Nine years on from the start of the credit crunch, could blockchain prevent a future crisis?
By Stewie Zhu, Founder and CEO of Distributed Credit Chain
On this day in 2007 when the credit crunch started, BNP Paribas became the first major bank to freeze three of its funds. In the words of Adam Applegarth, who was then chief executive of Northern Rock – one of the banks at the centre of the crisis – this was ‘the day the world changed’.
But a decade later, and we’ve still not fully learnt the lessons of the financial crisis. If you take a look at what happened during the 2008 crash, the fundamental issue was a result of negligence in the credit market. Although we have taken some steps to combat these issues, the current credit system urgently needs updating. Rather than adding greater centralization to police the ‘bad actors’, perhaps the answer is decentralization using the blockchain.
It is still early days but like the Internet before it, blockchain is gradually claiming its place as a revolutionary technology with the potential to transform almost every aspect of our lives. Known as a distributed ledger technology, the blockchain encrypts information which cannot be changed once added, enabling users the highest level of security.
Blockchain has the potential to herald banking’s ‘Uber moment’, with its promise to overturn the old ‘analogue’ banking system and create a more efficient, less costly, democratic, ‘digital’ system – one that’s fit for the twenty-first century and beyond. Importantly, this change could greatly improve social welfare. If we rebuilt the current banking system around decentralized blockchain technology, society as a whole would be better off; people would be happier; and more of their needs would be met more often.
Explaining the Credit Market Problem
Take the issue of credit scores; we live in a global world and yet that three-digit number that’s so important to our lives can’t even follow us across national borders. What about the issue of personal data? The world was gripped by the recent Facebook scandal and how it owns and sells the data we share on social media. But financial data is much more important than a photo of the food we eat for lunch. And yet we don’t own the data about our own finances. Barely a month goes by without yet another news story that there has been a data breach and our personal information has been hacked. Last year saw one of the biggest attacks on record, with personal information from 140 million Americans stolen from one of the big credit agencies.
Under the current system, we can expect more of the same. But what if we were to apply blockchain to banking, credit and finance? People would soon have control of their credit score, their important financial data and their overall banking footprint.
Globally Inclusive Credit
On a day-to-day level, credit would become more inclusive. There are currently millions of unbanked people in the developed world, and more than 2 billion worldwide who can’t access credit.
Imagine for a moment that you weren’t eligible for a credit card. As a contributing member of society with, let’s say a family to feed, how does one go about getting milestone necessities like a car, home, or even pay for your child’s higher education? This is something many of us take for granted, but an astounding number of people all over the world aren’t eligible for a credit card or don’t have a credit profile due to centralized regulations imposed by organizations like FICO or related credit agencies. In fact, according to this Business Insider article, the World Bank cited that more than 20% of unbanked adults receive wages or government transfers in cash, and many people in developing countries pay bills and school fees in cash.
If we were in charge of creating and feeding into our own credit footprint, credit agencies would have a much more robust outlook of our financial profiles and be able to make a much better assessment of eligibility. This would give more individuals access to loans without all of those third party fees and exorbitant interest rates.
The New and Improved Credit Profile
With decentralized credit, the system is much more financially inclusive on a global scale. For example, if an ordinary worker in South Africa needs to renovate their roof, their loan application may be declined by a number of local banks. Under the new system, any online banking mechanism would be able to process the loan application offering a loan at competitive rates. The benefit to a decentralized credit profile is that the individual has created a well-rounded credit profile that takes behavioral processes, finances and other important data into account to evaluate eligibility for a loan.
People would also finally take back ownership of their financial data. Currently it’s held by centralized credit agencies who hold a virtual monopoly and can charge people varied fees to access to it. All things considered, the fact that people have to request and pay for their own financial data seems a bit unethical but this is the system that we’ve all been forced to use. That score is one of the most important numbers in your life – it impacts your day-to-day life and major decisions like mortgages. Doesn’t it only seem that people regain control of it?
Enabling Decentralized Credit with Blockchain
A blockchain system just might be the answer to tack this problem. No longer would just a few large credit organizations own those scores in big data warehouses vulnerable to attack. Each and every one one of us would own our credit score and the information would be stored securely on the blockchain. Not only would this end the growing trend for increasingly severe financial cybercrime, but it would also allow people to easily access their credit data and play an active role in gaining access to loans.
How it works
For example, using a blockchain-based platform, a user can begin the credit management process by signing an application, and the data verifier will then send back the results, encrypted and signed, and submit it onto the blockchain with a summary of the verification. This process enables repeated, rapid and costless verification of the data stored on the blockchain. On the client’s interface, a local data storage framework would allow users to encrypt their information with private keys, and store it on the cloud. This ensures data security and makes data inquiries fast and convenient.
The Social Welfare Factor
Perhaps most importantly, society would be better off on a much larger- global – scale. The current centralised credit system causes day-to-day problems, with high fees which hit our wallets or data leaks that require us to change our security passwords. You only have to go back ten years to see the damage that the current system caused. Following the 2008 financial crisis, banks across the world cut off credit supply to users almost overnight. They became too nervous to loan money. In the recession that followed, millions lost their businesses and many more lost their homes. Lives and livelihoods were ruined.
A repeat of 2008 would be devastating, and yet we still have largely the same banking set-up that caused it. A decentralised credit system – which democratises credit away from just a few big banks – would inoculate against future credit crunches. The blockchain allows parties to co-create a permanent, unchangeable, and transparent record of exchange and processing without having to rely on a central authority. A decentralized ecosystem of financial service providers can transform different financial scenarios by empowering credit with blockchain technology.
From data hacks to global recessions to the charging of unlimited fees, the current credit system is clearly flawed and affects the livelihood of everyday people. A blockchain-based decentralized credit system could disable centralized parties and intermediaries, and allow people to lead the lives they’ve always dreamed.