The SSI entry into collateral elimination at DeFi
Since collateral removal (or at least collateral reduction) mechanisms rely on building a reliable lending history, Self-Sovereign Identity plays a relevant role in this task, as this requires a higher form of trust in the borrower.
Financial transactions in decentralized finance are made possible by sending tokens from one address to another, and by blockchain technology.
Admittedly, this address is pseudonymous, meaning that there is no close relationship between the user’s personal information, and this digital ID.
Digital wallets allow users to organize their addresses and give their consent to protocols to access their address and use it as an identifier (usually the only piece of information a user has as a reference).
The sense of financial identity (almost like a reputation), can be derived from the history of transactions, all visible and unmodifiable, as they are on the public blockchain. This could help form a relationship between users and protocols. But why?
As we already know, wallets provide ownership of an address and an interface to interact with decentralized applications. They use an address from a blockchain, and a set of keys to the user for safekeeping (self-custoldial).
Identity use cases in DeFi:
Some companies have tried to implement interesting identity solutions, and some have even tried to follow SSI principles:
MYKey for example uses smart contracts to store personal data and facilitate consistent identification, and instead of relying on an Ethereum address , for example, as an identifier, they offer Key ID usernames, which are auctioned to the highest bidder.
Bloom is an SSI solution that relies on credit scoring. The Bloom protocol relies on three systems to provide identity, risk assessment and credit history: BloomID, BloomScore and BloomIQ respectively. The BloomScore for example, offers people with no credit history a way to increase their score by mirroring scores in their social network. Since 2020 they have been working closely with the DIF (Decentralized Identity Foundation).
On the other hand, the famous sidechains use the distributed ledger for purposes, many times of identity.
An emblematic case in this sense is Sidetree, a layer 2 protocol that allows a decentralized identifier. This protocol is implemented in ION for the bitcoin blockchain, so it is able to fit 10,000 ID operations into a single bitcoin transaction and uses ION nodes in an IPFS.
SSI in DeFi: A a case in latam
Another use case of SSI in DeFi is that of DIDI, in Argentina, which aims to improve access to quality goods and services for populations in vulnerable neighborhoods, to reduce information asymmetry and generate financial inclusion. With DIDI, in addition to validating your identity and documents, the user can: track microcredits and access all the benefits of the program granted by the Microfinance Institution; register and share credit history with other people or institutions; obtain and store digital credentials of personal data privately and securely.
In Extrimian we are working to provide solutions with SSI technology, and adoption of this Identity system. If you want to know more about Extrimian’s Self-Sovereign Identity products and solutions, please visit our website.
Self-Sovereign Identity and how it works
As we have already seen in other articles of this blog, the concept of Self-Sovereign Identity or SSI, was launched by Christopher Allen, and is based on the principle that an identity subject has control over its own identity and all related credentials, eliminating third parties, and re-empowering the holders to control and disseminate their data.
Thus, we understand that this decentralized identity system allows the identity holder to specify who, when and what personal data they see (as opposed to traditional digital identity solutions).
To prove the validity of identity credentials (verifiable credentials), an SSI system needs a trust flow that includes three separate parts to verify the credentials. In this flow, the central part is the subject or holder who possesses all the credentials. The subject obtains the credentials from an authority or issuer, who issues them and attests to those credentials and their validity, and then the subject sends the credentials to a third party or verifier, who wants to verify those credentials.
How do SSI claims work?
We propose an SSI based on claims in which a holder claims a credential to the authority who then decides to attest the claim. This authority, or issuer, attests a claim by signing it and sending it back to the subject, who in turn re-signs the claim, resulting in two signatures (with private keys and cryptography, of course).
A verifier can then verify the signature of the authority or issuer attesting to the legitimacy of the credential to know if it is valid or not.
A signature is created using one’s private key and sent to the other party encrypting it with their public key. The other party can then decrypt the message using its private key.
In this asymmetric encryption scheme it is imperative that the private keys are kept secure and under the control of the key holder.
Identity and finance
Let’s look at an example of how identity works in the financial sector:
Suppose Paul wants to take out a loan at the bank where he is a customer. We know then, that the bank has access to his bank account history, monthly expenses, and income. In this way they are able to evaluate and understand the risk of a loan to a user with Paul’s conditions.
Translating this trust flow to today’s decentralized finance has similarities, but there are some differences with the characteristics of the borrower or funder.
As DeFi is based on distribute ledger technology, transactions are immutable and where the history of an account can be linked to an address on the blockchain. This means that there is no legal identity tied to this Adress.
So, we can assume that the problem that DeFi’s lending system has, and the one that The Self-Sovereign Identity comes to solve, are intertwined.
SSI and DeFi on the same sidewalk
As we said then, SSI is based on the fundamentals of the blockchain, but keeps the verifiable or identity credentials stored off-chain, which makes it “off-chain“, but with the possibility of displaying them when desired by the holder.
This means that its technology allows participants to securely identify themselves with only the necessary information and guarantees their sovereignty or control over their data.
More importantly, the SSI community is currently aiming for a scenario in which service providers, such as DeFi applications, do not have to store any user information in their databases.
Through this decentralized identification layer, SSI can enable protocols to assess a user’s ability to repay a loan (without the need for a centralized credit score) and eliminate some of the risks associated with decentralized lending.
Adoption of SSI for users, enterprises and institutions
Credentials are not necessarily limited to individuals, but companies and institutions can also receive an SSI with a DID associated with their entity, for use in communicating with customers and suppliers by receiving (and verifying), or issuing Verifiable Credentials.
It is for this reason, and for its user-centered nature, that Self-Sovereign Identity technology is increasingly adopted by users in the field of Decentralized Finance. It is evident that the most common cases, as we highlight, will be those of loans where users who require a loan can provide credentials that certify that their credit and/or financial history is good and appropriate to be creditor of a loan or other benefit. All this, of course, only by submitting a claim about such history and without the need to provide the verifier (or lender), other data that are not necessary for this procedure.