The emergence of crypto and Web3 has brought with it a new set of challenges for regulators and compliance teams. Though decentralized finance (or DeFi) platforms and NFTs have disrupted traditional financial systems by creating new opportunities for innovation, they also have opened up potential avenues for financial crime. According to VentureBeat, nearly $4 billion has been defrauded from Web3 ecosystems in 2022 alone. One solution to these legal challenges could be the use of decentralized identifiers (DIDs). 

DIDs are a type of decentralized identity technology that uses blockchain to allow individuals to control their personal data, while allowing for verification, without the need for intermediaries. Alongside a verifiable credential implementation of Zero-Knowledge Proofs (ZKProofs), which serve as a way to share information without disclosing personal data, Elastos DIDs are built with self-sovereignty in mind and provides a secure, tamper-proof way for users to establish their identity online. By using Elastos DIDs, individuals can create and own their digital destiny without relying on third-party identity providers.

Regulatory Crackdown

Web3 faces several regulatory challenges as it pioneers a new, decentralized internet. Some of these issues include cybersecurity risks and data breaches, increased difficulty in identifying transactions and money laundering, and lack of jurisdictional clarity.

The 2022 collapses of crypto projects and exchanges like Terra and FTX are causing lawmakers to scrutinize the industry much more closely. This year is likely to bring even more litigation as governments attempt to protect consumers from these financial meltdowns, as well as stablecoins. In the UK, for example, the deputy governor of the Bank of England has called for regulation of new stablecoins to ensure they meet commercial bank money standards.

Experts disagree over whether new legislation is necessary or if regulators should enforce existing laws more effectively. Critics argue that some legislation could stifle decentralized finance protocols. Luckily, DIDs may provide a solution. Below we will look at some regulatory issues governments and large corporations face and how Elastos DIDs can help.

Data Privacy and Ownership

One of the main benefits of DIDs and verifiable credentials is that they allow individuals to own and control their personal data. In the traditional online world, people often have limited control over their data, as it is collected, stored, and sold by various centralized third-party services.

However, with DIDs, users can control their digital identities and the associated personal data. They can choose which information to disclose and revoke access to their data at any time. This gives people greater control and reduces the risk of data breaches and unauthorized access. Additionally, DIDs can facilitate the creation of dApps that do not rely on centralized servers to store and manage private data. Instead, user data can be stored locally on a user’s device — with the DID serving as a unique identifier that enables secure and private access.

By using DIDs and verifiable credentials in combination, users can take ownership of their personal data and have more control over its use and sharing. This can help prevent unauthorized access and data breaches, and also enable individuals to monetize their data in a secure and privacy-preserving manner.

Streamlining KYC

Know Your Customer (KYC) is another critical regulatory issue in the crypto industry and is a core differentiator between centralized crypto platforms, like Coinbase and decentralized finance (DeFi) platforms. KYC regulations require centralized platforms to verify the identity of their customers and assess their potential risk for money laundering and other illicit activities. However, traditional KYC methods can be time-consuming, costly and may also compromise the privacy and security of users’ personal information.

DIDs and verifiable credentials can provide a more secure and privacy-preserving way to comply with KYC regulations. DIDs allow individuals to control their personal data and authentication credentials while also providing a secure and reliable way to establish their credentials. Users can establish their identity and comply with KYC regulations without relying on centralized third-party identity providers.

What about ZKProofs?

ZKProofs can also play a critical role in KYC compliance by allowing users to prove their identity and meet KYC requirements without revealing sensitive personal data, such as their birth date or passport information. ZKProofs can also be used to assess the risk profile of a customer without revealing any additional info beyond the minimum necessary to meet regulatory requirements. 

Moreover, the use of DIDs and ZKProofs can solve some of the challenges associated with cross-border transactions. Different countries have different regulatory requirements, and it can be challenging for businesses to comply with all of these requirements without compromising the security of their users’ personal data.

Preventing Money Laundering

Anti-money laundering, or AML, is a critical regulatory issue for the crypto industry. Cryptocurrencies have long been used for money laundering and other illicit activities due to their anonymous and decentralized nature. However, DIDs and ZKProofs can help address this issue by providing a more secure and privacy-preserving way to comply with AML regulations from government regulation.

One of the key features of DIDs is their ability to establish and verify a user’s identity without the need of a centralized identity. This means that individuals can control their personal data and authentication credentials without relying on third parties. By using DIDs, people can establish their identity and comply with AML regulations without revealing sensitive personal information.

In addition, ZKProofs allow individuals to prove the validity of a statement without revealing any additional information beyond the statement itself. For example, someone can prove that they have sufficient funds to complete a transaction without revealing the actual amount in their wallets.

By combining DIDs and ZKProofs, users can establish their identity and prove the validity of their transactions without revealing any sensitive personal information. This provides a more secure and privacy-preserving way to comply with AML regulations, as it eliminates the need for intermediaries and minimizes the risk of identity theft and fraud.

Conclusion

Though crypto has a ton of potential, the emergence of blockchain tech and Web3 has brought on a new set of regulatory challenges. However, DIDs and ZKProofs offer a unique solution to these regulatory and compliance issues.

By using DIDs and ZKProofs, individuals can control their personal data, establish their identity, and comply with regulatory requirements without relying on centralized intermediaries. This provides a more secure, privacy-preserving, and efficient way to address issues such as ownership, KYC compliance, and anti-money laundering. 

As the crypto industry continues to grow and evolve, the use of DIDs and ZKProofs will become increasingly important in solving these types of issues to ensure the overall safety and security of the ecosystem.