Blockchain technology has the potential to improve a variety of industries, especially the financial sector. Layer 1 protocols, which are essentially the foundational layer of any blockchain network, serve as the core components of a blockchain system. Examples of layer 1 blockchains include Bitcoin, Ethereum, and Binance Smart Chain. These blockchains serve as the base layer for various decentralized applications (DApps) and smart contracts.
Layer 1 protocols are responsible for establishing the basic rules and consensus mechanisms that govern the blockchain network. Determines how transactions are verified and added to the ledger. Additionally, layer 1 protocols are where interoperability between different dApps will take place in the future.
Enterprises can also deploy their own layer 1, known as “enterprise blockchain,” to achieve business goals or provide services. These blockchains are fundamentally different from the layered blockchains mentioned above, which focus on providing services while adhering to the core principles of cryptocurrency, including pseudonymity, decentralization, etc.
Enterprise blockchain can throw away its principles to provide services in a compliant manner. Regulations can therefore enable the provision of services that cannot be achieved in an anonymous environment and perhaps bring new kinds of users to Layer 1 technologies.
KYC and AML for compliance
In today’s digital environment, where financial transactions occur at an unprecedented rate, regulatory compliance is key. In the financial industry, everyone is familiar with Know Your Customer (KYC) and Anti-Money Laundering (AML) protocols. By verifying the identity of customers, businesses mitigate the risk of fraudulent activity.
KYC and AML are compliance processes designed to prevent and detect illicit activities, including money laundering and terrorist financing. This process is especially important in the financial industry, such as cryptocurrency exchanges and platforms that deal with virtual assets. These regulations ensure that companies actively monitor transactions, identify suspicious patterns or behavior, and report potential risks to relevant authorities.
The decentralized nature of layer 1 blockchains makes them difficult to implement directly at the protocol level. Some DeFi platforms and services built on top of layer 1 blockchains have implemented their own mechanisms for user identification and compliance.
For example, some projects are exploring the use of tokens or smart contracts specifically designed to facilitate compliance with regulatory requirements. These tokens can represent a user’s verified identity on the blockchain without publicly revealing sensitive information.
However, the more decentralized nature of enterprise blockchains makes implementing AML and KYC at the base layer a more practical endeavor. This gives ordinary people and institutions the confidence to interact directly with the enterprise blockchain of their choice.
Financial transparency through KYC and AML
Financial transparency is critical to building trust and integrity in financial systems, including blockchain-based systems. Integrating KYC and AML protocols into blockchain layer 1 protocols offers tremendous potential to provide transparency to users while maintaining confidentiality through technologies such as zero-knowledge proofs. A zero-knowledge proof is a way for one party to prove to another party that a particular statement is true. Disclosing information that goes beyond the truth of the statement. AML procedures on layer 1 blockchains mean transactions can be audited in real time.
Regulatory compliance is critical to the widespread adoption and integration of traditional financial systems, but the balance between privacy, decentralization, and compliance is a difficult issue. Regulatory developments in the cryptocurrency space are dynamic and jurisdictions may have different approaches to these issues.
As the industry evolves, there will likely be ongoing developments on how KYC and AML measures can be effectively implemented within the decentralized and pseudonymous nature of layer 1 blockchains.
Layer 1 possibilities
In fact, layer 1 protocols have the potential to provide seamless integration with external data sources to verify customer identities and monitor transaction activity in real time. Existing blockchains such as Bitcoin and Ethereum are based on core blockchain principles that effectively prohibit AML and KYC procedures. New enterprise blockchains do not necessarily have to adopt these principles, so they can be built with different demographics in mind.
These layer 1 protocols can integrate features such as identity verification mechanisms, transaction monitoring tools, and smart contract functionality to facilitate secure and transparent on-chain transactions.
Organizations can then use layer 1 blockchain to build trust among participants by ensuring all users comply with KYC and AML regulations in a tamper-resistant environment designed to securely store sensitive customer information.
New layer 1 blockchains that implement AML and KYC capabilities can create the incentives needed to attract new users who can benefit from layer 1 blockchain technology.