Decentralized Finance (DeFi) is undoubtedly one of the most important financial innovations in the last decade. The reason for this is not far-fetched. DeFi has successfully created a limitless financial system where every person can have access regardless of location or income level. So far, the traditional financial system has struggled with replicating this feature.
However, despite DeFi’s numerous value offerings, it has begun to garner attention due to one key flaw: lack of KYC controls. While it can be argued that DeFi’s lack of KYC controls is also an advantage, it is important to clarify exactly what DeFi is.
What is DeFi?
Decentralized finance is an emerging financial technology that provides financial services and products to anyone with an internet connection. Essentially, as long as you have access to the internet, DeFi enables you to trade financial products and utilize financial services. This is largely different from the traditional financial system where there are numerous barriers to accessing financial services. Traditional finance also uses middlemen to facilitate services. On the flip side, DeFi provides users with direct access to services.
DeFi’s appeal has grown significantly in recent years. For instance, the global DeFi market was valued at $13.6 billion in 2022 and is expected to experience annual growth of 46% till 2030. This immense success has majorly contributed to the rise of DeFi companies in recent years. However, despite DeFi’s immense success, the lack of KYC controls is a major concern for industry analysts.
Why KYC is Needed?
Know Your Customer (KYC) refers to the set of controls a company implements to verify users’ identities. KYC can include requesting a customer’s national ID card to ensure that financial crimes like money laundering can be easily traced. Many of the KYC controls implemented are mandated by the government.
The benefits of KYC are numerous. However, within the DeFi context, KYC could help reduce illegal activities. Since DeFi’s popularity exploded in 2021, its adoption has increased significantly. However, this popularity has also attracted bad actors who have used DeFi as a pipeline for financial crimes. Because DeFi lacks KYC controls, most activities are anonymous. Thus, regulators find it difficult to track illegal activities or apprehend perpetrators.
The DeFi-KYC Problem
While KYC will undoubtedly be beneficial to the DeFi ecosystem, many industry participants have argued that KYC integration will defeat DeFi’s purpose. This is because many users believe that DeFi’s primary appeal is its decentralization and KYC will remove this feature.
However, industry experts have rebutted this point by stating that KYC will not necessarily remove DeFi’s decentralization feature. This is because identity verification can be done by trusted third parties. This way, DeFi can uphold its decentralization while implementing KYC.
Ultimately, the tech industry is still largely divided on whether DeFi applications should integrate KYC. However, KYC integration will likely lead to increased DeFi adoption. This is because corporate organizations that have abstained from investing in DeFi due to a lack of KYC controls will likely join DeFi’s user base when KYC is implemented.