4 Minutes

Can DeFi Strike a Balance Between Compliance and User Privacy?

DeFi needs to continually evolve like any other innovative technology in its early days. The immediate path for DeFi might be regarding its regulatory compliance. But applying regulatory compliance on DeFi might not be that easy, and it would be critical that such a solution would need to address any user privacy concerns as well.
03 Feb 2021

The excitement surrounding DeFi - and the vast potential it presents - may have served as one of the catalysts in reviving the crypto space from a two-year-long slumber last year.

However, DeFi is still in its early days, and this effectively means that its ecosystem is continuously undergoing changes, evolutions, and improvements.

Perhaps the most important - and inevitable - evolution in the DeFi space is one that relates to regulations and compliance.  As DeFi gains more mainstream attention, the issue of bringing actors in the DeFi space into a regulatory fold has become more pressing. 

The idea of implementing a regulatory framework for DeFi might sound similar to the process of extending existing financial regulations to centralized crypto exchanges, which has been ongoing for a few years now. Yet, such an implementation in DeFi might not be as straightforward and easy as in the case of centralized crypto exchanges and other Virtual Asset Service Providers (VASPs).

The first reason for this is fairly obvious: many crypto exchanges that have been able to comply with new regulations, such as the updated FATF Travel Rule, are of a centralized nature.

Hence, the task for regulatory bodies to prepare and recommend a regulatory framework for such exchanges has been a pretty straightforward affair. However, it might prove to be much more complicated to regulate DeFi platforms, which tend to be highly decentralized.

This decentralized approach might mean there is no server, no office address, and maybe no team. Can regulators control or shut down something which exists purely in a smart contract?

Furthermore, developing a regulatory framework will not simply solve regulatory concerns overnight. A majority of centralized exchanges still lack a comprehensive framework to counter KYC/AML fraud on their platforms.

Finally, it is also fair to say that exchanges that have managed to implement a regulatory framework that ensures compliance has largely achieved this at the expense of user privacy, to varying degrees.

Moreover, the methods used for collecting and processing user data for KYC/AML requirements are modelled similarly to the processes that are followed by traditional financial entities like banks and other financial institutions.

As a result, it is safe to say that a straightforward, ‘traditional’ regulatory framework that covers all aspects of KYC/AML will not be the answer when it comes to safeguarding DeFi users from identity theft/compromise and other potential dangers.

Added to that, when it comes to DeFi, most  DeFi platforms are designed to prioritize user privacy.

Indeed, this quality has been one of the prominent features that have helped the space to grow in popularity. As discussions about implementing a regulatory framework begin to increase, a growing concern among  DeFi users will be the effect regulations will have on their privacy.

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Creating a Regulatory Solution for DeFi

Regulations and user privacy can co-exist and do not need to have a zero-sum relationship. The solution for a regulated DeFi ecosystem that respects user privacy can be achieved by striking a balance between these two factors.

However, a solution that equally weighs both concerns should not be considered an immediate solution, as comprehensive and institutional-grade regulatory compliance often takes more time to develop and implement.

Nevertheless, with each passing day reports of new financial institutions entering the crypto space are increasing with the world’s largest asset management corporation Black Rock Inc, being the latest entrant into this list.

Hence an immediate solution to address both the regulatory woes as well as the privacy concerns of users that accompanies a regulatory framework might be the need of the hour. 

SelfKey could help both traditional financial institutions joining the crypto space become comfortable with a compliant approach to DeFi and marry this with user privacy and self-sovereign digital identity. 

Decentralized Identity

Decentralized identity may be the most ideal solution that can bring a balance between regulatory compliance and user-privacy.

A decentralized identity ecosystem, similar to the one envisioned by SelfKey in its whitepaper, users have a verified identity and can be regulatory compliant and at the same time. They potentially would not have to worry about losing their privacy through over-sharing of data or their personal data being handled by third parties.

Decentralized identity can potentially ensure growth and maturity for the DeFi space, and experts like Ryan Sean Adams tend to agree to the same.


Solutions such as these can potentially nudge the DeFi and crypto space in the right direction, and the gradual maturation of the ecosystem, and the implementation of such solutions, will in the long run elevate the DeFi industry to a category of its own in the financial industry. 

DeFi has the potential to be distinctly better than the centralized traditional financial industry on multiple fronts - from security to user privacy and accessibility - and it is only inevitable that its adoption will continue to accelerate if key actors in the space continue to innovate and improve its offerings.

Mainstream attention and institutional investments can definitely boost the confidence of the crypto community, and SelfKey aspires to play a crucial road in augmenting DeFi as well as the crypto industry towards an institutional-grade.

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