Credit infrastructure is the very foundation of modern finance, tracing its roots back some five thousand years, well before even the introduction of currency. But this is probably underselling the importance of credit, as it has arguably been foundational to the emergence of civilisation itself. After all, one of the first use cases for lending and borrowing was to address challenges in ancient crop cultivation. Planting, growing, harvesting, and processing wheat before the advent of mechanised agriculture was an extremely resource- and time-intensive operation. Bankrolling upfront expenditure for the earliest farmers was an obvious win-win for everyone involved.

As human life flourished and became more complex over the millennia, credit systems became more sophisticated too. Today an individual could have multiple loans from different financial institutions, all with different terms, a range of rates, and secured by a variety of assets.

Modern credit is an incredibly powerful tool that can act as a catalyst for success and wealth. It provides people with easy access to capital and unlock opportunities that could otherwise be out of reach. One of the earliest examples of this that many people are exposed to is taking a loan for education purposes, with an investment early in life paying out multiple times over throughout the decades to follow.

Almost all businesses have been built on credit, with the process of purchasing equipment and stock well in advance of receiving sales revenue being not too dissimilar to the experience of ancient farmers — it allows someone with a good idea the opportunity to create amazing things. Even more everyday purchases are often only enabled thanks to today’s credit infrastructure, such as housing and vehicles.

And when times are tough, credit can provide a lifeline to avoid financial, medical, or other types of disaster. The common thread here is ensuring a positive return — that the benefit outweighs the interest payments.

Credit scores have become increasingly important as a way to demonstrate how people have interacted with the credit infrastructure in the past, and hence predict their future actions. In the United States, scores are calculated by three major companies: Equifax, TransUnion, and Experian. These credit bureaus get to decide what someone’s credit score is based on an interpretation of financial activity, using a proprietary “black box” of calculations. The obvious main concern for financial institutions is timely repayments and hence risk of default. Credit scores provide banks and other lenders with an insight into an individual’s risk profile, and a credit score results in higher trust and larger debt facilities being made available in a virtuous cycle. But this flywheel can also play out in reverse, with actions that trigger a credit score reduction leading to a spiralling restriction of credit facilities.

Since a credit score at its core is a reflection of behavioural traits, it can have an impact on other important parts of life, such as renting a house, obtaining insurance, and even applying for a job. China has taken this concept even further in their quest for a social credit system that reflects non-financial behaviour such as traffic violations or even cheating on university exams.

In a way, credit is just as important to modern civilisation as it was back in the days of Mesopotamian farmers. But despite their importance, credit scores are generally not immediately available, and only be obtained upon a valid request to a credit bureau. Interestingly, accessing a credit score can actually be problematic, with repeated checks indicating abnormal behaviour such as financial distress and could even result in a score reduction.

With the rise of cryptocurrency comes a new financial framework and an opportunity to remake credit structures from the ground up. But credit has evolved to work a little bit differently in the crypto world. The type of borrowing that has become widespread is overcollateralised, where the only way to take a loan is to pair it with an asset of higher value to act as collateral.

At first glance this might seem counterproductive but consider housing loans where banks usually require a loan to be no more than 70% to 90% of the property’s value, with the balance usually made up by a cash deposit. The use cases for crypto include leveraged positions, by lending and borrowing different coins and tokens based on their denomination, price, and rates.

But there is yet no onchain equivalent to zero-collateral lending such as credit cards or education loans, where the borrower does not need to put up any asset as security. There is an obvious reason why, and it comes back to credit scores.

In traditional finance [TradFi], there are real-world consequences to defaulting on a loan, with a resulting drop in credit score making life difficult for the unfortunate individual. Due to the anonymity of onchain transactions, a similar environment is difficult to replicate when it comes to crypto though. In a way, decentralised finance [DeFi] has developed in reverse, with more complex credit arrangements appearing first, but the simplest idea of a pure borrower still not being viable.

Zeru aims to change all of this, by bringing modern credit infrastructure onchain. In theory, like many other aspects of finance, the transparency and availability of crypto transactions could make the entire process easier for everyone involved, but providing onchain protection for lenders is the missing puzzle piece.

Zeru is building a range of both carrot and stick mechanisms to keep the financial equation balanced. At its core, Zeru aims to replicate the process of building a TradFi credit score.

• Users will be able to easily transplant their existing DeFi borrowing activity to Zeru and build up a history of activity that will result in an onchain credit score, call a ZScore.

• As total protocol activity increases over time, a portion of the revenue generated will be diverted to build up in the protocol-controlled reserve to mitigate bad debt in the case of loan default.

• With time users become available for a collateral-free loan, after aquiring credit tokens.

• In addition, users can effortlessly deploy the funds in a range of advanced strategies that are integrated into Zeru, from providing liquidity to participating in restaking, or simply going long or short on a range of tokens.

• Regardless of a user’s behaviour results in their ZScore being increased or slashed, the changes will be visible immediately.

• Finally, we introduce revenue share to the protocol’s most active users to provide an incentive to maintain a high ZScore and continue participating.

There is still a lot of work to be done to build up DeFi to the point of providing a viable alternative financial system, but Zeru’s onchain credit infrastructure will provide one of the keys to unlock mass adoption.

This is only the beginning. We invite you to stay connected with us as we continue to innovate, refine, and expand our offerings. Exciting developments await on our roadmap, and we’re committed to sharing every milestone with you.

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Originally posted on Medium on May 15, 2024:

Why DeFi needs credit infrastructure to onboard the next billion users

Credit infrastructure is the very foundation of modern finance, tracing its roots back some five thousand years, well before even the introduction of currency. But this is probably underselling the...

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