When it comes to personal privacy, the promises of the DeFi summer have sounded hollow.
Projects flooded the scene with buzzwords like “financial privacy” and “cryptographic security” during the 2021 DeFi boom, sending user expectations through the roof when the industry was still in its early stages.
As a result, once the dust settled, it became clear that most of DeFi’s bold privacy statements fell short of expectations. This problem has been further underscored by the rise of new on-chain analytics services such as Arkham Intelligence and Chainalysis, whose data dashboards revealed just how trackable DeFi users’ on-chain activity actually is.
Now the DeFi sector is facing increasing regulatory pressure to de-anonymize certain transactions and user profiles, while at the same time dealing with declining user confidence in terms of their individual data privacy rights.
But do these challenges mark the demise of privacy in DeFi? We certainly don’t think so.
The fact is that today’s most pressing issues are not criticisms of the nature of DeFi itself, but of its current state of evolution. More specifically, the problem for developers is that much of this madness is built on underdeveloped technology that hasn’t lived up to the hype. However, the underlying infrastructure is rapidly maturing and the Web3 development paradigm is shifting away from the idea that ‘transparency’ must invariably be linked to a ‘lack of privacy’.
There is a significant difference between a libertarian approach to crypto privacy (do what you want, without regard to anti-money laundering efforts) and privacy that enables new use cases in a regulatory-friendly way (do what you want, as long as you money is available). come from a legitimate source).
Read more: Privacy remains a sticking point in the ongoing CBDC debate in America
Fortunately, most privacy laws allow for this demarcation, and therefore the vast majority of existing regulations have more to do with areas relating to customer protection rather than a general opposition to ‘privacy’.
For example, the US government supports privacy-enhancing technologies – as long as they align with existing AML/CFT rules. However, when organizations use private blockchains without following these guidelines or use services outside current laws, they create unnecessary risks for their users.
For example, the key to making this approach to privacy both practical for regulators and enjoyable for users could be a decentralized data store of user data such as idOS – a GDPR-compliant identity system recently announced at this year’s TOKEN2049 conference. With such a solution, no party has control over the user’s login credentials, even though the system verifiably guarantees that users are not on authorized sanctions lists.
Rapidly maturing technologies such as zero-knowledge proofs and decentralized identity systems eliminate the need (and ability) to expose remote user data to outside parties. At the same time, they enable regulators to identify and take action on malicious activities within the chain with confidence and speed. The combination of such a storage system with privacy-enhanced DeFi apps creates a comprehensive privacy trading package that is also aligned with AML regulations.
All of this is to say that Web3 builders are listening to both regulators and end users and developing more nuanced solutions that target both ends of the spectrum. There is no doubt that the industry as a whole is currently falling short of both parties’ expectations.
Read more in our opinion section: DeFi has a reputation problem
However, the same could be said about the modern internet, which reflects the evolutionary trajectory of DeFi from both a development and regulatory perspective.
For context, the birth of the Internet can be traced to an academic initiative by the US Advanced Research Projects Agency – but the Internet as we know it today was largely the result of a series of informal interactions and decisions by tinkerers and fringe enthusiasts. the coming years. Small, experimental “test networks” and applications that few people thought would ever matter led to essential Internet protocols still in use today, including file transfers and TCP/IP.
During this time, the Internet was essentially unregulated. Until the expansion and commercialization of the Internet in the mid-1990s, the Internet’s primary governance model was decentralized and based on informal standards and protocols voluntarily adopted by builders, with an emphasis on making networks interoperable.
And yet, eventually, regulations followed, developers adapted, and the vast majority of today’s global financial activity is conducted online – something that would have been unthinkable just a few decades ago given the internet’s obscure origins. For all its problems, the internet has undoubtedly been a positive force in the world: the rapidly maturing DeFi sector has the potential to have a similar impact on the financial system and beyond.
As DeFi continues to grow and mature, regulators will develop new frameworks to govern this sector, while developers will create new, responsible privacy-preserving technologies. That’s why Web3 builders must recognize that current privacy shortcomings are a puzzle to be solved, not an indictment of the industry. And if an industry outsider can’t imagine a Web3 protocol that addresses regulators’ privacy concerns while meeting users’ privacy needs, it’s only because that solution hasn’t yet been built by an industry insider.
Antoni is a co-founder of the Aleph Zero Foundation (Switzerland), an organization overseeing the development of the Aleph Zero blockchain, and a Managing Partner of Cardinal Cryptography (Poland), a company focused on the core development of the Aleph Zero Ecosystem.