Why Ethereum Can’t Help You Get a Small Business Loan: Part 3 — Borrower Intel
A lendtech company CEO astutely observed in 2012, “All data is credit data!”
And yet, DeFi lending as we know it today works with anonymous borrowers and lenders, and with no memory of borrower behavior. The argument goes, “there is sufficient collateral to recover the loan in case of default, why bother with borrower identity and history?”.
This misses two important points.
- There is good behavior in repaying the loan and bad behavior in defaulting on it, independently of collateral. This information is useful for the next loan of the same borrower.
- Credit access can be improved if lending does not rely solely on collateral (or not at all, as is the case with unsecured loans).
No country for unsecured men!
Small businesses and thin-file borrowers face an uphill task in accessing credit. They don’t even get the opportunities to demonstrate their honesty and start to create a creditworthiness score. The only recourse is a collateral-backed loan. This severely limits the access, especially in contexts where a liquid enough and acceptable collateral is hard to come by.
The borrower can be a highly regarded business within a community and may have solid cashflows. But if it does not have collateral, most of the DeFi and TradFi doors are shut!
Social Capital — how do I put a number to it?
The standing that an individual or a small business enjoys in a community of individuals and other businesses is currently too vague and ill-defined to be of use in the formal assessment of that individual/business. Firstly, nobody is collating this data and secondly there are not enough incentives to update this, unless people start to use it.
But imagine for a moment that a lender (centralized or decentralized) could get a quick check of a borrower’s trustworthiness as assessed by her community and also a scan of her history of transactions (and of contract adherence or violation).
Wouldn’t that go a long way in quantifying the social capital of the borrower? This is a place where a public blockchain stands out as an obvious solution — if only it were not for their current focus on anonymity and trustless transactions. In Newrl, we are building a trust network to address exactly this shortcoming. More on that later!
Generalizing a memory-based distributed ledger
Combining the above two points — community’s assessment of an individual and on-chain history of her contract adherence or lack of it — we can see the possibility of a memory-aware blockchain that can significantly improve the access to credit for a small business and a thin-file borrower.
In fact, this approach generalizes nicely to all instances of counterparty assessment. Consider tenant/landlord interaction in most renting situations, wouldn’t it be great if both could get a sense of the other’s trustworthiness before signing the lease? How about employer-jobseekers? And even start-up founder and angel investors?
Recently I had a chat with an innovative startup in electric vehicle space — on the specific possibility of crowdfunding the EVs and leasing them to specific organized businesses, paying the lease receipts onwards using a smart contract on-chain. In such situations, the trust scores could go a long way to comfort the investors and the leasee business without relying solely on the organizing platform to do all the heavy-lifting!
The future of mainstream DeFi requires memory of participant behavior in addition to identity. The sooner we recognize it the faster the adoption will be!