Opinion by: Josef Je, co-founder of PWN DAO
This isn’t another article insisting that Know Your Customer (KYC) practices are the only way to legitimize crypto, nor is it declaring that KYC is doomed to disappear. Instead, let’s look at how we got here, why we still deal with these burdens, where KYC can be beneficial or harmful and how we may leverage optionality in “Knowing Your Peer” to meaningfully comply in relevant contexts without compromising privacy and freedom of choice.
How did we get here?
KYC regulations emerged from decades-long efforts to fight financial crime. The US Bank Secrecy Act (BSA) of 1970 required financial institutions to document and report large cash transactions. This laid the groundwork for modern customer due diligence, even before the term “KYC” was coined. As global financial systems expanded, the G7 created the Financial Action Task Force (FATF) in 1989, issuing recommendations that countries adopt Anti-Money Laundering (AML) measures, including identifying customers.
The 21st century brought a tighter clampdown. After 9/11, the USA PATRIOT Act (2001) demanded comprehensive Customer Identification Programs. Europe followed with successive AML Directives, gradually getting more sectors, including crypto exchanges, under KYC requirements. Over time, “KYC” became a universal norm — a checklist for any institution deemed part of the regulated financial system.
Where we stand today
The rules hit our wannabe anonymous crypto ecosystem with full force. Centralized exchanges now require ID documents, selfies and proof of address, echoing traditional finance. KYC frameworks now shape the user experience at many crypto on- and off-ramps, slowly approaching the decentralized finance (DeFi) space.
Different viewpoints on KYC
From a regulator’s standpoint, KYC makes sense: If you want the protection of a regulated market, you must monitor suspicious activities. If crypto wants real-world integration — tokenizing tangible assets, bridging traditional banks and satisfying institutional investors — there are norms to be followed.
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Yet the Libertarian or cypherpunk perspective sees KYC as an invasive overreach. Criminals can still exploit loopholes, while honest users are treated like suspects. The average user feels hassled by ID checks at every turn. Meanwhile, personal data collected under KYC often ends up leaked or hacked, exposing users to identity theft.
Where KYC helps in crypto
Let’s face it: Crypto is still full of scams and rug pulls. KYC can help crypto earn legitimacy. KYC controls reassure newcomers that some basic standard of accountability exists. Also, the more real-world assets (RWAs), such as property titles or tokenized securities, are ported onchain, the more regulators will demand some identity proof to mitigate fraud and ensure legal enforceability, preventing an ownership vacuum on the physical level.
Where KYC hurts crypto
KYC is also an outdated solution that is now imposed on cutting-edge technology. DeFi protocols are decentralized code, not transacting intermediaries. True DeFi protocols can’t run away with your money. The “KYC or bust” model is awkward at best and lacks regulatory diligence at its worst. They also diminish the effects of other regulations like privacy protections, which lack impact on deterring serious crime but often burden honest users and create data-honeypot risks.
Know Your Peer: A new path
Rather than always “Knowing Your Customer,” we might shift toward “Knowing Your Peer.” In true DeFi, peer-to-peer interactions dominate. If a business needs to ensure compliance, it can selectively verify a counterparty’s attributes without revealing or storing the identity.
Zero-knowledge (ZK) proofs and privacy-preserving tools can help. Services like ZK-based identity checks enable people to validate specific facts without exposing all their data, similar to Privado.ID or zkPassports could help prove someone’s eligibility without the delicate paperwork.
Reputation systems and self-regulation
Onchain transparency allows for reputation systems. You might judge a counterparty’s trustworthiness by past transactions rather than passport photos. Tools like Chainalysis can tag suspicious addresses, while credit-scoring protocols rely on verifiable history. Combined with ZK-proofs, we could create a self-regulated ecosystem where bad actors are naturally filtered out.
That won’t magically solve regulatory acceptance, but it may demonstrate that decentralized, privacy-respecting methods can achieve similar aims. Over time, regulators might accept these new methods if they see effective results.
As currently enforced, KYC might linger in centralized exchanges and custodial solutions in places where legacy regulators have a clear line of sight. Across DeFi, however, we can experiment with alternative models. Instead of mandating complete identity checks, we can rely on cryptographic proofs, selective disclosures and reputation systems and stay on the right side of the law and ethics without punishing everyone else.
The optimistic hope is that, by self-regulating, we can filter out bad actors and convince policymakers that crypto doesn’t need to be forced into legacy frameworks. Yet it still can achieve the same or even better outcomes.
Opinion by: Josef Je, co-founder of PWN DAO.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.