Although the crypto community has always stood firmly behind the concept of ‘trustless’ blockchain’, it has never quite been able to sell the idea to the wider world.
The concept of a trustless currency – one that doesn’t need third party or intermediary involvement for conducting transactions or moving assets, for example – is often equated to illicit activity and untraceable transactions.
People and organisations fundamentally just want to know who they are doing business with. On the one hand, this is to make sure they are following regulations when they are conducting business and, on the other hand, it is simply because trust is hard to build within the parameters of anonymity.
Know Your Customer (KYC) checks have become important compliance checks for traditional institutions to use to ensure they have adequate information and records about the people they are conducting business with. These checks will play an important role in helping to build trust in the crypto sector.
The most basic level of crypto trading is not where KYC checks can make a significant difference. This becomes obvious when we note the similarities between crypto trading and stock trading.
In both instances, no one really knows who is buying and selling stocks except the broker, which is similar to what happens on centralised cryptocurrency exchanges. In this sense, knowing the details of who you are buying from or selling to is less important.
So where do KYC checks make a difference in traditional finance?
To answer that, we first need to consider why people need to identify themselves at all when it comes to finance.
To state the obvious, governments need to know who owns which assets in order to help them collect taxes. It’s also important that they are able to track how people and institutions earn money in order to keep the economy running.
KYC checks play a big part in helping them keep track of this. They also help to verify that businesses are working in a regulatory compliant manner and will not put other companies or individuals at risk if they do business with them.
For the crypto industry as a whole to truly flourish and benefit from the capital and resources of traditional industry players, KYC will need to come into play in some form. This is a notion that was echoed by US Security and Exchange Commission Chair Gary Gensler when recently speaking to the EU Parliament.
In addition to this, recent regulatory efforts in the US aimed at introducing taxes on crypto as part of the Infrastructure Bill have been widely criticised by the crypto community. Nonetheless, efforts to regulate crypto and place checks on the industry may also help to bring legitimacy to the sector, while KYC checks will also put better protections against scams and hacks in place.
Trading cryptocurrencies and doing business within the DeFi sphere are two different things. In DeFi people conduct business by exchanging ideas for investment, using collateral to secure loans, raising funds, and exchanging value. Relationship building, reputation, and trust are all important factors in all of these processes.
Getting investment for a project is not only about writing a good white and green paper, it is also about showing who is behind that project. People want to see the enthusiasm of a project’s founders, the effort and drive they have put into creating it, the spark in their eyes when they speak about their ideas, and ultimately the trust they make you feel when you see their passion.
Verifiable checks must be in place
The same logic applies in the opposite way when a project is taking on investors. They want to know that the investor has the same ideas about the market that they do, and that they can trust them to stand behind it and put forward money even when the project hits roadblocks. In order to do this, verifiable checks whereby the identity of entities is made known must be put in place.
Perhaps unsurprisingly, there is a huge difference between generations when it comes to ideas on doing business. I am from generation X. Born in 1978. I joined the workforce during the time of fax machines. At that time, we were focused on building relationships through calls, in-person meetings, lunches, and networking events.
Things have changed, and those that have grown up in the digital era have become accustomed to being more anonymous and less personal. Nonetheless, building trust is still important, especially when you consider that a lot of the capital that new projects need is still in the pockets of wealthy, older generations.
KYC is mandatory to make sure we do business within the boundaries of international regulations, but it’s also integral for building business relationships in DeFi, which will, in turn, generate growth and progress for the sector.
Irrespective of whether the need for trust is removed through trustless technology, people who exist behind the blockchain still need trust in a human sense for enabling business growth and forging strong relationships and bonds.
In order for the crypto sector to thrive and benefit from the capital and resources of traditional industry players and wider bodies, KYC checks will be essential.
By Gerben van den Bergh, Chief Innovation Officer at AllianceBlock, the chain-agnostic blockchain project building compliant and data-driven products that enable financial institutions to access opportunities in decentralised finance.