On-Chain Credit Risk Score in Decentralized Finance

Paper: arXiv 2412.00710

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

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.

Complexity vs Empirical Score

• Math Complexity: 5.5/10
• Empirical Rigor: 3.5/10
• Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper provides a formal statistical framework for quantifying default risk in DeFi using subscores for wallet behavior, including probability bounds and simulation analysis. However, it relies heavily on synthetic simulation data rather than empirical backtesting on real historical blockchain datasets, limiting its immediate practical rigor.

Research Flowchart

  flowchart TD
    A[Research Goal: Assess Wallet Credit Risk & Improve DeFi Capital Efficiency] --> B[Input Data: Historical Real-Time On-Chain Wallet Activity]
    B --> C[Methodology: Probabilistic Modeling vs. Heuristic Evaluation]
    C --> D[Computational Process: Calculate On-Chain Credit Risk OCCR Score]
    D --> E[Implementation: Predict Risk & Scenario Analysis]
    E --> F[Outcomes: Dynamic LTV & Liquidation Threshold Adjustments]