KYC Without the Hassle: How DeFi is Embracing User Privacy

Table of Contents

• What is KYC?
• The Contradiction Between Crypto And KYC
• Implementing Document-Free KYC
• Decentralized Identities On The Blockchain
• A New Era Of Compliant, Privacy-Preserving DeFi 

The crypto industry is on the rebound and digital assets like Bitcoin and Ethereum are slowly but surely beginning to approach their previous all-time highs, sparking renewed interest in the sector. In particular, there’s a lot of curiosity around the possibilities enabled by decentralized finance, which opens the door to some truly novel revenue-generating opportunities for investors. 

Whereas the last DeFi Summer was primarily driven by retail investors, this time around it's the institutional investors who are expected to take the industry to the next level, as they’re uniquely able to inject billions of new dollars into the sector. Many in the DeFi industry believe it’s essential to attract this capital if the sector is to go mainstream, but doing so is not easy, as most financial institutions insist on DeFi protocols meeting certain standards in terms of regulatory compliance. 

This is one of the main factors pushing DeFi protocols to adopt KYC procedures, so they can identify who their users are and take steps to prevent them from engaging in fraudulent activity. 

KYC has become synonymous with the traditional financial industry, with every bank on the planet requiring their customers to show some kind of identity document that proves they are who they claim to be. With TradFi, the user’s identity is therefore always known, in contrast to DeFi, where users can remain totally anonymous. While some argue that the lack of KYC has resulted in DeFi becoming rife with scams and illegal transactions, others say it’s one of the most appealing aspects of the industry, in line with crypto’s ideals of decentralization, user privacy, and open access. 

But with DeFi now moving to embrace KYC to entice institutional capital, it threatens to erode what has become one of the foundations of the Web3 movement. However, the blockchain industry has built a reputation for being at the forefront of innovation, and a number of promising solutions have emerged that aim to resolve this clash of interests. 

What is KYC?

KYC stands for “Know Your Customer” and has become the industry standard for financial institutions in matters of due diligence. They use KYC to verify the identity of their customers and assess whether there’s a risk of that individual using their services to engage in illegal activities such as money laundering and terrorist financing. 

KYC checks involve asking the customer to provide government-issued identity documents, including a photo, and sometimes additional information such as their financial records. This enables them to understand exactly who they’re doing business with and is critical for them to adhere to financial regulations. 

For many people, KYC has become an irritant, due to the lack of standardization, the protracted verification process, and the high costs. It’s also extremely repetitive, as customers generally have to repeat the process every time they interact with a new organization. 

The Contradiction Between Crypto And KYC

For crypto users, what’s even worse is that the very idea of KYC compromises the basic principles that decentralized money is supposed to uphold. KYC is a centralized and invasive process that eliminates the user’s anonymity. They’re required to hand over personal information to centralized companies that then determine whether or not that person is allowed to use the service or product in question. So it doesn’t just erode privacy but also encourages censorship, which crypto also seeks to eliminate. As such, KYC is seen as antithetical to the crypto movement. 

DeFi appeals to many people precisely because it enables them to access financial services anonymously. They can use DeFi products without any friction, and no one can prevent an individual from accessing these protocols. But when DeFi insists on KYC, it takes away these benefits. 

By adding the friction and invasiveness of KYC, the DeFi industry effectively becomes more centralized, which limits its appeal and its growth prospects. It also erodes trust in DeFi protocols and adds what most users will perceive as an unnecessary layer of bureaucracy that limits their freedom to participate. 

There are other problems with KYC in crypto too. One of them is that DeFi apps are global and accessible to anyone in the world. However, the exact nature of KYC requirements differs from country to country, which means it’s challenging to implement a KYC process that is compliant in every jurisdiction. In addition, some DeFi products leverage KYC compliance as a kind of “stamp of approval”, but in reality, such a process is not a guarantee of legitimacy. 

Implementing Document-Free KYC

Thankfully, the blockchain industry is pushing to get around these concerns by enabling DeFi protocols, crypto exchanges, and other services to implement KYC in a more decentralized way, creating a secure and trustworthy approach to identify verification that doesn’t impact on the privacy of their users.

One of the pioneers in this regard is Ramp Network, the crypto on- and off-ramp service that recently debuted a new, document-free KYC process for users in Brazil. It’s doing so in an effort to make it simpler for users to sign up and start trading crypto, and it only requires users to jump through two very simple hoops to get started using its services and engage with hundreds of DeFi applications and exchanges. 

To pass KYC with Ramp, Brazilian users are now only required to provide their official tax number and a selfie, and they’ll be verified almost instantaneously so they can get started buying and selling crypto. 

The company is eliminating the need for customers to find and upload any official documents in order to encourage more people to sign up, and assuming it does well in Brazil, plans to offer the same service to users in other countries later. "By reducing barriers to entry, document-free KYC can play a pivotal role in driving the mass adoption of digital currencies," said Jose Jiminez-Mancha, chief commercial officer of Ramp. 

What’s especially interesting about the new service is that it doesn’t just benefit Ramp’s users, but also anyone who uses MetaMask, Trust Wallet, Sorare, BitPay, and other supported DeFi wallets. It simplifies onboarding and improves privacy for users, enabling them to continue engaging with hundreds of DeFi protocols in an anonymous way, streamlining the user experience and promoting greater convenience while ensuring full compliance with legal regulations. 

Decentralized Identities On The Blockchain

Another innovation that promises to be a game-changer for KYC is the concept of the decentralized identity or DID, which enables users to create a blockchain-based profile that can then be shared with any financial institution, be it TradFi or DeFi. In this way, DIDs eliminate the need to undergo multiple KYC checks for each service or product, saving time while also preserving users’ privacy. 

By using smart contracts, DIDs enable the user’s profile to be updated automatically whenever they provide a new document to strengthen their ID. This ensures that their profile can be kept accurate and up to date. 

With DIDs, customers only need to undergo the KYC process one time to create their decentralized identity, which can then be used repeatedly with any organization. DIDs protect privacy too, as the only entity that views their personal documents is the KYC provider, which means users can remain anonymous when interacting with DeFi protocols in a compliant way. 

There are a number of pioneers building comprehensive DID solutions, with protocols such as Fractal and Polygon ID helping on the identity verification side while ensuring privacy, while Decentralized oracles such as Clique can handle reputation management and multichain interoperability.

A New Era Of Compliant, Privacy-Preserving DeFi 

These innovations around document-free KYC and DIDs hold an enormous amount of promise for the crypto and DeFi industries, enabling them to onboard millions of new users and billions of dollars of new capital in a compliant way while ensuring they remain true to their principles of decentralization, transaction privacy, anonymity, and censorship resistance. 

By simplifying the process of proving one’s identity, eliminating the red tape involved, and creating a more seamless and user-friendly environment, crypto and DeFi have finally stumbled on a path to full compliance in a way that doesn’t go against the beliefs of their biggest proponents. 

Once again, the blockchain industry is showing that it’s at the forefront of innovation. By enabling crypto and DeFi to appeal to institutional investors, the introduction of privacy-preserving KYC can play a pivotal role in attracting new capital to the industry, help to accelerate the next great bull run, and, perhaps, bring us closer to the goal of mainstream adoption. 

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.