Crypto Needs to Get Real About Compliance

Cryptocurrency has come a long way since the enigmatic creator of Bitcoin, Satoshi Nakomoto, invented Bitcoin in 2008. Slowly but surely, major investment banks, publicly-traded companies and even a government have come to embrace crypto.

But as far as crypto has come, its further growth is hamstrung because of the underlying properties of the blockchain technology that underpin it. That's because to date, blockchains haven't been designed to reflect the world as it is; instead, developers expect the world to mold itself around the quirks of the blockchain's underlying code.

And while “Code is law” is the common refrain of crypto advocates, that code doesn't take account of existing regulations such as identity verification, or KYC (know your customer) requirements.

Crypto's regulatory incompatibility is proving to be a stumbling block for the lofty goal of global adoption; according to PWC's 2021 Global Crypto Hedge Fund Report, over four-fifths (82%) of hedge fund managers described regulatory uncertainty as the greatest barrier to investing in crypto; fully half of those who have invested in crypto cited it as a major challenge.

"There is a huge infrastructure of law, regulation, due diligence and more that asset managers must adhere to, that gives asset owners confidence that their assets are safe," Carl James, global head of fixed-income trading at Pictet Asset Management, told The Trade News. But, he pointed out, "The crypto world has been specifically designed to obviate the need for intermediaries."

Until cryptocurrency can work in tandem with the existing financial system's regulations and requirements, institutions and many retail users will stay clear of crypto's many legal grey areas.

"I've been a believer in Bitcoin from the beginning, and I'm a big believer in privacy," Michael Jackson, former COO of Skype and advisor to blockchain project Concordium, told Decrypt. "But one has to recognize that we live in a world where financial transactions are analyzed and noted. The existing society has accepted all these things, and accepted the fight against money laundering as part of the way things work in the modern world."

Enter Concordium

Concordium offers a way out of this impasse: a blockchain with KYC baked in at the protocol level, offering the best of two worlds: privacy-centric decentralization and full-on regulatory compliance.

Concordium is a next-gen blockchain network developed by academic cryptographers and professionals with experience of heavily-regulated sectors like traditional finance and telecommunications. The network’s development takes place in collaboration with the Concordium Blockchain Research Center Aarhus (COBRA) at Aarhus University in Denmark and the Swiss Federal Institute of Technology (ETH). 

Concordium's mainnet is live as of summer 2021 and has already hosted an NFT drop by world chess champion Magnus Carlsen. 

At the heart of Concordium is its Identity Layer. It’s composed of several actors like trusted identity issuers and anonymity revokers, and it’s this unique feature that helps applications using Concordium to fulfill the regulations.

Although the technology underpinning it is sophisticated, the user journey is simplicity itself. Users verify their identity with an identity issuer before getting on the network, and their details (such as jurisdiction and age) are cryptographically recorded on their Concordium wallet. That means that when users interact with the network, they are both pseudonymous and KYC’ed; protocols built on Concordium don't know who the users are—but they do know that users have performed full KYC verification. 

"I don't really mind as a bank who you really are as a person," Jackson explained. "You could be American, six foot tall, five foot tall… it doesn't make any difference. But I do want to know that you're a suitable customer for my products, and that independent actors have attested your credentials.” 

As well as resolving many of the issues around regulatory compliance for crypto, Concordium also addresses problems with the legacy finance world's regulatory framework. “Concordium's ID layer can replace the hassle we have today with paperwork like MiFID rules, where people constantly make mistakes," Lone Fønss Schrøder, CEO of Concordium, told Decrypt. "You don't have that document, you don’t have this document… and so there’s so much money being thrown into compliance by financial institutions today.” 

But Concordium's pre-approved smart contracts don't need to be revisited, Fønss Schrøder explained. “They are already compliant and then you can have the auditability proven directly on the chain. I think, in a nutshell, that's really where you can make use of blockchain  in financial institutions.”

Bringing DeFi to the masses

Having a blockchain infrastructure that's fully compliant with the existing regulatory framework is only set to become more important as decentralized finance (DeFi) gains traction.

DeFi has already drawn the attention of regulators and lawmakers, while venture capital firm Andreessen Horowitz has called for "targeted" regulation of DeFi and Web 3. It’s hardly surprising when you consider that DeFi fraud cost users a total of $10.5 billion in 2021, up from $1.5 billion the previous year, according to a report from Elliptic.

“The biggest challenge that the DeFi space has right now is, how do you impose or create the safe environment that consumers, the industry, and the financial ecosystem need—and do so with a different technology stack, different responsibility stack?" Jackson said. 

Protocol-level identity can give users peace of mind in knowing that everyone on the platform has performed KYC checks—including the developers who deploy smart contracts controlling millions of dollars in funds. “The contract itself can specify who accesses the contract as well. So it's not ‘permissioned’ in that somebody goes in and says who needs permission to use it, but rather: ‘users of this category have permission to use it’,” Jackson told Decrypt.

Contrary to popular perception, an added layer of compliance, and therefore reduced risk, doesn’t have to come at the cost of high rewards. “A lot of the high rewards in DeFi come from lending pools, where the counterparty really wants liquidity into their protocol. So they're getting people to pledge assets into the pool, and the projects are prepared to give high rewards for that,” Jackson said. “And I think that aspect of DeFi continues with Concordium.”

There could also be a gamified element to qualification, Jackson said. Concordium plans to launch a tiered onboarding experience to make novice DeFi users more comfortable with the protocols and the wide array of financial actions they can perform. It would be similar to Ethereum's rabbithole.gg, which lets users earn xp (experience points) as they interact with different protocols and gain new skills.

Familiar infrastructure

Concordium’s value proposition is bold, but beyond its Identity Layer is a familiar set of technical infrastructure—making it easy for developers to get to grips with. The blockchain is written partly in Rust, like Solana and NEAR, and partly in Haskell, like Cardano.

The Concordium network is powered by its native token, CCD. The token is used to pay for network fees that are earned by the validator nodes called bakers, which process transactions and secure the network—similar to stakers of Ethereum 2.0 or miners of Bitcoin. But unlike the wildly varying gas fees found on other networks, Concordium's transaction fees are stable and expressed in euro terms. 

The Swiss Financial Market Supervisory Authority has already classified CCD as a payment token, making it legal for use in on-chain settlement of transactions, collateralization, and any other DeFi use-cases. 

And staying true to the crypto ethos, Concordium will decentralize governance, granting on-chain voting power to CCD holders who will help shape the future of the network.

If you want to be one of them, keep an eye on upcoming announcements for public token sale by following Concordium’s social media accounts.