DEX and KYC: Are fire and water incompatible or can we have both?

Israeli serial entrepreneur Ariel Shapira reports on emerging technologies in the fields of cryptocurrencies, decentralized finance and blockchain, and their role in shaping the 21st century economy in his monthly crypto column.

The White House recently issued an executive order on regulating cryptocurrencies. Across the ocean, European lawmakers have thwarted a piece of legislation that could spell major trouble for proof-of-work networks. These developments remind us of what most crypto enthusiasts have long been accustomed to: regulation is still largely on the agenda, and while the blockchain community is now more compliant than ever, this will at least cause some of dissatisfaction.

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One thing that will inevitably come up on the regulator’s target list is KYC (know your customer) protocols. As far as today’s ecosystem is concerned, these protocols are almost everywhere. Some platforms (often the more centralized ones) handle KYC in more or less the same way as traditional financial institutions, at least including identity checks. However, its platform is basically plug-and-play based, which means that as long as you have a crypto wallet, you can start your business.

Decentralized exchanges (DEXs) are typical of the latter approach. For example, using Binance Smart Chain on PancakeSwap, or Cardano on WingRider, you can interact with smart contracts that drive liquidity pools. In most cases, anyone can stake their tokens into the pool, earn a share from their accumulated transaction fees, and anyone can utilize the pool to exchange their tokens without much KYC. This is a convenient, fast and reliable way to transfer value between different token ecosystems, and also allows liquidity providers to profit by keeping their services running.

Compliance needs will increase

When delving into the blockchain space, regulators may find this approach a bit too laissez-faire. They may ask for more KYC from such protocols, and such requests may get a routine response: how exactly do you expect KYC to be performed on the on-chain code snippet?

At the most basic level, this is indeed a tricky problem. “Code is law” is a popular crypto saying, so the ability of any decentralized application is inherently limited by its underlying code. Bringing KYC to these capabilities is a daunting challenge from both a technical and ideological standpoint. From the former point of view, this means that an all-encompassing digital KYC platform must be built that can handle the task itself without human involvement. From the latter point of view, this means staying away from some of the core values ​​and beliefs of the crypto world that love and value anonymity and privacy.

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Some companies in the crypto space, like Everest, have implemented eKYC through traditional means. The company can also anonymously confirm the uniqueness and humanity of each user, which is very important in our age of bots. In the future, anonymity is likely to be KYC’s battle cry for blockchain. A system where a trusted third party can verify customer identity compliance and issue a cryptographically secure confirmation of a successful check without revealing the customer’s data itself could become a common ground for crypto purists and regulators alike. This token will enable both centralized and decentralized exchanges to verify the identity of users without knowing them.

Importantly, such a solution would also eliminate the need for exchanges to actually store users’ private data. A centralized database of users’ personal information doesn’t even have to include their banking information or private keys, which is valuable to hackers, but an exchange would have to create such a database if it wanted its proper KYC. This creates a vicious cycle that exposes users to tangible threats, while also creating the additional hassle of having to manage and maintain these records for the exchanges themselves.

Decentralized KYC compliance?

Another way to deal with the decentralized KYC puzzle is to let AI try to solve it. This may require a multi-layered solution, where the first model will process the scan of the document and pass the output to one or more other models to complete the task. While this is complicated, it’s not entirely unthinkable – at least as long as we don’t envision something like this being deployed into a smart contract. However, off-chain implementations can still act as trusted third-party KYC providers, enabling exchanges to operate with all the right rules.

Essentially, like many other processes, KYC always follows a protocol. It includes input (documents, financial statements and other information that the counterparty may need to process) and output (approval or rejection). Many of these processes are easy to digitize because they follow the same logic that most computer algorithms follow. Of course, building a system that is flexible enough to accommodate different KYC rules in different jurisdictions will be a challenge, but it is also quite possible. It is not difficult to imagine that in traditional finance where KYC is the primary responsibility, the value of this system can also be seen, thereby creating a potential market worth billions of dollars.

Improved KYC procedures could also spark a revival of user interfaces, making DEXs easier for ordinary investors to use. One of the biggest pain points in the crypto space as a whole, and especially on decentralized platforms that are geared towards crypto enthusiasts rather than novices, is the complexity of usage. For example, crypto users couldn’t even confirm that they were sending crypto to the correct address until Kirobo’s revoke button appeared. With strict compliance with regulations, more mainstream users influx, they often need a smoother mechanism for buying and selling cryptocurrencies.

Those more innovative DEX development teams, who build their projects with KYC compliance in mind, while still staying true to the value of decentralization, will definitely stand out – so they better start innovating now for what’s coming Be prepared for change.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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