Op-ed: Not all blockchains need to be pseudonymous

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Blockchain technology holds the potential to enhance various industries, particularly in the financial sector. Layer one protocols, which are essentially the base layer of any blockchain network, serve as key components of a blockchain system. Examples of layer one blockchains include Bitcoin, Ethereum, and Binance Smart Chain. These blockchains serve as the base layer for various decentralized applications (DApps) and smart contracts.

Layer one protocols are responsible for establishing the fundamental rules and consensus mechanisms that govern a blockchain network. They determine how transactions are validated and added to the ledger. Additionally, layer one protocols are where interoperability between different dApps will take place in the future. 

Businesses can also deploy their own layer one, known as an “enterprise blockchain” so as to achieve goals of their business or offer services. These blockchains are fundamentally different from the abovementioned layer ones, which focus on delivering services while in alignment with crypto’s core principles, which includes pseudonymity, decentralization, and more. 

An enterprise blockchain can ditch the principles so as to deliver services in a compliant manner. They can therefore offer services otherwise unachievable in a pseudonymous environment due to regulations and perhaps bring a new kind of user onto layer one technology. 

KYC and AML For Regulatory Compliance

In today’s digital landscape, where financial transactions occur at an unprecedented pace, regulatory compliance takes center stage. In the financial industry, everyone is familiar with Know Your Customer (KYC) and Anti-Money Laundering (AML) protocols. Businesses verify the identity of their customers, mitigating the risk of fraudulent activities. 

KYC and AML are regulatory compliance processes designed to prevent and detect illegal activities, such as money laundering and terrorist financing. These processes are particularly important in the financial industry, including for cryptocurrency exchanges and platforms that deal with virtual assets. Such regulations ensure that businesses actively monitor transactions, identify suspicious patterns or behaviors, and report any potential risks to relevant authorities. 

The decentralized nature of layer one blockchains poses challenges for their direct implementation at the protocol level. Some DeFi platforms and services built on top of layer one blockchains have taken to implementing their own mechanisms for user identification and compliance.

Some projects, for example, are exploring the use of tokens or smart contracts specifically designed to facilitate compliance with regulatory requirements. These tokens could represent a user’s verified identity on the blockchain without disclosing sensitive information publicly.

The more distributed nature of enterprise blockchains, however, make prospects for implementing AML and KYC at the base layer a more practical endeavor. This gives everyday people and institutions the confidence to interact directly with an enterprise blockchain of their choice. 

Financial Transparency Through KYC and AML 

Financial transparency is crucial for building trust and the integrity of financial systems, including blockchain based systems. The incorporation of KYC and AML protocols on a blockchain layer one protocol offers tremendous potential to provide users with transparency while preserving confidentiality through technology such as zero-knowledge proofs, a method by which one party proves to another party that a certain statement is true without revealing any information beyond the fact of the statement’s truth.  AML procedures on a layer one blockchain mean that transactions are auditable in real-time.

While regulatory compliance is crucial for widespread adoption and integration with traditional financial systems, the balance between privacy, decentralization, and compliance is a challenging one. Regulatory developments in the cryptocurrency space are dynamic, and jurisdictions may have different approaches to these issues. 

As the industry evolves, it’s likely that there will be ongoing developments regarding how KYC and AML measures can be effectively implemented within the decentralized and pseudonymous nature of layer one blockchains. 

The Possibility On Layer One 

The fact is, layer one protocols have the potential to provide seamless integration with external data sources, allowing for real-time verification of customer identities and monitoring of transactional activities. Original blockchains such as Bitcoin, Ethereum and many others are based on core blockchain principles which effectively forbid AML and KYC procedures. New enterprise blockchains do not necessarily need to adopt these principles, and can thus build with a different demographic in mind.

Such layer one protocols can incorporate features such as identity verification mechanisms, transaction monitoring tools, and smart contract functionalities to facilitate secure and transparent on-chain transactions.

Organizations could then use layer one blockchains to establish trust among participants by ensuring that all users are compliant with KYC and AML regulations in a tamper-resistant environment designed for storing sensitive customer information securely.  

A new crop of layer one blockchains, which have implemented AML and KYC functionalities, could create the incentives necessary to bring in new users who could benefit from layer one layer one blockchain technology.

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