- The US Treasury has today opened a consultation seeking public feedback on how to best mitigate the risks of illicit financial activity associated with digital assets.
- One of the Treasury’s proposed solutions is embedding digital ID checks into DeFi smart contracts, easing compliance but also raising concerns around government surveillance.
- The consultation stems from the passage of the GENIUS Act, which requires that Treasury investigate “innovative and novel methods” of mitigating the financial risks of digital assets.
The US public is being asked for input on “innovative or novel methods” to clamp down on the financial risks associated with the use of digital assets as part of a consultation process being run by the US Department of Treasury, which started today.
One of the innovative and novel methods earmarked for further investigation by the Treasury is the use of digital IDs. Treasury has suggested digital IDs could be embedded in the smart contracts powering decentralised finance (DeFi) protocols.
Digital identity verification tools can also potentially be used by regulated digital asset intermediaries to support onboarding or by decentralized finance (DeFi) services’ smart contracts to automatically check for a credential before executing a user’s transaction.
US Treasury consultation document
The request for comment stems from the recent passage of the GENIUS Act, which requires the Treasury investigate how the risks of digital assets can be mitigated. Four technologies were identified in the GENIUS Act as requiring further study:
- application program interfaces (APIs),
- artificial intelligence (AI),
- digital identity verification, and
- use of blockchain technology and monitoring.
The consultation period runs for 61 days, ending on October 17. Following the consultation, Treasury will conduct its own research into identifying ways to limit the risk of illicit financial activity associated with digital assets and provide a report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives.
Related: Tether Eyes US Institutional Launch Following GENIUS Act Approval
Digital IDs Could Streamline Compliance, But Privacy Issues Remain
If any scheme to embed digital ID checks into DeFi smart contracts were implemented it could streamline compliance. Platforms could automatically conduct know-your-customer (KYC) and anti-money laundering (AML) checks, perhaps speeding growth and adoption of digital assets.
According to the consultation request, there are already several DeFi platforms exploring the use of embedded digital IDs “to support various elements of AML/CFT and sanctions compliance, maximize user privacy, and reduce compliance burden on financial institutions.”
However, the use of digital IDs could also allow governments to track and monitor DeFi use and raises issues around privacy and overly restrictive government surveillance of citizens.
The US Treasury said it’s aware of these concerns, and that it will evaluate and consider any “privacy risk associated with the information that is collected or reviewed.”
In June, Ethereum co-founder, Vitalik Buterin, raised concerns around the use of one-identity-per-person digital ID systems, arguing that even zero-knowledge proof (ZK proof) based systems could potentially compromise user privacy. He instead called for the use of ‘pluralistic identity’ systems.
“Under one-per-person ID, even if ZK-wrapped, we risk coming closer to a world where all of your activity must de-facto be under a single public identity,” Buterin wrote.
Related: Buterin Warns ZK-Wrapped IDs Aren’t Enough, Advocates ‘Pluralistic Identity’ for True Privacy
Buterin warned that any one-identity-per-person systems could undermine users’ online pseudonymity and suggested that employers and governments could compel users to reveal their various online accounts, compromising the protections offered by ZK proof based systems. He said a decentralised pluralistic identity model that has “no single dominant issuing authority” would better balance robust authentication with adequate privacy.
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