Blockchain-based KYC: the solution or make-believe?

If you have ever opened an account with a bank or financial institution, or have an interest in crypto, finance or compliance, you probably understand what KYC is and why it is grabbing increasing attention. If you haven't make sure you have read the Zeux 101 on KYC and AML. To build up your knowledge on this topic, it might interest you to know more about how blockchain technology could potentially revolutionise the KYC practices widely adopted in the industry.

The KYC challenge
The current way to conduct KYC due diligence by financial institutions (FIs) is to ask for identity documents from customers and then verify they are who they claim to be. Here lies the tricky issue – the documentation requirements varying from bank to bank and lack of trust amongst FIs mean that customers have to submit these documents repeatedly to each FI every time they want to open an account. The regulation is not doing much favour either – with the introduction of GDPR and the 4th Anti-Money Laundering Directive, FIs will become anything but friendly to customers in this regard in the light of higher pressure to uphold the regulation. The result, in many cases, is tedious process triggering huge time and financial costs for FIs and lengthy waiting for customers unaware of how their data would be used.

Considering the strengths of blockchain technology – the immutability and transparency of data stored on the blockchain – it seems natural to wonder if using blockchain technology would provide a more efficient future for sharing KYC information without compromising privacy and security.

Potential benefits of using Blockchain
So what are the benefits of KYC using blockchain? Conceptually, it would build a trustworthy platform to speed up the pace of business due to reduction of labour-intensive, usually duplicated data gathering and processing. From the perspective of customers, it implies shortened onboarding waiting time and fewer tortuous efforts to submit the same information over and over again. And don’t forget the regulators, the adoption of a blockchain could provide a single source of customer data and a clearer audit trail in terms of the customer’s activities across different institutions.
Although a consensus of a blockchain protocol has yet to emerge, some players have already been exploring possibilities of a blockchain-enabled KYC solution. Current proposals can be categorised into two main approaches which test different aspects of the idea.

Utility model
The first one, better known as the utility model, consolidates customers’ KYC information from various sources, such as government databases and data vendors, in an off-chain, centralised database which can be accessed by different financial institutions with the customer’s consent. A node will be created onto the blockchain once an FI has accessed, verified or amended the customer’s information, generating a chain of KYC verification history for individual customer across different FIs.

Document exchange model
The second model goes a step further to deal with the concern of centralisation which, by its definition, is the most appealing selling point of blockchain. By standardising, storing and distributing KYC-related documentation actually on-chain, a centralised database is no longer necessary, removing the huge investments in cybersecurity. Despite several pilots, however, such an approach currently is neither technically sustainable nor legally compliant with the GDPR.

So is blockchain the future?
Like any other promising technological breakthrough, however, there are always strings attached. Apart from the technical challenges, several hurdles are still ahead to be overcome, such as the standardisation of KYC data model across the industry and jurisdiction, access to data sources, and not to mention the cost on developing, implementing and migrating incumbent systems to a blockchain-based solution. Reassuringly, the challenges do not outshine its upside, and overcoming those challenges could bring a new landscape to the industry.

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