How SBTs can unlock financial reputation

Soulbound Tokens (SBTs) are a new category of non-fungible token that could unlock powerful new uses for decentralized finance (DeFi) and beyond. Learn how they work, their origins in the World of Warcraft, their importance for DeFi and governance, how they might usher in a new, decentralized society, and how Spectral’s non-fungible credit tokens (NFCs) can fill a similar role.

What are Soulbound Tokens?

Ethereum co-founder Vitalik Buterin’s Decentralized Society: Finding Web3’s Soul lays out a vision for creating a layer of trust on the Ethereum network. He proposes creating what he calls Soulbound tokens (SBTs), indelible, nontransferable tokens associated with a particular wallet. The concept was inspired by “soulbound weapons” in the massively multiplayer online game World of Warcraft, which described magical weapons bound to a single user.

Normal nonfungible tokens (NFTs) can be transferred between wallets, which limits the use of NFTs for credentialing or access to online communities. For example, if someone presents an NFT received in exchange for attending an event or completing a course of study, there are no guarantees the current owner is the same person who earned the token, rendering something like an NFT diploma essentially useless.

NFTs–as an indelible receipt on the blockchain–have tremendous potential for use in accounting, badging, and finance–but are held back by their transferability. SBTs, by being bound to a single wallet, could allow developers to automate nearly any activity where provenance and accountability are required, such as land deeds, legal contracts, resumes, and, given the composability of digital objects, eventually create an entire category of new applications.

Regular, transferable NFTs would continue to exist. SBTs simply open the door for new use cases.

How Soulbound Tokens could simplify paperwork, governance, and finance

A number of projects are already using SBTs. RhinoX, uses an integrated credit rating system to deliver SBTs into users’ wallets. They’re meant to act as identity badges, ideally reflecting ones “sociability and credibility in the web3 space” and allowing users to maintain a consistent identity across multiple projects.

Sismo is another project experimenting with SBTs. They call their SBTs badges, and plan to use them for attestations, such as “Donated to Gitcoin grants", "Voted 2 times in the ENS DAO" or "Sent 100+ transactions on Ethereum.” Badging is particularly interesting for precisely tailored token airdrops or highlighting valuable community members.

Governance (facilitation)

Typically, decentralized autonomous organizations (DAOs) use ERC-20 governance tokens for transferring executive functions, but it’s difficult to delegate power to a subordinate organization through tokens alone without ownership changing hands. SBTs could transfer limited amounts of power, perhaps even using built-in expiration dates.

Souldrops and Airdrops

An important and likely early use case for SBTs are airdrops. Airdrops are supposed to reward active users and incentivize community building, but because tracking more than one or two exclusionary conditions for an airdrop becomes taxing, airdrops are often targeted by people gaming the system by the conditions in an extremely minimal way (such as “dusting” multiple wallets to create many active accounts).

Rather than defining by exclusion, using SBTs to whitelist a wallet creates an opt-in system. Airdrop rights might be distributed to all users attending a community call or fulfilling multiple complex conditions such as maintaining a certain balance over time, having a certain MACRO Score or attending a certain number of snapshot votes.

Proof of Attendance (credentialing)

One vision of the future is that micro-credentialing suddenly becomes much more feasible. Certificates and assessments could eventually create a blockchain-based CV, which would remove ambiguity.

There are other uses such as in gaming – for example, confirming a particular achievement and porting it to another game – or in the legal system, such as confirming a possession has traded hands or a rental unit has been occupied.

Proof of Identity (verification)

SBTs could also be essential for confirming identity and other aspects of humanity such as streams of income or wealth. A marriage SBT could streamline paperwork, such as name changes and updating paperwork; and in the event of a divorce, being served a divorce SBT could automatically reverse those changes and, perhaps, ease the pain of separating assets.

Workarounds for verifying identity do exist, such as publicly associating a wallet with a social media presence, and other verification methods, but these usually rely on a centralized authority that can be compromised, sacrifice speed, and requires giving up a user’s privacy (often publicly).

DeFi Lending

Perhaps the most important immediate use for SBTs is to facilitate DeFi lending. As identity primitives they can tie a digital credit score such as a MACRO Score to a wallet without revealing the identity of a wallet owner. They could also be used to blacklist bad actors, reward repeat customers, or flag creditworthy wallets.

The pseudonymity of blockchain wallets makes traditional verification difficult to incorporate into DeFi applications. An application using multiple wallets owned by a single user, for example, would require a very convoluted verification process to trace ownership. SBTs could use publicly available on-chain information for verification, instantly verifying ownership, enabling all kinds of complex composability for dApp developers.

In traditional finance, credit and undercollateralized lending rely on reputation systems like America’s FICO Score to gauge the creditworthiness of borrowers. DeFi has yet to develop a replacement. “Currently, the web3 ecosystem cannot replicate simple forms of uncollateralized lending because all assets are transferable and saleable,” says Vitalik Buterin.

Introducing Spectral’s Non-Fungible Credit tokens

On August 23rd, 2022 Spectral released the Open Beta version of their on-chain credit analysis dashboard. There were two major applications: the first was an on-chain credit score, a human-readable risk analysis of their on-chain behavior. The second was the non-fungible credit token (NFC), an ERC-721 containing a timestamp and a bundle of Ethereum addresses.

Together, they offer the DeFi community a financial reputation primitive.

NFCs are capable of bundling multiple user-verified wallets together around a master wallet, which can be any wallet a user chooses, ensuring a degree of pseudonymity is preserved. Being able to bundle wallets also allows communities of wallet owners to work in concert, a DAO could easily generate a credit score or use the NFC as a form of identification.

Today, DAOs and other decentralized organizations are plagued with coordination problems. Building a credit assessment layer and creating apps that can use this layer for verifiable proof of identity that is owned by the users it is serving could end many of those problems. Routine decisions could be delegated to NFCs rather than forced to a vote.

How NFCs and SBTs could level-up fractionalized ownership and dApps

Vitalik imagines SBTs and the apps they allow enabling a “richer, more pluralistic ecosystem” he calls decentralized society, or “DeSoc,” where the combination of encoded trust relationships, the ability for NFTs to represent fractionalized ownership, and governance mechanisms like quadratic funding could combine to “eschew today’s hyper-financialization” and create something far better.

In the nearer term, SBTs have tremendous potential for improving decentralized applications. NFTs, for example, have come to be recognized and exchanged as a form of digital property, particularly for gaming and artwork. SBTs could make it far easier to combine dynamic feeds of information into NFTs, for example, creating unsecured loans tied to pseudonymous wallets that can take into account a user’s trading habits and dynamically update as more information comes in.

Various permutations of Soulbound NFTs are working their way through Ethereum’s improvement proposal system. Spectral stands with these efforts. We think SBTs will de-risk tech choices for builders and increase composability. What do you think?

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