The consumer credit market size, which was valued at around $12 billion, is expected to surpass $18.5 billion by 2031. According to the International Monetary Fund (IMF) article, private credit has delivered higher returns compared to other asset classes, including the S&P 500.
However, traditional credit models are inefficient and unable to keep up with the incredibly globalizing world.
Centralized institutions dominate the process, making credit access heavily reliant on opaque scoring systems, restricted data availability, and regional financial infrastructure. This often excludes billions from the formal financial ecosystem. Think unbanked populations or small businesses struggling to secure loans due to lack of credit history.
On-chain credit offers a transparent and efficient alternative to traditional credit systems using blockchain to assess creditworthiness and facilitate lending.
On-chain credit refers to a decentralized system of lending and borrowing that operates entirely on blockchain networks. Unlike traditional credit systems that rely on centralized authorities like banks or credit bureaus, on-chain credit utilises smart contracts, digital assets, and verifiable on-chain data to facilitate transparent, efficient, and permissionless credit transactions.
In the end, on-chain credit increases accessibility without the traditional barriers requiring collateral without compromising security, verifiability, and transparency.
While decentralized lending has experienced significant growth over the recent few years, we are still in the early stages of DeFi's broader evolution into mainstream credit offerings. However, with the emergence of on-chain credit protocols, there are signs of accelerated adoption and potential disruption of traditional lending models.
According to RWA.xyz, the value of tokenized private credit was over $9.68 billion as of January 2025, up from around $900 million in 2021, representing a remarkable growth of over 930% in just three years.
On-Chain Credit |
Traditional Credit |
|
|
Accessibility |
Global and borderless. Anyone with an internet connection and a crypto wallet can participate. |
Limited by geography, financial infrastructure, and institutional requirements. |
|
Credit Assessment |
Based on on-chain data, transaction history, and digital asset ownership. |
Heavily reliant on credit scores and centralized credit bureaus. |
|
Intermediaries |
None. |
Requires banks, credit unions, and other intermediaries for processing. |
|
Transparency |
Fully transparent and public. |
Opaque credit processes and scoring algorithms. |
|
Cost |
Low. |
Higher fees due to administrative costs and intermediary involvement. |
|
Approval Time |
Instant or near-instant. |
Lengthy. Involves manual reviews, credit checks, and bureaucratic processes. |
|
Inclusivity |
Open. No prior credit history required. |
Excludes those without formal credit history or access to financial services. |
|
Security |
Blockchain’s immutability and cryptography ensure high levels of security. |
Prone to breaches in centralized databases and identity theft. |
|
Flexibility |
Fully customizable loans and a wide variety of collateral is accepted (both tangible and intangible). |
Limited. |
On-chain credit typically uses blockchain, smart contracts, and decentralized identities to facilitate lending and borrowing without traditional intermediaries.
Broadly, there are five phases:
Borrowers use blockchain-based identities that aggregate on-chain and off-chain data, like transaction history, assets, and reputation. This serves as an alternative to traditional credit scores.
Anyone with a crypto wallet can request credit. So, the bureaucracy typically associated with banks is completely abstracted away.
Evaluating Creditworthiness
Credit assessment in DeFi platforms involves evaluating a user's profile based on their on-chain activities like transactions and wallet behavior. This process analyzes the overall history of borrowing, lending, and crypto transaction patterns on DeFi platforms.
Platforms can generate a credit profile that reflects the borrower's repayment history and reliability by examining detailed user on-chain data, such as token holdings and previous loan repayment records. This decentralized yet transparent approach eliminates the need for traditional credit scores and allows for more inclusive lending.
Issuing Loans
Once creditworthiness is evaluated, loans are issued through smart contracts, which automate the entire loan agreement process. Smart contracts encode the terms of the loan, such as interest rates, repayment schedules, and collateral requirements, ensuring trustless execution without the need for intermediaries.
Loans can be of two types:
Once the loan terms are finalized and collateral (if any) is locked, the loan amount is disbursed automatically via the smart contract. This disbursement is typically in the form of stablecoins or other cryptocurrencies.
If a borrower fails to repay the loan as per the agreed schedule, the protocol initiates predefined steps to mitigate losses for lenders. These steps are governed entirely by the smart contract, ensuring fairness and transparency.
Here’s what a typical default management process looks like:
Huma Finance manages defaults by giving borrowers a grace period to repay. If they don’t, the Evaluation Agent (EA) declares a default, pausing new deposits while still allowing repayments and withdrawals. Losses are covered first by reserve funds, and any unpaid profits are shared with lenders.
If borrowers repay later, the recovered money is used to repay senior lenders first, then others. Once enough funds are recovered, the Huma Pool can reopen for normal use, ensuring fairness for all lenders.
An on-chain credit system incorporates many blockchain-based components to facilitate lending and borrowing. Below are the primary technical components:
Decentralized Oracles
On-chain credit systems rely on decentralized oracles to provide real-time data from external sources, including live prices, updated liquidity pool details, and current market conditions. These oracles collect off-chain information and deliver it to their smart contracts to ensure that the credit evaluations remain accurate and up-to-date.
By using decentralized oracles, DeFi platforms can adjust risk factors and collateral requirements dynamically, making the lending process more responsive to changing market conditions. This approach facilitates the flexibility of on-chain credit, allowing it to better reflect real-world asset price fluctuations and provide more tailored lending solutions to its users.
Smart contracts are the backbone of on-chain credit systems, automating every stage of the lending process, from loan issuance to repayment and liquidation.
To maintain security and reliability, these contracts undergo thorough audits to identify vulnerabilities such as re-entrancy attacks or logic flaws.
The security and reliability of smart contracts are crucial for executing DeFi loans and assessing credit risk. Smart contracts, which play a crucial role in automating the lending process, must undergo thorough audits to ensure they are free from security vulnerabilities.
Proper auditing from trusted and reliable firms with extensive experience in the crypto space ensures that agreements are executed as intended, protecting both lenders and borrowers. With a safe and secure framework, the DeFi lending ecosystem becomes more trustworthy, reducing the risks of exploitation or fraud that could compromise users' funds and personal data.
Decentralized identity systems are the foundation of user verification and credit evaluation in on-chain credit systems. Unlike traditional systems that rely on centralized credit bureaus, DIDs aggregate on-chain data such as transaction history, wallet activity, and staking records, as well as off-chain data through cryptographic verifications.
Borrowers can create a self-sovereign identity, retaining full control over their personal data and sharing it selectively with lending platforms. This ensures privacy while enabling lenders to evaluate creditworthiness based on a transparent and tamper-proof data trail.
However, DID’s are not currently widespread or mainstream. The lack of knowledge and adoption among the general population makes it difficult for potential borrowers to create their self-sovereign identities. Huma takes a different but familiar approach.
Huma Finance utilizes Persona to manage its Know Your Customer (KYC) and Know Your Business (KYB) processes. Persona is a trusted compliance platform that specializes in identity verification and regulatory compliance, ensuring that Huma Finance operates within legal and secure frameworks.
One of the standout features of on-chain credits is their ability to make financial services accessible to a much wider demographic, regardless of their geographical location. Traditional credit systems often leave out individuals without a formal credit history or those in regions with limited access to banking services.
The use of decentralized data, such as transaction history, user activity, and reputation systems, to assess creditworthiness bypasses the need for traditional credit scores and the intermediaries behind them. This innovation opens the door to tens or even hundreds of millions of people who previously had no way to prove their creditworthiness, allowing these individuals to borrow, lend, or invest like never before.
In traditional finance, accessing capital involves complex and time-consuming paperwork, long approval times, and strict eligibility criteria, which also vary from lender to lender. However, when it comes to on-chain credits, blockchain technology streamlines this process by allowing instant, transparent access to credit lines, with the collateralized funds remaining on-chain.
This collateralized fund availability helps capital flow more freely, with less risk of capital being tied up or misallocated. It allows both individuals and institutions to optimize their capital usage, fostering a healthier and more dynamic ecosystem and making the entire financial system more agile and efficient.
Financial inclusion has long been a goal for governments and policymakers, but it has remained elusive for many parts of the global population, such as developing and underdeveloped regions. On-chain credits are bridging this gap by providing credit access to those who have traditionally been excluded from the financial system, such as the bankless population.
With the help of blockchain technology, credit can be extended based on a person's behavior within the decentralized ecosystem, not just based on their traditional financial history. As a result, individuals in underbanked or underserved regions can participate in the global economy, access loans for building homes, education, business, or other personal needs, and build their credit profiles without relying on traditional banks.
Centralized gatekeepers, credit score biases, and delays in processing requests have long restricted traditional financial systems. With on-chain credits, all of the intermediaries involved are eliminated, making it possible for blockchain's transparent and immutable nature to ensure that credit history and lending terms are accessible, reliable, and secure.
Borrowers and lenders alike can interact directly without intermediaries, leading to faster transactions, more competitive interest rates, and a broader range of opportunities. On-chain credit ratings built on real-time, decentralized data remove the friction of traditional credit models, creating a more inclusive market.
On-chain credits bring new flexibility to the DeFi space with their adaptable, efficient, and secure credit systems at the core. They enable seamless interaction with a variety of DeFi protocols, whether for borrowing, staking, or liquidity provision.
Unlike traditional loans, which are bound by rigid terms and conditions, on-chain credit allows for custom adjustment, with smart contracts automatically adapting to the user's requirement. This flexibility not only enhances user experience but also encourages innovation in the DeFi sector, allowing users to manage their assets more effectively and unlock new financial opportunities.
On-chain identity is a digital identity created, maintained, and verified directly on a blockchain. It allows individuals and entities to securely manage and prove their identity without relying on centralized authorities, ensuring greater privacy, transparency, and control over personal data.
On-chain identity plays a crucial role in the on-chain credit system in the following ways:
On-chain credit scoring tracks and analyzes a user's interactions with on-chain applications like liquidity pools, lending platforms, and transaction volumes to evaluate their creditworthiness. In decentralized credit markets, this game-changing approach does away with traditional credit scores, providing more inclusive, data-driven lending decisions while ensuring transparency and security for both users and institutions.
One notable example of on-chain credit scoring is the Cred Score by Cred Protocol, a credit data infrastructure that provides credit data from 30 lending protocols spread across 8 blockchains. With Cred Score, platforms can check the creditworthiness of single to multiple account addresses on a scale of 300 to 1,000.
A credit scoring system, in the end, empowers decentralized platforms to evaluate risk and make lending decisions grounded in real data. It enables a more inclusive and fairer financial ecosystem away from outdated credit score models.
In TradFi, collateral is king. Borrowers pledge their assets to access credit, which is liquidated in cases of default.
Both, conventionally and in DeFi, over-collateralization is the norm. Borrowers are required to pledge more than the borrowing value and this restricts liquidity as borrowers are unable to access the full potential of their capital, limiting their ability to invest, consume, and grow.
On-chain undercollateralized credit addresses this gap, offering a more inclusive financial model by enabling borrowing based on factors like income, reputation, or alternative data sources, rather than requiring excessive collateral. It enables borrowers to unlock the future value of their income or receivables to address immediate financial needs, fostering economic dynamism.
Huma Finance offers undercollateralized credit solutions by leveraging borrowers' income and receivables to assess creditworthiness. This approach enables access to financing without requiring full collateralization, making it more accessible for businesses and individuals.
ReputeX is a web3 platform that provides users' on-chain behavior and creditworthiness within the DeFi ecosystem, allowing lenders to assess risk more accurately and offer undercollateralized loans, thereby unlocking more liquidity for borrowers.
This platform offers various metrics, such as ReputeX Scores, ThriveX Scores, HODL Scores, and SybilGuardX. These metrics make it easy to cite credibility, loyalty, user behavior, and engagement, allowing users to identify and mitigate malicious actors and untrustworthy users.
Credora provides on-chain credit scores and assessments to offer transparency and trust in the crypto lending market. Their detailed assessment process involves on-chain distribution, comprehensive reports, real-time analytics, and transparent methodologies.
Leveraging the latest borrower information along with the benchmarking data to decide on the creditworthiness. Their on-chain credit metrics can be seamlessly integrated with DeFi applications to improve risk management and lending decisions.
On-chain credit eliminates the need for intermediaries and enables anyone with access to a blockchain network to participate in a global, borderless credit ecosystem. Borrowers can access funds without lengthy approval processes or stringent credit checks, and lenders can deploy their assets into lending protocols, earning interest in a trustless environment.
Using blockchain, on-chain credit eliminates barriers that have long excluded underserved communities, offering access to capital based on decentralized data rather than outdated credit scores.
With increased capital efficiency and tailored lending solutions for its users, on-chain credit is essential for how we view and manage credit in the digital age.