-based credit scoring methodology. Transitioning from a centralized to a disintermediated blockchain-based credit ecosystem is not a question of technical feasibility, but merely the pace of mass adoption.
Serafin Lion Engel is Founder and CEO of DataWallet, a decentralized consumer-to-business data exchange provides internet users with a self-sovereign wallet that puts them in charge of their data, and allows them to monetize as well as utilize an asset that is rightfully theirs. He is a fellow at the Royal Society for the encouragement of Arts, Manufactures and Commerce (The RSA) in London and was a Petra Vorsteher Scholar at Draper University.