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What will happen if zkKYC is applied to DeFi

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The decentralized Finance industry is at crossroads where the next move is bound to define its future- Whether or not to mandate zkKYCs for the users. “zk” stands for zero-knowledge, which means that KYC is possible without actually knowing the details of the individual. zkKYC implies that an organization has proof, say through a referral, that the individual under consideration is “known” without actually having any of the details of the individual on their records.

The reluctance from the DeFi industry is high as a KYC by nature is anti-anonymity. Whereas, the regulatory authorities are hoping zkKYC would bring some amount of “control” over the unregulated digital realm of money making.

How did DeFi reach here?

In the first half of 2022, $2 billion has been laundered from the blockchain space; 97% of which has been through the exploitation of DeFi platforms. Overall 69% of money laundering activities globally have taken place in digital space and the rest (less than ⅓ rd ) through traditional finance.

The statistics are indeed bothersome. As the DeFi market hits 50 billion in TVL, the scale of scams, rug pulls, and cryptojacking has exploded too. This has raised concerns regarding the security of user assets as well as the whereabouts of huge amounts of financial assets being drained anonymously out of the system.

Being an unregulated space, decentralized finance is persistently under scrutiny for enabling money laundering and financing criminal activities on one hand and making it difficult to identify the culprits on the other. Regulatory and legal authorities have been struggling to enforce compliance and identify mischief makers.

There is certainly a requirement to prevent financial crime and ensure the safety of this nascent financial infrastructure and the assets it holds for its users. Thereby creating an urgency to employ AML/CFT provisions to make its safety comparable to that offered by CeFi or traditional finance.

Though not a new concept, zkKYC is being examined to be a solution to maintain anonymity while enabling the identification of those acting against the interests of the network.

The Reluctance

DeFi has been expanding profoundly disrupting traditional finance on a global scale. DeFi evangelists, emphasize the need to keep DeFi as anonymous and as transparent as it is today. Skepticism is definite when a nascent technology is about to allow a predominant methodology to direct its development.

There is a major concern regarding the accessibility of individuals’ data on the transparent platform hindering privacy protection.

Not based on any analysis is a myth that the costs and implementation overheads for the zkKYC process will outweigh the benefits.

Additionally, it is assumed that “knowledge” of any kind regarding the users might give rise to discrimination based on birthplace, income, nationality, etc as is rampant in traditional finance.

Lastly, the reason behind massive growth is the availability of anonymous access which might get hindered and discourage potential users when forced to undergo zkKYC processes.

How zkKYC Will Help?

Decentralized finance has a goal to become a wealth creation platform, providing equal opportunities through open access. The whole blockchain space is trying to make uniformly available, all facilities traditionally available to only the privileged through its permissionless and anonymous operation.

Zero Knowledge Proofs, present an approach where without having to reveal any personal information on the decentralized network, a user may be verified as a known legitimate user. This can be accomplished via a distributed consensus on the network itself. In effect, only a source from where a user can be identified is revealed on the network and not the user’s identity. Thereby enabling an anonymous KYC. This provisions for authorities to be able to track individuals under certain circumstances as laid by the ecosystem. User identity is revealed through a consensus under predefined dire circumstances only.

A decentralized and permissionless space must not be left unregulated! In addition to regulatory compliance and auditability, zkKYC has the potential to drive greater adoption of the decentralized financial architecture –

  • Trustability: A robust KYC process is bound to instill a sense of responsibility among the users and enhance the trustless operation of the network. As the ecosystem evolves into one with only legitimate users, staking, lending, and borrowing activities are bound to proliferate as trust is embedded into the system right from user onboarding.
  • Mass Adoption: Being unregulated the space is looked down upon, by skeptical traditional finance safe-players. Having a regulatory framework will quieten down those voices and make them gravitate towards experimenting with limitless opportunities DeFi puts forward.
  • Better Security: Definitely!, the primary goal is to protect the DeFi-ecosystem from becoming the weakest link across financial spaces. zkKYC coupled with barrier-less entry and transparent operation is going to strengthen the safety of user assets.

The Promises of a zkKYC-Powered DeFi Infrastructure

zkKYC is set to mark another era for DeFi, through its unique feature of not revealing identity yet being verified.

This allows individuals to exercise Self Sovereign Identity i.e. a digital identity created and authenticated by them only. Which establishes trust in the system without having to actually trust the involved parties. The availability of tools such as NFTs and oracles paves way for KYC applications within the DeFi realm. Organizations like PrimaFelicitas offer deeply researched and analyzed solutions for building a secure DeFi platform. Listed among the best blockchain development organizations it enjoys a reputation for excellent customer service.

This era in DeFi is set to give a new direction to how the decentralized financial infrastructure matures while ensuring that it does not end up being a goons hotspot for financing criminal activities.

 

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