Reputation as Collateral

Allows borrowers to secure loans with less than 100% collateral value by supplementing with a reputation score. This reduces capital inefficiency and expands access to credit. Key mechanisms include:

• Credit Delegation: A user with high reputation can delegate a portion of their credit line to another.
• Progressive Terms: Loan-to-Value (LTV) ratios and interest rates dynamically adjust based on the borrower's reputation tier.

Protocols use reputation scores to assess counterparty risk, allowing for more efficient capital deployment and lower insurance premiums. This is critical for:

• Liquidity Pools: Adjusting rewards or slashing based on a liquidity provider's historical behavior.
• Insurance Funds: Offering coverage at variable rates; users with strong repayment history pay lower premiums for smart contract failure or hack coverage.

Mitigates vote manipulation by weighting governance power with on-chain reputation instead of just token holdings. This ensures long-term, engaged participants have greater influence. Implementations include:

• Reputation-based Voting: One's voting power is a function of both tokens held and a verifiable reputation score.
• Proposal Submission Rights: Only addresses meeting a minimum reputation threshold can submit governance proposals, reducing spam.

Acts as a gating mechanism for advanced financial products and exclusive platform features. High-reputation users gain access to:

• Higher Leverage: Increased borrowing limits on margin trading platforms.
• Whitelists & Launches: Priority access to token sales, NFT mint allowlists, or beta features.
• Reduced Fees: Tiered fee structures where reputable users pay lower transaction or protocol fees.

Serves as a portable, verifiable record of a user's financial history across different protocols (a DeFi Passport). This enables:

• Composable Reputation: A score built on Ethereum can be used to access services on Avalanche or Polygon without restarting from zero.
• Soulbound Tokens (SBTs): Non-transferable tokens that attest to specific achievements or consistent behavior, forming a persistent identity layer.

Maximizes capital efficiency within complex DeFi strategies by allowing reputation to act as a virtual asset. For example:

• A user could provide 80% in ETH and 20% in reputation points to open a full 100% LTV position.
• In yield farming, reputation can reduce the required safety margin or overcollateralization for leveraged positions, increasing potential returns.

Smart contracts that algorithmically assess a user's reputation score to determine credit terms. These systems analyze on-chain data points such as:

• Wallet age and transaction volume
• Historical loan repayment from protocols like Aave or Compound
• Governance participation and delegation history
• Social graph connections and attestations The output is a credit score or trust score that dictates loan-to-value (LTV) ratios and interest rates.

Decentralized services that aggregate and verify off-chain reputation data for on-chain use. They bridge Web2 and Web3 identity by attesting to:

• Traditional credit scores (with user permission)
• Professional and employment history
• Social media reputation and community standing These attestations are issued as verifiable credentials, allowing undercollateralized loans based on a holistic view of creditworthiness.

Critical security challenges for reputation systems. Sybil attacks, where a user creates many fake identities, are mitigated by linking reputation to costly or unique actions (e.g., holding a specific NFT, KYC). Collusion risks involve groups artificially inflating each other's scores. Solutions include:

• Context-specific reputation that isn't globally transferable
• Time-decaying scores to prevent stale data exploitation
• Peer-to-peer attestation with stake-based slashing for false claims

The evolution from single-protocol scores to a composable, user-owned identity graph. This is a decentralized data structure that maps relationships between:

• Various SBTs and attestations
• Wallet addresses across chains
• Social connections and community roles Protocols can permissionlessly query subgraphs of this data to underwrite complex financial products, moving beyond simple collateralization to programmable reputation.

The foundation of reputation-based systems is a decentralized identity built from immutable on-chain data. This includes:

• Transaction History: Volume, frequency, and consistency.
• Protocol Interactions: Long-term participation in lending, staking, or governance.
• Wallet Age & Network: The longevity of addresses and their connected counterparties. Algorithms analyze this data to generate a Soulbound Token (SBT) or non-transferable credit score, quantifying trust.

A primary security challenge is preventing users from creating multiple fake identities (Sybil attacks) to game the reputation system. Mitigations include:

• Proof-of-Personhood: Integration with services like Worldcoin or BrightID to verify unique humanness.
• Costly Signaling: Requiring a history of gas fees paid or time-locked assets to build reputation.
• Social Graph Analysis: Evaluating connections within decentralized social networks to detect artificial clusters.

Unlike over-collateralized loans, reputation-based systems use a dynamic collateralization ratio based on the reputation score. Key economic models include:

• Progressive Unlocking: Higher reputation scores grant access to larger loan-to-value (LTV) ratios.
• Reputation Staking: Users can "stake" their reputation score, which can be slashed for default, aligning incentives.
• Portfolio-Based Assessment: Reputation is evaluated across a portfolio of DeFi activities, not a single asset.

When a borrower defaults, the protocol must enact recourse without seizing physical assets. Common mechanisms are:

• Reputation Burn/Slash: The borrower's non-transferable reputation score is permanently reduced or reset.
• Social Enforcement: Defaults are recorded on-chain (e.g., in an SBT), impacting future access across all integrated protocols—a form of decentralized credit bureau.
• Future Cash Flow Claims: Protocols may gain a right to claim a portion of the borrower's future on-chain revenue or airdrops.

The system relies on carefully designed incentives to ensure honest participation. Core principles include:

• Long-Term Value: The present value of a high reputation score must exceed the short-term gain from defaulting.
• Cross-Protocol Utility: A reputation score is most valuable when it grants access to multiple services (lending, under-collateralized stablecoins, job markets).
• Oracle Reliability: The system depends on oracles for off-chain data (e.g., credit history, KYC), creating a trust dependency.

Early implementations demonstrate the concept's practical application:

• ARCx: Issued a DeFi Credit Score based on wallet history to determine lending limits.
• Spectral Finance: Creates a cross-chain, programmable credit score (MACRO Score) as a non-transferable NFT.
• Reputation-Based Governance: Protocols like Optimism use voting power based on a user's contribution history, a form of non-financial collateral for influence.

Soulbound Tokens (SBTs) are non-transferable, non-financialized tokens that represent credentials, affiliations, or achievements. They are the foundational primitive for building a persistent, composable on-chain identity, or "Soul."

• Core Function: Act as verifiable, tamper-proof attestations of reputation.
• Use in Lending: A user's collection of SBTs (e.g., proof of governance participation, educational credentials) can be programmatically assessed to determine creditworthiness, forming the basis for underwriting reputation-based loans.

On-chain credit scoring is the algorithmic assessment of an entity's financial trustworthiness based on its historical blockchain activity. Unlike traditional models, it uses transparent, verifiable on-chain data.

• Data Sources: Includes transaction history, wallet age, asset diversification, protocol interactions, and repayment history from previous loans.
• Mechanism: These data points are aggregated into a credit score or reputation score, which can be used to determine loan terms, such as the collateralization ratio or interest rate, for undercollateralized borrowing.

Undercollateralized lending is a loan structure where the value of the borrowed assets exceeds the value of the collateral provided. It is the primary financial application enabled by reputation systems.

• Traditional Contrast: Defies the standard DeFi model of overcollateralization (e.g., 150% collateral ratio).
• Risk Mitigation: The credit risk of the lower collateral is offset by the borrower's verified reputation and identity, often enforced through Soulbound Tokens (SBTs) and the threat of social or legal recourse.

Decentralized Identity (DID) is a framework that gives individuals control over their verifiable digital credentials without relying on a central authority. It is the infrastructure layer for portable reputation.

• Components: Consists of a DID identifier (a unique URI) and associated verifiable credentials stored in a user-controlled wallet.
• Role in Reputation: DIDs allow a user's reputation—built across multiple protocols—to be persistently linked to their identity, making it portable and usable as collateral in any application that recognizes the standard.

Sybil resistance refers to the defensive measures a system employs to prevent a single entity from creating multiple fake identities (Sybils) to gain disproportionate influence or exploit rewards. It is a critical challenge for reputation systems.

• The Problem: Without Sybil resistance, an attacker could create countless identities to build false reputation and drain undercollateralized loan pools.
• Solutions: Methods include proof-of-personhood protocols (e.g., Worldcoin), biometric verification, social graph analysis, and bonding curves that make identity creation costly.

Social recovery is a mechanism for regaining access to a crypto wallet or identity by relying on a pre-approved group of trusted contacts ("guardians") rather than a single private key. It enhances the security and practicality of reputation-based identities.

• Function: If a user loses access to their Soul (their identity wallet holding SBTs), their guardians can collectively authorize a recovery process to transfer the identity to a new wallet.
• Importance: Makes non-transferable reputation assets like SBTs practically usable, as the risk of permanent loss due to a lost key is mitigated.