Decentralized Finance & Self-sovereign Identity: A tale of decentralization, a new paradigm of trust

May 27th, 2021

DeFi’s the talk of the town. And while the self-sovereign identity market is still gaining traction, bridging these two concepts has the potential to spur global economic growth.

Because of the lack of literature, and the desire to educate our users of the endless possibilities of SSI, we decided to publish this article. We are aware that DeFi’s growth is explosive and inevitable yet its growth needs to be sustainable and responsible. This can be done with SSI.

The main idea behind decentralized digital identity, also known as self-sovereign identity or SSI, is giving users back control over their personal information. What does this really mean? Basically, users should be able to have complete control over where their personal data -- usernames, email, address, sex, nationality, etc. -- is shared, who has access to it and what entities do with it.

Now let’s break down DeFi: it's the upcoming industry that replicates traditional finance market processes, such as borrowing and lending, into a decentralized and blockchain enabled system using smart contract functions. While SSI focuses on giving users control of their data, DeFi’s goal is to give users access and control of their finances. Both have a goal of creating new sources of financial opportunities for the global population.

DeFi meet SSI, SSI meet DeFi

So where do both worlds collide? DeFi, unlike other centralized financial systems, lacks the identity layer aspect, which usually takes the form of KYC (Know-Your-Customer) checks. This is partly because introducing such features would decrease their decentralized nature as its users remove their anonymity cape. Instead, DeFi directly links to smart contracts and eliminates the need for a legal identity verification process, and thus the platform is not required to interact with your identity in order to execute trades. As of now, a user only needs a blockchain wallet within the liquidity pool where they wish to exchange tokens.

In addition to prioritizing decentralization, DeFi places a large emphasis on anonymity. Decentralized Apps (DApps) users are attracted to the idea of being able to borrow, trade, exchange, and lend without the other side knowing a single characteristic about the user. The downside of this structure is that users cannot make informed decisions on how much to lend, interest rates, and lengths of loan, which results in high collaterals. High Collaterals, in turn, restrict the pool of potential borrowers as it requires their collateral to be worth just as much as the loan itself - which may not be available to them at the moment. So, by treating all users with the same level of risk, DApps are unable to offer personalized services and non-collaterized borrowing, decreasing the user experience.

Decentralized Know-Your-Customer (KYC)

While we believe KYC will be needed, at least as an option for users, in order to maximize the efficiency of decentralized financial services and reduce fraud/terrorism online, we’re conscious the methods used by centralized exchanges (CEX) such as Binance, Kraken, and Coinbase, are not the answer. These CEXs request highly sensitive data including proof of address and personal identification documents, which are then stored in their databases. The solution is a decentralized KYC model using self-sovereign identity technology.

SSI is built on blockchain fundamentals but maintains identity credentials stored off-chain, hence its technology enables participants to securely identify themselves with only necessary information and guarantees their sovereignty, or control over their data. More importantly, the SSI community is currently aiming for a scenario where service providers, such as DeFi Apps, do not have to store any user information in thier databases. Through this layer of decentralized identification, SSI can enable protocols to assess a user’s ability to repay a loan (without the need of a centralized credit score) and eliminate some of the risks associated with decentralized lending.

Introducing decentralized KYC checks also unlocks value by:

  • Opening the path for more DeFi services by offering users a certain level of trust or reputation
  • Providing one KYC across all-platforms, eliminating end-user frustration
  • Enabling users the ability to revoke a platform’s access to their information at any time
  • Safeguarding access to users whose identity has been verified
  • Tackling the young trader demographic problem
  • Eliminating design vulnerabilities in current authentication protocols

Additionally, since regulatory entities such as the Financial Action Task Force (FATF), comprised of 37 members including strong economic powers such as US, Switzerland, UK, and China, considers anonymous financial transactions to be dangerous and vulnerable to exploitation by criminals, a minimal tie to identity is necessary for the DeFi sector to continue existing if it wants to avoid massive regulation or elimination.

GATACA, the DeFi App’s ideal partner

One of GATACA’s SSI platform’s pioneering applications is real-time, decentralized KYC. GATACA’s fast and hyper-secure decentralized identity technology positions itself as the ideal service provider for any DeFi App as it complies with European blockchain regulations but does not risk its decentralized nature. Our technology uses advanced cryptography and blockchain technologies which allows it to outsource key technology components of identity management currently centralized by organizations, such as unique identifiers, for every individual worldwide. As such, we let blockchain become the global registry of these identifiers, so that no identity provider becomes a single point of failure, but still can ensure a single source of truth.

What’s more, GATACA is working with government organizations to provide financial consumers with verifiable digital KYC/AML related certificates to enable instant access to financial services, while reducing identity fraud risks. Financial consumers would only need to scan a QR code and consent to share these verifiable credentials stored in their wallet to instantly access any DeFi service worldwide and would have the ability to revoke access to such info at any time. The value added? GATACA is blockchain-agnostic, promising interoperability and rejecting vendor-lock in situations.

Decentralized KYCs bridge SSI and DeFi’s mission and vision to give users back control of their data and finances.

Challenges to DeKYC Adoption

Nonetheless, with innovation and disruption comes challenge. The 3 main challenges that we foresee are:

  1. Compatibility

    In order for DeKYCs to be a success, as with all decentralized applications, one needs to ensure that the same digital identity can be used/is received across multiple blockchains and that different wallet providers are compatible with KYC verification tools implemented in DeFi systems.

  2. Regulation & Compliance

    As previously mentioned, the DeFi sector is skeptical towards traditional KYC checks as it implies centralization, and while SSI tackles this problem, SSI has yet to be completely regulated as a legally valid KYC process. We need trusted authorities to issue verifiable credentials and regulators to accept SSI-based authentication as a compliant KYC process in order to guarantee the sovereignty of financial consumers.

  3. Education

    Just over 1% of the world uses cryptocurrencies - the data point for DeFi and SSI is much lower. So, for the relative social promise of both technologies (control over finances and personal data, respectively) and to be able to unlock the potential of bridging these two worlds, we need to aim for mass conscientization of the power of these novel technologies. This takes time.

Conclusion

Collaboration and technologic perseverance are the key ingredients to solving these problems. First and foremost, we need to find common ground between SSI & DeFi technology providers and since SSI already has an established ecosystem of regulatory and standardization bodies, compliance will follow. At the same time, both DeFi and SSI players must maintain the determination and motivation that has pushed these sectors into the public eye, despite the murky regulatory waters that lie ahead.

And while decentralization and anonymity are two separate ideas, fortunately, both can be maintained by connecting DeFi & SSI.

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Photo by Pierre Borthiry on Unsplash