TLDR: KYD Oracle means Institutional adoption meets 🤝 DeFi Principles. It’s a ‘firewall’ for DeFi protocols making sure they only allow Users they are legally eligible to interact with. Powered by on-chain data with no need for access to sensitive information and no additional third-party risks. Invisible for the End User – the interaction with a ‘protected’ protocol looks identical as with a regular, ‘unprotected’ protocol.
2022 has already demonstrated clearly that Forced Regulations for Web3 are coming. DeFi Protocols face an existential threat if they fail to implement the necessary legal procedures such as KYC or AML. There is a major concern that regulated DeFi would inherit the same issues TradFi struggles with. Centralized Exchanges have already gone the ‘hard regulation’ path and this might be the future for DEXs and other decentralized protocols as well.
Does KYC/AML undermine the purpose of Decentralised Finance?
There are many benefits behind a situation where the protocol you interact with does not know anything particularly sensitive about you as the user. We have heard numerous stories of people’s bank accounts being attacked after the data breach associated with the recent FTX meltdown. CEXs already cannot operate without implementing strict legal measures and collecting substantial amounts of sensitive user data.
DeFi’s accessibility, deeply embedded in its ethos, is largely based on the fact that KYC is not required there. It allows people from underprivileged backgrounds to participate in the global ecosystem under the same conditions as everybody else with an internet connection being the only barrier to entry. It also preserves digital freedom for everybody who is deeply concerned about it.
On the other hand, we are gradually approaching the institutional adoption of blockchains. Major Investment Banks already have 500+ people teams working solely on Web3-related products. JP Morgan recently announced making its first DeFi trade. However, institutional clients need regulatory stability with KYC/AML being an essential part of it. This is the main source of friction that needs to be alleviated before we see some serious moves from the big players.
Traditional KYC implemented on DEXs probably would not undermine their existence but surely would reduce their utility in many areas. Also, you wouldn’t want to give your ID to every single DEX you have ever interacted with would you? However, there might be a way around it. In essence, regulated DeFi protocols would have to accept only those Users, who meet certain legal conditions.
Let’s assume that the data needed for such validation might already be on-chain. There should be a way to perform the User check without the need to collect more data or introduce new third-party risks. This would mean that the protocols can make sure they are fully compliant with the regulations and the user can leverage their on-chain activity and KYC processes they have already completed to get access to ‘regulated’ DeFi.
We might have just the right solution for that.
Introducing KYD Oracle
Today, we present a new approach: a robust proof of the User’s legitimacy, invisible for the End User of a dApp and needing no access to the End User’s personal data. This opens DeFi up for institutions while maintaining seamless User Experience and introducing no counterparty risk.
KYD stands for Know Your Data (also, potentially, Know Your Defi-user). The Oracle checks a given wallet against a set of conditions specified by the Smart Contract creator. Everything you do on-chain is an immutable piece of your reputation. KYD Oracle leverages that along with the KYC/AML processes you have already gone through to give you a ‘score’ within the DeFi space.
This is an automatic way of checking your legal eligibility when you interact with the DeFi smart contract. No additional steps on your end are needed, no popups, no logging into an external service. It all happens through the code and is powered by on-chain data.
Example Use Case
Let’s assume a major Investment Bank wants to open a new Decentralised Exchange for Tokenised Real-Word Assets. Because of legal reasons, the newly created DEX can only be accessed by Users meeting a predefined set of conditions, such as:
- The User received a transfer from Coinbase within the past 6 months,
- The User received a single transfer of at least $100,
- The User has never interacted with a mixer.
For the End Users, the flow of interaction looks as follows:
- The User clicks Connect Wallet and signs the message,
- Underneath, our Oracle checks the User’s address against a predefined set of conditions.
The check happens instantly within a single transaction. If the User’s address is eligible the transaction gets through seamlessly – the interaction works the same way as with any other DEX. If the End User’s address is not eligible, the transaction gets reverted with a message explaining the cause.
It is important to remember that AML/KYC is the art of dealing with risk and mitigating it by raising standards and implementing best practices. KYD Oracle does not eliminate the risk of interacting with a malicious actor completely. You can think of it the way you would think about Risk Scoring – we don’t eradicate the risk but we make sure that it is minimized to a level acceptable by institutions.
The right AML/KYC implementation is also heavily dependent on a variety of factors such as the specific case of a given institution, jurisdiction, accepted business risk, and many others. Institutions must also be ready for dynamic changes in this field, especially in the blockchain context where rules are still being shaped. Offering an off-the-shelf AML/KYC product with strictly predefined functionalities would not make much sense at this point.
Therefore, our goal is to develop technology allowing institutions to define their own rules and adjust them flexibly to their own use case.
Technical details
RedStone takes care of indexing the chain to build an instantly accessible database for verifying conditions. For POC purposes, we have built an Indexer gathering all the addresses that have ever received a transfer from Coinbase. Currently, we are adding more data sources to cover a broader spectrum of conditions and meet the needs of interested parties.
The system uses an on-demand model where the Oracle Node provides the score of a requested wallet address. Everything happens instantly and within a single transaction triggered by the End User interacting with the Smart Contract. No additional steps are required thanks to our EVM-connector technology pushing the data on the chain via meta transaction pattern.
That is just the first implementation we have created for POC purposes. However, we can easily go way beyond that by leveraging our 2nd product – Warp Contracts. This will allow for the implementation of significantly more complicated data rules, including large sets of conditions, and performing complex computations.
Want to try it out?
Go to the KYD Oracle Demo Page.
To dive deeper into the tech be sure to check out KYD Oracle Repository.
Path Forward
The flexibility of our Oracle design allows us to provide deeply customized solutions for institutional use cases. This is the first time we are showing this solution to the public. However, we have already had many talks with parties interested in integrating it, and right now we are adjusting the product to their specific needs.
Next steps? Including some more sophisticated logic and combining on-chain + off-chain data. Instead of asking: Has this wallet ever received a transfer from Coinbase? the institutional client might be asking for an attestation that the End User is above the legal age in their country of residence. As you might have guessed, we are also experimenting heavily with ZK Proofs in this field as well. Expect more information on that after we finish testing the hypotheses with interested parties.
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At RedStone we are on a mission to build the next generation of Oracles. Our solution has an unrivaled ability to exert significant control over any new data listings. Result? The flexibility to follow any emerging market trends, alongside substantial cost savings, allows us to stay at the frontier of a new wave of Decentralised Finance.
Join us on the journey!
