zkKYC: Zero-Knowledge Proofs in Blockchain KYC

The emergence of decentralized platforms and the quick development of digital banking have created new opportunities and difficulties for both private citizens and corporations. The idea of pseudo-anonymity is one of the fundamental parts of this change, and it is becoming more crucial with the introduction of the zkKYC system.

What is KYC?

Know Your Customer, also known as KYC, is a collection of steps organizations take to confirm the identities of their clients. In the financial industry, it is also utilized to evaluate any possible concerns for money laundering or financing terrorism. It is essential for companies to thoroughly comprehend their potential clients before forming a relationship with them.

KYC policies have become increasingly important in preventing financial crimes since the 1970s. Governments all across the world started establishing legislation after major financial crises to make sure banks and other financial institutions have systems in place to identify customers, spot suspicious activity, and report questionable transactions.

What is zK Proof?

Zero-knowledge, or ZK, is a cryptographic technique for producing crypto proofs without divulging the secret data they are based on. Z-based solutions are setting the standard for online privacy. Due to their small transaction size and privacy-preserving features, ZK technologies have been driven to innovation by the blockchain sector.

ZKPs are intended to allow one party to demonstrate to another that a claim is accurate without disclosing any other information, save for the fact that the claim is accurate. It's similar to establishing someone's adult status without revealing their age. They may be useful in DeFi, a collection of financial applications developed on Ethereum-like blockchains that have long functioned beyond the scope of financial regulators. Even if their creators  wanted them to, it would be challenging to make these procedures adhere to the current banking rules, such as know your customer and anti-money laundering checks.

The Role of zkKYC Technology: How It Can Solve the Problem

In digital finance, "pseudo-anonymity" describes a situation in which a person's identity is hidden, but their actions may still be tracked and validated. This difficult balancing act between privacy and openness has acquired particular importance since it enables secure transactions and regulatory compliance without turning to total anonymity. zkKYC may facilitate crypto mass adoption.

Since complete anonymity can be used for money laundering, financing terrorism, or other illegal actions, it might cause difficulties for financial institutions and authorities. Conversely, pseudo-anonymity offers a more sensible solution, enabling legal financial transactions while protecting privacy. It is crucial for the industry to adopt privacy-focused tools and technologies like zkKYC/AML as the Web3 ecosystem continues to grow.

Recently, a new paradigm in how we can manage and prove our identity in a digital setting has emerged with the introduction of Self-Sovereign Identity (SSI), also known as Decentralised Identity. It also opens up a lot of potential that goes far beyond the realm of identification. Since SSI is a crucial part of the zkKYC solution concept, it is important to go deeper into this model. This demonstrates that SSI offers a variety of advantages when properly implemented, some of which help to achieve organized transparency in the KYC information flow.

What is Self-Sovereign Identity?

An approach for maintaining digital identities called "self-sovereign identity" gives private citizens or organizations complete control over how their accounts and private information are managed. Without the need to rely on a central data repository, people with self-sovereign identities can store their data on personal devices and supply it for transactions and verification. With self-sovereign identity, users have total control over how their personal information is stored and utilized.

The SSI paradigm is expanded by zkKYC. The primary distinction is that holders are no longer required to give each verifier they join their personally identifiable information. Holders can instead show they are qualified and eligible based on the verifiable credentials they possess and create a special token that symbolizes their identification for that Verifier using their digital identity wallet. It will be known as a zkKYC token. A Verifier can then give this token to the Government if and when the necessity arises (for example, legal charges or regulatory reporting). 

To identify the original Issuer of the credential used to produce the token from, only Government will be able to read the token. As a result of being able to read the token, the originating Issuer will also be able to see a special Holder identifier that will allow the government to conduct an investigation or take legal action by providing the Holder's personal information to that Holder identity.

Overview of the zkKYC Solution Concept

This method of KYC achieves two significant privacy advantages:

• A User's personal information is only shared with a third party performing the role of the Government if and when there is a legal or regulatory reason to do so, not earlier than that. 
• No Verifier needs to receive, store, or manage personal information of its Users any longer in order to comply with KYC obligations.

Businesses may establish a variety of KYC policies for different legal or voluntarily commercial purposes (or a combination of both):

• Customer eligibility: A company implements a policy outlining the requirements for customer eligibility. The company may have established this policy, but often it is required by law. A common case is the restriction on selling certain goods (such as alcohol and tobacco) to those below a specific age. In this scenario, a company only needs to determine whether or not the buyer is older than the set age barrier. KYC is more concerned with confirming specific client claims than with personally identifiable data in the traditional sense.
• Operational risk management: A company has a compelling reason to control its counterparty risk and, as a result, requires customer identification when conducting high-value or high-risk transactions with its clients. Legal action can be taken against the identified customer if an adversarial scenario develops.
• Regulatory compliance: A business may be required to develop formal KYC processes to comply with AML/CFT regulations. This often entails creating a customer acceptance policy, putting customer identification procedures into place, keeping an eye on (and reporting suspect) customer transactions, and creating a risk management policy.

Additionally, for businesses required to adhere to KYC regulations, this lowers the risk of data breaches disclosing their clients’ personal information and the expense and labor associated with maintaining customer records.

zkKYC Benefits

Zero-knowledge evidence inside a zkKYC token is encrypted with a Government public key and includes the necessary information without revealing what that information is. Given that the Verifier cannot see the content of the token, they want evidence that the right data is present to guard against malicious actors introducing fraudulent data.

• Privacy first – Use cutting-edge cryptographic technologies to safeguard consumers' privacy.
• Flexibility: Verifiable credentials may be given to people and organizations, connections, and things (both real and digital). Numerous use cases and topics can be addressed using the same straightforward approach. Even though verified credentials are digital in nature, it is simple to create physical, paper-based representations of them. 
• Complete security - The possibility of data leaks is eliminated because no personally identifiable information is kept on a central server.
• Liability: By limiting the data that other parties can access, it is feasible to lower the risk of data breaches and the corresponding penalty.

Self-sovereign identification is built upon by zkKYC, which also does away with the requirement that personally identifiable data be disclosed to Verifiers for the purpose of KYC. To prevent dishonest users from using their services, verifiers can confirm that their consumers meet specified requirements. zkKYC enables enterprise-ready DEX. Additionally, if a bad actor's behavior or transaction pattern is later determined illegal or fraudulent, their identity may be made public. Because less or no personally identifying information is shared or misused, good actors' identities and privacy are entirely preserved. Likewise, their security and safety are improved.

General KYC Procedure Problems

The KYC process has two basic problems. Customers need to complete the KYC procedure with each new KYC provider because they do not share information, necessitating several times for each client to furnish the same information. Secondly, consumers have yet to learn how providers use the vast amounts of personally identifying information on their accounts that are stored in a centralized system. KYC providers are increasingly vulnerable to intrusions from hackers who wish to steal and sell this information since they hold such sensitive data in large quantities.

Use Cases

One example of projects working in this zkKYC area is ZK.me - a decentralized Web3 credential network that leverages the power of zero-knowledge proofs to enable secure and private credential issuance and verification. 

Another example is Threelo, which allows users to share reusable Zero Knowledge KYC Signature securely with different dApps.

Conclusion

The importance of pseudo-anonymity in the digital finance community is growing, emphasizing the need for creative solutions that put privacy and security first. These technologies enable lawful financial transactions while safeguarding the personal information of users by striking the correct balance between privacy and transparency.

We anticipate more developments in zkKYC technology in the near future. We'll observe a wider integration of these technologies across the digital finance industry as more businesses and financial institutions understand the significance of these privacy-focused solutions.