Know-Your-Customer (KYC) protocols are among the most basic requirements for financial institutions around the world. It involves understanding the user’s identity and financial history, while also cross-referencing that information with a series of lists of known criminals to make sure they’re not doing business with them.
Financial institutions are required to do this to comply with Anti-Money-Laundering (AML) and Combating the Financing of Terrorism (CFT) protocols. Failure to follow the procedures adequately can lead to billions of dollars in fines and accidentally sanctioning illegal activity.
Decentralized Finance (DeFi) evolved from blockchain technology as a trustless, permissionless and anonymous environment wherein users can exchange and do business without the involvement of third parties. In other words, users can transact with each other without having a good idea of who the other person or entity might be.
This structure opens up considerable potential legal issues that can result in a complete shutdown of the associated systems that enable this behaviour. As such, financial institutions have been slow to enter into DeFi, given the considerable risks for them. After all, from a legal point of view, they might potentially be seen as enabling criminal activity by participating in liquidity pools, node staking, etc.
This anonymity also increases the risk of scams as people are likelier to act immorally when they know their actions are unlikely to be traced back to them. So crypto is unnecessarily seen as a dangerous environment given that this lack of accountability stops the authorities from policing the environment.
Then, the “tamed” DeFi ecosystems where people are KYC’ed before doing business present their own issues. After all, due to the decentralized nature of the financial ecosystem, each separate microservice is its own entity, and they don’t “talk” with each other. For example, lending is done by a separate app than NFT creation or secondary market sales.
In other words, from a financial institution perspective, it’s a compliance nightmare as suddenly a single transaction might have you interacting with five different organizations that might have wildly different vetting procedures and are headquartered in different jurisdictions.
Furthermore, they will need to give their financial information several times. It also bears saying this procedure will take days, or even weeks to accomplish and every organization might have slightly different requirements.
The original vision of blockchain technology was to be anonymous, however as the industry formalizes this is increasingly becoming untenable. There must be a middle ground between transparency and anonymity and the CRD Network has found it.
Instead of having you fill out fifty different forms, we will simply have you fill out your KYC details once. Then, we would mark your mainnet Ethereum wallet addresses via Hyperledger Besu as being compliant with KYC regulation.
In other words, the DeFi system at large could recognize that you have passed KYC procedures at some point. The authorities would be able to double-check this information, but independent app owners would simply be satisfied with the fact that a trustworthy entity has verified the documents and the user’s identity.
This would considerably fast-track application processes and could make starting and using a new DeFi service, even after a regulatory crackdown, quite seamless.
Not only that, but this opens up several opportunities for the creation of safer ecosystems. For example, the CRD Network is planning on only accepting users that have already had their KYC details onboarded, and so we will create a “walled garden”, where all users are vetted.
This not only decreases the risk of scams considerably, as authorities can go after people that try to perform illegal actions, but this will also increase the rate of institutional adoption. After all, the main reason why they’re not presently participating is the risk of interacting with users that aren’t legally compliant, and they will now have the option of avoiding them entirely.
In time, this will be good for us as an industry, as with institutional acceptance we gain their lobbying power and connections with regulators.
The CRD Network hence stands to become the prime example of how to do DeFi while being legally compliant and ready for the next stage of the continuing evolution of our industry.