Nimantha Siriwardana
There’s no way for blockchain-based businesses, financial service providers or banks to bypass Know Your Customer (KYC) processes. But existing KYC solutions that have been developed over the years, such as manual and online identity verification, video and biometrics, have their drawbacks, including a high risk of error and effort duplication.
With the advent of blockchain technologies, companies are realizing that there are better, more efficient KYC solutions that let them avoid having to collect and store personal information.
Not your run-of-the-mill KYC solution
As blockchain technology matures, many people are looking toward decentralized identity or self-sovereign identity as an ideal — people will gain control over their digital identities and they’ll avoid having to provide excessive, unwarranted information.
Mechanisms already exist to help us reach that ideal. In web3, physical assets will eventually be owned by someone, but a digital-only relationship between the buyer and seller won’t suffice. There must also be a physical relationship so that a buyer has legal recourse to get this physical asset — a complexity most people are glossing over.
That’s where blockchain can be used to improve on traditional KYC providers. Typical KYC processes require people to upload their proof of identity to a verifier. However, businesses working toward becoming more decentralized shouldn’t need this extent of information, nor should they require custody of a person’s tokens. Businesses must be able to simply and credibly confirm that an account or digital wallet interacting with them has been verified.
There are a multitude of off-chain KYC solutions that come with different capabilities and price points. The difference comes down to what level of detail and scale a company needs. The major downside of all these operations is the storage requirement from a regulatory perspective. Often, KYC and AML (anti-money laundering) details have to be stored for a certain time period to meet reporting standards and in case there are irregularities. This presents a major weakness in the system, as a company’s customer data is stored by multiple parties whose cybersecurity mechanisms may vary in effectiveness.
On-chain KYC replaces this massive cache of data with a simple token that says a person has been verified by a designated verifier. The verifier is the only one who has to store the credentials, and they must have the correct cybersecurity processes in place to ensure the data is protected.
Choosing a KYC service provider
Founders must understand how to select a KYC vendor for their specific project. A vendor’s platform should be simple, as ease of use is paramount and complexity will only deter people from participating in your project. Also, customer support is as important for crypto businesses as it is for non-crypto ones. You must be able to quickly and easily contact the vendor for any issues or questions.
Consider the cost implications, too. There is usually a cost to verify every user — all services charge this, and at scale, it can get fairly expensive. Consider a solution that can scale with your business — if it costs $0.50 to verify one user, you’ll have to pay $500,000 for a million users.
On-chain solutions can solve this cost issue. A user doesn’t need to be verified 50 times for 50 services; they only need to be verified once, and those credentials can be used by all services. This makes on-chain pricing much more competitive.
For luxury goods businesses looking to incorporate blockchain solutions, KYC becomes particularly relevant if there’s a secondary sale. Once a company sells a product, the user should get access to the product’s digital twin, an NFT, so the business can interact with the person that owns it. Brands thinking about enabling secondary trading must ensure a KYC solution has some sort of controlled access in place down the line.
Exchanges, marketplaces and other decentralized applications (dApps) using on-chain KYC solutions can restrict access to people verified by a third party and add this requirement into their smart contracts. For example, verified pools on decentralized finance (DeFi) protocols can establish rules that don’t allow people to interact with a pool unless they’ve been verified.
Start from the roots: Your blockchain
Few KYC and AML vendors have integrations that let you verify an identity independently and have it reflected as a token on the blockchain. Select a provider that is transparent about what they do with their data and confirm that they’re doing all the checks you need.
Once you start working with the vendor, you’ll learn more about the legal ramifications of what you’re trying to do. You can research this beforehand, but the extent of your legal rails will depend on whether you need KYC or AML, so make sure that the lawyer your company is working with is very familiar with AML processes.
KYC alone is a checkbox exercise, but AML brings different requirements — the need to store the documentation for long periods, ongoing monitoring and reporting, etc. Since most apps will operate in multiple jurisdictions, it’s impossible to know all the flavors, but working with a provider that has a broad reach can help clarify any quirks. For example, a business moving the personal data of Chinese users outside of the Chinese border will complicate most verification processes.
It pays to be careful when selecting a blockchain, because it will greatly impact KYC processes. The blockchain should be supported by your KYC vendor of choice or be capable of supporting them — it will already have an existing base of verified users if it is compatible.
Eventually, you may look at which blockchains have good verification systems in place and use that as a metric in the decision-making process. It’s not going to be possible to know how many users are verified, but many verifiers providing coverage on a chain is a good indication.
KYC wasn’t built in a day
Businesses are already reporting data to regulators locally and have external audits in place, but this information can be even more organized and streamlined when it comes from a reputable source on the blockchain. Even for high-end luxury goods brands that want to tell the story behind their product and verify their assets, putting this data on the blockchain is the easiest solution.
The biggest hurdle to putting blockchain-based KYC processes in place is convincing Bitcoin die-hards — who are pushing for true anonymity — to buy into the concept of verifying themselves so they can engage with a business’ products or services. Luckily, the larger mass of people waiting to adopt blockchain solutions are already familiar with KYC processes and are more willing to experiment with applications that resemble processes in the non-crypto world.
Businesses adopting on-chain KYC should target everyone, not only crypto natives, and convey that they’re offering verified and secure systems. Adopt robust procedures that give people confidence and show that your business is fit for the digital future.
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