On-Chain Credit Risk Score in Decentralized Finance

Rik Ghosh, Arka Datta, Vidhi Aggarwal, Sudipan Sinha and Rajdeep Sengupta
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Rik Ghosh: Chainrisk
Arka Datta: Chainrisk
Vidhi Aggarwal: Chainrisk
Sudipan Sinha: Chainrisk
Rajdeep Sengupta: Chainrisk

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Abstract: Decentralized Finance (DeFi), a financial ecosystem without centralized controlling organization, has introduced a new paradigm for lending and borrowing. However, its capital efficiency remains constrained by the inability to effectively assess the risk associated with each user/wallet. This paper introduces the 'On-Chain Credit Risk Score (OCCR Score) in DeFi', a probabilistic measure designed to quantify the credit risk associated with a wallet. By analyzing historical real-time on-chain activity as well as predictive scenarios, the OCCR Score may enable DeFi lending protocols to dynamically adjust Loan-to-Value (LTV) ratios and Liquidation Thresholds (LT) based on the risk profile of a wallet. Unlike existing wallet risk scoring models, which rely on heuristic-based evaluations, the OCCR Score offers a more objective and probabilistic approach, aligning closer to traditional credit risk assessment methodologies. This framework can further enhance DeFi's capital efficiency by incentivizing responsible borrowing behavior and optimizing risk-adjusted returns for lenders.

Date: 2024-12, Revised 2025-03
New Economics Papers: this item is included in nep-pay and nep-rmg
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