As We Build Towards Web3, We Need to Shift Our Focus Towards On-Chain KYC Solutions

As Web3 continues to develop, lawmakers and platforms are shifting their focus towards refining KYC, or know-your-customer, which serves as the barrier between Web3’s true calling for decentralization and centralized institution’s concerns for public good.

While much of the proposed legislation recognizes the need for compliance to counter money laundering, it has simultaneously forced many of the industry’s known platforms and services to raise concerns over the effect it will have upon the operations, scalability, and business strategy.

Last month, Bored Ape Yacht Club APE/USD creator Yuga Labs faced backlash from the community after announcing that Bored Ape fans would be required to reveal their identities if they want to participate in Yuga Labs’ latest project with crypto game developer Animoca Brands.

Sen. Warren’s Proposed AML Bill

In early March, Sen. Elizabeth Warren (D-MA) introduced a bipartisan AML bill that would require the collection of personal data from private cryptocurrency wallets. In the wake of the Russia-Ukraine geopolitical crisis, Sen. Warren’s bill aims to enable the seizure and sale of Russian oligarchs’ assets to support humanitarian efforts in Ukraine.

Last week, Warren and Sen. Sheldon Whitehouse (D-RI) sent a joint letter to Secretary of the Treasury Janet Yellen and SEC commissioner Gary Gensler to close the loophole that exempts the $11 million private investment industry from AML and countering the financing of terrorism (CFT) obligations. On Thursday, Yellen will outline how the Treasury Department views crypto as an emerging part of the U.S. economy, according to a Tuesday statement issued by the Treasury Department. Experts believe will echo some of the sentiments expressed in President Joe Biden's executive order calling for additional scrutiny in the industry.

While Web3 is still very nascent, questions of how to migrate Web2 over have continued to linger, leaving it up to innovators to actually build the proper solutions to encourage individuals to accept Web3.

Zero-Knowledge Proofs and On-Chain KYC

It’s true that almost every platform on the market requires its users to complete a KYC/AML process before registering an account.

However, in the move to foster more widespread crypto and blockchain adoption, KYC/AML policies need to be implemented in such a way that the balance between information that is voluntarily shared and information necessary and crucial to share are respected.

Enter zero-knowledge proofs.

By adhering to self-sovereignty principles which are designed to put users in control of their identities, while still participating in the blockchain ecosystem, these principles afford users the freedom to navigate on-chain KYC.

Zero-knowledge proof enables one party (the prover) to prove a specific statement as true to the other party (verifier), without disclosing any additional information. While this comes into play for end-to-end encryption for messaging, storage protection, and sending private blockchain transactions, it also is extremely important for authenticating user information without revealing it.

As NFTs continue to populate the space with conversations and new investment opportunities, having a network that is able to identify a user through their wallet’s metadata, without requiring a user to divulge their personal information is advantageous.

Otto Blockchain

The Otto Blockchain is one such mechanism that allows clients to launch their respective projects without worrying about implementing KYC requirements. The network relies on NFTs that represent every user wallet’s KYC metadata, so that asset custodians can offer services without having to worry about compliance. To better clarify how this type of on-chain KYC works, I spoke with PLUGnet COO, Jeff McDonald, who advises market participants to look at projects focused on helping crypto and blockchain-based services meet mandatory compliance, governance, and identification requirements - while maintaining data privacy and security. McDonald referenced his company’s ability to attest to someone passing a KYC, while simultaneously guaranteeing product through code by means of a smart contract through auditable means. In other words, individuals aren’t required to share their private information with anyone. “We’ve had a lot of experience where we’ve actually conducted and audited a number of token sales,” he says, continuing that “each token sale has always been fully opened to the public in a decentralized way, but through a fully KYC/AML/CFT scored process.”

He added that for those users who have an Otto account, they are able to deposit any asset, where the asset is then sent to a leading custodian that works with most major exchanges.

“From there, that custodian will then provide you with a one-to-one representation of that asset credited to your public address on the network.” Polygon MATIC/USD ID

Last week, Polygon also launched its new user identification service, Polygon ID, that gives blockchain-based applications the ability to check a person’s credentials without revealing their personal data.

According to the announcement, applications running on the Polygon blockchain will be able to authenticate user data while keeping sensitive information private by using iden3, a decentralized identity protocol that also uses zero-knowledge proofs.

Ultimately, we are witnessing a shift in how these proofs and encryption methods are being used to still put forth the necessary efforts to maintain compliance, while respecting an individual’s right not to have their information revealed.