Everything you need to know about digital identity and the KYC process on the blockchain

Jason Howard (J-KIND)
6 min readMay 24, 2021

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KYC stands for ‘know your customer,’ and the KYC process is a way to identify an individual or corporation before you enter into any kind of business arrangement. It has become increasingly important since the passage of the Patriot Act in the United States that was designed to limit the ability of terrorists to have access to funding.

The KYC process allows you to better understand the source of any funds, and as such, banks, other kinds of financial institutions, and cryptocurrency platforms are now required to utilize strict KYC processes. This means that any kind of financial institution is going to need to collect information about you to verify your identity.

The problem is that when your data is located on a centralized platform, as is the case with a bank, for example, your data privacy becomes vulnerable. For that reason, a main focus of financial institutions, websites, and any other digital platform where you might need to share your data has been to find a way to create a form of digital identity so that they can secure your data privacy and ensure safe transactions.

Digital Identity Challenges

One of the main challenges to establishing a digital identity is providing a unique digital identifier that can be used for secure transactions without compromising data privacy. In a world where someone is subjected to identity theft on average every two seconds, securing your data privacy is key to a safe online browsing experience.

In the early days of the internet, there was little need for verifying identities since it was only really used as a communication tool at that time. But as the internet has evolved into the veritable metaverse we know today, the need for identity verification has intensified.

As the internet has evolved, so has the field of cryptography which has been constantly seeking new, more sophisticated ways to secure data and online communications. Encryption is one result of that evolutionary trend, but that doesn’t really get the job done as far as identity verification is concerned.

For encryption to really work as a means of securing transactions, it would require that you can trust the person or entity that’s doing the encrypting. For that reason, digital infrastructure systems that are managed by trusted third parties were developed. You see this whenever you log onto a site that has the HTTPS prefix. Essentially, you’re trusting that the website owner’s identity has been verified by a certificate authority.

Just when that seemed to be a viable solution, however, social media and the rise of the big tech monopolies changed the game. When you log into a site using your Facebook or Google credentials, the sites are trusting you’re who you say you are based on that fact alone.

That means they’re using your email address as a digital identifier, which is clearly something that’s vulnerable to hacking. It’s certainly more convenient for users, but it also means you’re outsourcing the management of your own digital identity to these tech monopolies.

Blockchain Technology

Enter into this picture blockchain technology. Many online gaming platforms began to use unique identifiers known as non-fungible tokens (NFTs) and blockchain distributed ledger technology to secure intra-game transactions.

NFTs are unique digital identifiers that are virtually hack-proof, and while they provided individual users with a digital identity, it was initially only valid within the specific game platform in which they were a part of the community. Virtual reality (VR) games also used blockchain as a means of securing digital transactions made with an NFT digital identifier. This model is now being expanded for use in other applications.

The way blockchain technology works is that it records every transaction made by embedding it in digital code and then storing it in transparent, distributed databases. That creates blocks of data that are then chained together. While each and every NFT transaction is transparent, your identity is not. You maintain control over your identity, and you can choose if you want to reveal it.

Because every transaction made in blockchain is attached to a unique digital signature and because that unique digital identifier is validated by the entire network of users in a virtual space, the transactions are protected from tampering, modification, and deletion. This effectively means that these stored transactions are not contained on a centralized third party platform.

By eliminating massive stores of data held on third party platforms, that helps ensure your data privacy. In this way, blockchain technology has the potential to revolutionize data transparency and security.

Blockchain is the technology that is behind cryptocurrencies like Bitcoin, but of course, it has the potential to have many more far-reaching applications. Every business and individual who relies on some level of transparency, trust, security, or operational efficiency can benefit from this digital technology.

The unique identifiers associated with each and every digital transaction would enable every individual in a business, for example, to gain valuable insights into how a product goes from production to the store. Blockchain can streamline production processes and minimize delays while maximizing transparency. But how is it applied to the creation of digital identities and how can it help secure your data privacy?

Blockchain and Digital Identity

Blockchain decentralizes your data transactions, and because the NFTs you would use to make those transactions are not digitally tied to your data, that can secure your data privacy.

The way it works is that you would go to what is called an off-chain identity provider. The identity provider would verify your identity using state issued identity cards like passports, driver’s licenses, and other valid forms of ID. They could also run a credit check on you to verify you’re a good credit risk.

The identity provider then issues you a digital identity that is not linked to any of your documentation. If an online business, bank, or financial institution needs to verify your identity, they use your digital identity and verify that through the identity provider. The identity provider can also validate that you’re a good credit risk if that’s what they need, but that is accomplished without revealing your documentation to the institution requesting the identity validation.

Additionally, the digital identifier issued by the identity provider is not linked to your identity documentation. Because everything in the process is decoupled, your data is far more secure.

Furthermore, by not having your data stored in a centralized location, such as with a bank, your data privacy is more secure, and the institution can get the information they need as part of the KYC process.

Blockchain, Digital Identity, and KYC

While KYC processes vary by country and industry, they almost always involve verifying your full name, date of birth, and residential address. You might also need to prove you’re not a politically exposed person (PEP), and for businesses, you might need to show you are the beneficial owner.

That means the KYC process often involves current identification information and global and historical databases that include legacy passports. Moreover, the KYC process needs to determine if you are now or have ever been a PEP — that is, a person who has held a prominent public position — since such persons have more opportunities for acquiring assets unlawfully. Because blockchain technology keeps a record of all digital identity transactions, historical information is available.

While being a PEP doesn’t automatically disqualify someone from a financial transaction, it does help businesses and financial institutions determine the potential for money laundering or other financial crimes associated with terrorist activities. This kind of scrutiny in the KYC process also applies to corporate clients. Moreover, all of this has to be done while ensuring data privacy and security. Blockchain technology utilizing unique digital identities offers the best way to do that.

To Sum It All Up

In our rapidly evolving modern world where your online browsing experience is ever expanding to include transactions across multiple digital platforms, blockchain technology offers the most secure way to decentralize data and utilize unique digital identifiers for validating your identity. It is the safest way to fulfill the KYC process while still maintaining data privacy.

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Jason Howard (J-KIND)
Jason Howard (J-KIND)

Written by Jason Howard (J-KIND)

DJ / Producer (Techno), Customer Support & Marketing Pro, Blockchain/Crypto Enthusiast

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