The How and Why of Kudo’s Risk Scores

Risk scores are a commonly used way to classify the risk of an asset. In the traditional world, rating agencies like Standard & Poor’s are identifying bonds and associating them with the proper risk scores eg. “AAA” (Best possible score).

Kudo’s risk evaluation framework works in a similar way. “D”  is the lowest possible rating (highest risk), while “AAA” is the best score (lowest risk). This helps investors assess the credit risks from the loan of interest.

 

  1. How the Risk Score Is Calculated

The risk score is determined by several parameters that present a real threat to the loan. All parameters are publicly available. 

Here’s an overview of the ratings:

Ratings Definition Risk Score
AAA Rated as the highest quality and lowest credit risk. Borrower has extremely strong financial security characteristics. 100 – 80
AA Rated as high quality and very low credit risk. 80 – 70
A Rated as upper-medium grade and low credit risk. 70 – 55
BBB Rated as medium grade with marginal financial security and moderate credit risk. 55 – 40
BB Judged to have speculative elements and a significant credit risk. 40 – 25
CCC Rated as poor quality and very high credit risk. 25 – 15 
*CC Near or in default, but some possibility of recovering principal and interest. 15 – 0
*D Rated as the lowest quality, default and low likelihood of recovering principal. ( D rating can be awarded in case of collateral asset ongoing attack) 0

*Temporary rating awarded to the loan 

 

Summary of the Risk Parameters:

Parameter Weightage
Asset intrinsic risk 8%
Collateral Liquidity 15%
Volatility bands 5%
Credit score 10%
Exchanges 10%
Token transfers 5%
Socials & Community 7%
Market Capitalisation 25%
Token Distribution, lockups & Issuance Schedule 15%

 

  • Asset intrinsic risk: This parameter is based on the heart-piece of the asset itself – The source-code. Poor code quality and unfixed bugs inside smart contracts lead to a bad score here.
  • Collateral liquidity: The aggregate asset liquidity from various exchanges is used to calculate the average available liquidity.
  • Volatility bands: The implied volatility of the collateral asset in the next 30 days to be calculated against the ethereum benchmark.
  • Credit score: Every first term loan has the credit score 0. Previous positive credit history on Kudo is factored in the future credit score of the loan. The same goes for a previously negative credit history.
  • Exchanges: Some exchanges are more secure than others. This parameter takes into an account, on which exchanges the asset is listed.
  • Token transfers: This parameter measures the number of transfers of a collateral asset.
  • Socials & Community: Is there an active community behind the asset? That’s what this parameter is factoring in.
  • Market capitalization: A smaller market capitalization presents a larger risk versus a bigger one. Hence, this parameter is responsible for this perspective.
  • Token distribution & issuance: The distribution of the token is measured against the Ethereum Gini coefficient as a benchmark. The concentration of tokens among few holders will devalue the collateral value. A fixed supply with all of the tokens in circulation will get the highest rating. In case of lockups and vesting of any sort, the collateral value required will increase.
  1. The Future of Kudo’s Risk Score

The crypto industry is changing. Rapidly. Did anyone in the bear market in 2018 foresee all the great innovations that happened in the last years? We don’t think so.

For this reason, we decide to keep the risk factors subjective to change. This enables us to adapt Kudo to potential new market conditions even we didn’t see coming.

  1. Summary

Kudo’s risk score presents users with a single metric to assess the risk of a loan. This provides users with information they would otherwhise have to look out for themselves. We know very well that time is money and that’s one of the reasons why we created this feature.