Does cryptocurrency mean fake identity?
Top of the list of misconceptions about cryptocurrency is that people get into the crypto space with a fake identity. The earliest adoption of cryptocurrency indeed took place in the dark web where anonymity was the greatest currency.
However, as in many things, the strangest places and circumstances birth objects of value – think of the accidental discovery of the X-ray, The Internet started from Arpanet which had military origins; the GPS had military origins as well, whereas human flight and aviation became as advanced as it is today due to the development of the aeronautical industry by the military.
Since the turn of the new decade, cryptocurrencies are fast becoming mainstream. There has been a massive movement away from the cover of the dark web for cryptocurrencies. Value chains have been created, central banks and traditional financial institutions have had their monopolies challenged, the bottlenecks and limitations that plagued the transfer of money across international borders – both as a unit of exchange and as a store of value have been blown out of the water by cryptos. Suddenly, the whole world is buzzing.
Whilst pro-traditional finance contend that crypto transactions are shady and lurk in secrecy, the distributed ledger technology upon which the blockchain that houses most crypto projects characteristically says otherwise: there is a record for everything. The blockchain records are open for all to see, for all to audit and interrogate, there is no hiding place – from the genesis block to the forks. Everything is open as the sky. Blockchain technology keeps information confidential, not anonymous!
The reality is that many crypto adopters appreciate the pseudo-anonymity which the crypto space grants, instead of the stratified caste system of traditional finance models where the big rollers get special treatment on account of their net worth.
In our recent survey, the majority of the subjects are happy to comply with the necessary Know Your Client (KYC), Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) process provided that they are then able to transact without making themselves targets for harassment by both thieves and the taxman. These are not bad sentiments in themselves. We are yet to see any sizeable die-hard supporters of the taxmen except perhaps the taxmen themselves.
Evolving inside the ‘fake identity argument’ storm comes a topical development in blockchain and crypto technology – the integration of a Zero Knowledge Proof (“ZKP”) protocol to limit determiners. Whereas the global task force for combatting money laundering and terrorism financing, The Financial Action Task Force (“FATF”), has gone all out to campaign for the total implementation of the Travel Rule which requires all financial institutions to pass on certain information to the next financial institution in a single financial transaction; ZKP only requires that one party (the prover) should prove to another party (the verifier) that a given statement is true, without conveying any information apart from the fact that the statement is indeed true. The essence of zero-knowledge proofs is that it is trivial to prove that one possesses knowledge of certain information by simply revealing it; the challenge is to prove such possession without revealing the information itself or any additional information.
Instead of transmitting entire determiners (which is subject to interception) in a transaction, ZKP protocol will receive just the right amount of information to validate the transaction and to verify the transmission with anyone attempting to intercept any such message being unable to do anything with such truncated data.
The common properties of ZKP include:
- Completeness: where a statement is true and users at both ends apply their data set properly, then the verifier would be convinced without the need for further external inputs.
- Soundness: where a statement/data set on one side is false, the verifier would not be convinced in any scenario which is probabilistically checked to ensure the probability of falsehood is zero.
- Zero-knowledge: the verifier would not have excess information that will enable a third party to piece together a complete picture to exploit.
Apart from the ZKP’s application in cryptocurrencies, other use cases are limitless and can range from:
- Authentication: ZKP ensures no one party have all the pieces unless intended for. Unauthorized users will face improved security for complex documentation. This will be useful for legal practitioners and legal departments handling what is essentially ultra-sensitive information.
- Data Sharing: sharing of data, emails, blueprints, business secrets across the breadth of the internet without needing to worry about a third-party is crucial for most data transactions. ZKP will help by making information transmitted across the internet unusable save for the intended recipient. The information will be copy-proof.
- Documentation: sensitive information can be safely stored and transmitted with an added layer of protection as you will need the key to access with extra security implemented.
- Encrypted Messaging: in most messaging, end-to-end encryption is necessary with end-users having to verify and trust the server of each side (giving rise to opportunities for man in the middle [MITM] attacks). ZKP will mitigate MITM risks significantly by providing end-to-end trust without the need to put too much information out there.
- File System Control for Large Firms: file systems can use ZKP to enhance security with every file, user and login having different security. With more and more data breaches becoming common (especially among the legal profession dealing with privileged information.
- Security for Sensitive Information: implementation of ZKP can improve security drastically by reducing the ability of cybercriminals to make off with usable data (not having all the pieces).
- Storage Protection: ZKP can keep hackers away from storage units with data intercepts being harder to orchestrate and exploit.
IMPLICATIONS ON ZKP ON FATF TRAVEL RULE
Though the FATF has been proactively pushing for anti-money laundering regulations in virtual asset transactions. The FATF adopted the Travel Rule, requiring Virtual Asset Service Providers such as cryptocurrency exchanges and digital wallet providers to pass along certain client information during cryptocurrency transactions valued at US$1000 or above. The FATF published a paper in June 2021 stating that most countries have not implemented the Travel Rule, it was reported that “many jurisdictions have continued to make progress” in implementing the Travel Rule.
If the Travel Rule is implemented globally, information of traders will have to be disclosed during most transactions, meaning that solutions such as ZKP that work towards preserving the anonymity of traders may have to be abolished in the area of virtual asset transactions.
Even outside of cryptos, ZKP still has multipurpose applications.
Whilst Blockchain technology has mainstreamed various characteristics like transparency, immutability, decentralization, and distributed ledger into everyday life, enabling users to act anonymously and perform transactions with high-end security. It has attracted the criticisms of traditional regulators who discovers that the tech is difficult to cast into the existing moulds of regulations. The biggest challenges being: who should regulate, and what should be regulated.
As the FATF is championing the worldwide implementation of the Travel Rule in virtual asset transactions, ZPK applications may have to be moved elsewhere. In most Blockchain environments, users’ sensitive information stored on a Blockchain network is only confidential, not anonymous. The question, therefore, comes down to do Blockchain networks need to be anonymous and how can Blockchain offer more anonymity and better privacy protection to their users?
Zero-Knowledge Encryption makes sure that no one, except the intended user (not even the service provider, blockchain app developer etc), can access secured data. ZKP is therefore hailed as the solution to making Blockchain-related applications safer.
ZKP also has applications beyond blockchain.
Planning to launch your crypto or blockchain business? Don’t forget to get in touch with Yellow Silk Attorneys. Our seasoned crypto-practitioner and blockchain legal analyst Churchill Kalu, and the team of specialists are well equipped to help you navigate the regulatory murky waters safely.
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