Decentralized Finance, also known as DeFi, is an emerging industry that uses blockchain technology and smart contracts to create a more open, transparent, and accessible financial system. DeFi enables users to access and control their finances without relying on intermediaries and includes decentralized exchanges, lending and borrowing protocols, and stablecoins.
According to Azeem Azhar, the benefits of DeFi are gaining attention worldwide and it has grown explosively in the past few years. The value of assets locked into DeFi services has swirled from less than $1 billion in 2019 to a peak of about $180 billion in December 2022.
However, as DeFi grows, regulators are paying increasing attention to the industry, and one of their main concerns is the anonymity of users.
Self-sovereign identity (SSI) is a concept in the field of digital identity that emphasizes the individual's right to own and control their own personal identity information. SSI allows individuals to control the data that represents their identity, rather than involving third parties such as governments or financial institutions to store and control identity information.
In an SSI-based Identity management infrastructure, users can create, manage and control their own digital identity, using a variety of tools and technologies. This can include blockchain-based infrastructure, biometric technologies, and other forms of decentralized identity management.
There are several advantages to having a decentralized digital identity system.
Firstly, it gives users more control over their data. They no longer have to rely on central authorities (such as governments or big tech companies) to manage and protect their data.
Secondly, it makes it easier for people to prove their identities online. This is because they would no longer need to remember a bunch of different usernames and passwords for different websites and applications.
Thirdly, it would make it easier for people to share only the information that they want to share. For example, if someone only wants to share their name and email address with a particular website, they would be able to do so without having to share any other personal information.
Finally, the system is designed to increase security by decentralizing information, this architecture allows a drastic drop in data breaches.
What is the relation between DeFi and SSI?
The potential of combining DeFi and SSI is vast — and with the right policies and regulations in place, we can realize this potential while ensuring that the benefits of decentralized finance are shared by all.
There are many potential benefits to decentralized digital identity, including giving users more control over their data and increasing the security of that data. However, there are also some challenges associated with this approach, such as the need for better education and awareness about digital privacy and security.
One area where the intersection between SSI and DeFi becomes particularly interesting is in the realm of financial inclusion. By enabling individuals to control their identity data, SSI can help to reduce the barriers to entry for financial services, particularly for those who may not have access to traditional forms of identification or may be excluded from the financial system for other reasons. For example, with SSI, an individual could easily prove their identity to access a decentralized lending platform, without needing to go through traditional means such as presenting a government-issued ID or utility bill.
Another area where the intersection of SSI and DeFi could be beneficial is in the realm of financial privacy. With SSI, individuals can selectively share the data that represents their identity, rather than having to disclose all of their personal information to a central authority. This can help to protect individual's privacy, while still allowing them to access the financial services they need.
While SSI empowers users to regain control of their data, DeFi has the potential to create new sources of revenue and opportunity for users beyond what traditional financial institutions can offer.
What is Know Your Cutomer (KYC)?
KYC, or “Know Your Customer”, is a process used by financial institutions and other organizations to verify the identity of their clients and assess their suitability for financial products or services. The goal of KYC procedures is to prevent financial crimes, such as money laundering and terrorist financing, by ensuring that organizations only engage in business with individuals or entities that have been properly vetted.
KYC typically involves several components, including identity verification, risk assessment, and ongoing monitoring of client activity and transactions.
While KYC can help to prevent fraud and terrorism, it requires financial institutions and other organizations to collect users’ sensitive data on users which are usually stored in centralized databases, vulnerable to hacks and data breaches.
A decentralized KYC model, built around self-sovereign identity, could make the process more efficient, improving the accuracy and reliability of KYC checks. With SSI, individuals can selectively share the data that represents their identity, rather than having to disclose all of their personal information to a centralized authority. This can help to ensure that the information used for KYC checks is accurate and up-to-date, reducing the risk of false positives or other errors.
Moreover, individuals can control their identity data, rather than having to rely on centralized authorities to manage and protect that data.
What is the relationship between DeFi and KYC?
One key difference between DeFi and traditional finance is that DeFi lacks the identity layer aspect, which usually takes the form of KYC (Know-Your-Customer) checks.
This is partly because introducing such features would decrease their decentralized nature as its users remove their anonymity cape. Instead, DeFi directly links to smart contracts and eliminates the need for a legal identity verification process, and thus the platform is not required to interact with your identity to execute trades.
As of now, a user only needs a non-custodial blockchain wallet. By deploying cutting-edge technologies like zero-knowledge proofs and ring signatures, DeFi protocols stand to pave the way for a more private and secure financial future.
On the other hand, regulators are increasingly advocating for a tout-court DeFi legislation concerning also the requirement for DeFi platforms to identify the users interacting with it.
Decentralised KYC checks also unlocks value by:
1 - Opening the path for more DeFi services by offering users a certain level of trust or reputation. Decentralized checks provide a base level of assurance that a user is who they say they are, and that their data has not been tampered with. This allows service providers to offer more complex financial products and services without having to worry about the risk of fraud.
2 - Providing one KYC across all platforms, eliminating end-user frustration. Users are often required to go through multiple KYC processes when using different platforms. Decentralized KYC checks would allow users to share their verified identity information with multiple platforms, eliminating the need for duplicate efforts.
3 - Enabling users the ability to revoke a platform’s access to their information at any time. Under current centralized models, once users provide their personal information to a platform, they have no way of knowing how it will be used or where it will end up. With decentralized KYC checks, users would have the ability to control who has access to their information and revoke access at any time.
4 - Safeguarding access to users whose identity has been verified. If a user’s account is hacked or stolen, their personal information could be compromised. By using decentralized KYC checks, personal information would be stored on a distributed storage where it would be much more difficult for hackers to access it.
5 - Tackling the young trader demographic problem. Many young people are interested in trading cryptocurrencies but are put off by the complicated KYC process. Decentralized KYC checks could make it easier for young people to get started in the world of cryptocurrency trading.
6 - Eliminating design vulnerabilities in current authentication protocols. There have been numerous instances of personal data being leaked due to vulnerabilities in centralized KYC systems. By moving to a decentralized model, these vulnerabilities can be eliminated, providing an extra layer of security for users.
How can Togggle help you comply with KYC requirements?
At Togggle, we believe that everyone has the right to take ownership of their digital identity and control which data is shared with what companies. We want to empower businesses to verify the identity of their customers without being prone to customer data management risks. Our SSI platform’s pioneering application is real-time, decentralized KYC.
Togggle’s fast and hyper-secure decentralized identity technology positions us as the ideal service provider for DeFi as we comply with European blockchain regulations but do not risk our decentralized nature. Our platform is the perfect solution for businesses who want to streamline their customer onboarding process while ensuring compliance with regulatory requirements. Get in touch with us today to find out more about how using our platform can benefit your business.
In conclusion, the union of SSI and DeFi enables financial privacy and inclusion. In this context, a decentralized KYC model, built around self-sovereign identity, could make the process more efficient and reliable. Individuals can selectively share the data that represents their identity, rather than having to disclose all of their personal information to a centralized authority.
As the world progresses, we face new challenges that require innovative solutions. The rise of the digital economy has given birth to a new era of finance, known as Decentralized Finance (DeFi). However, this sector is still in its infancy and faces many challenges. At the same time, the traditional financial world is also evolving, thanks to the advent of Self-Sovereign Identity (SSI). To solve the challenges facing both DeFi and SSI, collaboration and technological perseverance are key.
First and foremost, we need to find common ground between SSI & DeFi technology providers. Only by working together will we be able to overcome the challenges facing these industries. Fortunately, SSI already has an established ecosystem of regulatory and standardization bodies, so compliance should not be an issue. At the same time, both DeFi and SSI players must maintain the determination and motivation that has pushed these sectors into the public eye, despite the murky regulatory waters that lie ahead.
And while decentralization and anonymity are two separate ideas, fortunately, both can be maintained by connecting DeFi & SSI. Doing so can create a more inclusive financial ecosystem that benefits everyone involved.
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