Written by: Zhang Feng
Real World Assets (RWA) are accelerating their entry into the DeFi space, bringing liquidity transformation to traditional finance. However, currently, the anonymity of DeFi conflicts with the strong regulation of traditional finance (especially KYC/AML) in practice. Achieving compliance is not a simple transplant; it requires innovative architecture and technological integration.
The integration of RWA and DeFi is not a simple 'access', but gives rise to a new type of financial infrastructure. Successful KYC/AML compliance solutions must be hybrid architectures: off-chain identity verification and legal entities as the foundation, with on-chain efficient and privacy-friendly verification and execution through ZKP, DID, and programmable compliance. Regulators need to embrace innovation and clarify adaptive rules under the principle of 'same risk, same regulation'. Technological developers must view compliance as a core design goal rather than an afterthought.
1. Decoupling identity and transaction settings into a layered architecture.
Deploying in two dimensions: blockchain identity and contract access.
Off-Chain/On-Chain Hybrid Identity. Users complete stringent KYC/AML verification through off-chain specialized KYC providers like Circle (USDC issuer), Fractal ID, and Parallel Markets. Biometric verification, document verification, and risk database screening are all completed in a secure off-chain environment. At the same time, based on on-chain verifiable credentials, zero-knowledge proof (ZKP) credentials (such as Polygon ID) or soulbound tokens (SBT) are generated to prove that the user 'has passed KYC' or 'is not on sanctions lists', without exposing specific identity information. The credentials are bound to the user's wallet address.
Compliance access layer (Gated Access / Permissioned Pools). Specific RWA funding pools in DeFi protocols (like Centrifuge, Goldfinch) set access control rules based on credentials. Users must provide valid credentials to participate (deposit, borrow, trade specific RWA assets). When KYC status expires or is revoked, the credentials automatically become invalid, triggering preset dynamic credential management rules within the protocol (such as prohibiting new investments, initiating exit processes).
2. Real-time transaction monitoring and automated AML screening challenges.
In terms of dynamic regulation, various measures are taken through off-chain data integration, on-chain transaction behavior monitoring, and suspicious activity reporting.
On-chain transaction behavior monitoring. For example, tools like Chainalysis and Elliptic can analyze wallet transaction history, associated addresses (such as interactions with dark web, mixers), generating address risk scores. Additionally, build anomaly pattern detection to monitor large, frequent, and unusually sourced/directed transactions (like suddenly transferring in large amounts of funds to immediately invest in RWA).
Integration of off-chain AML databases. Integrating real-time screening APIs like ComplyAdvantage and LexisNexis. The key challenge is to associate wallet addresses with off-chain identities (relying on the aforementioned credential system) for the screening to have legal effect. On the other hand, how can on-chain smart contracts securely and reliably obtain updates for off-chain AML lists? Specific solutions for decentralized oracle networks (like Chainlink) need to be developed.
Suspicious Activity Reports (SAR) on-chain-off-chain linkage. When protocols or monitoring services detect high-risk transactions, they need to report the encrypted transaction data + associated identity information to regulatory agencies/compliance teams through compliance interfaces. The key challenge is to standardize the reporting process, responsible parties, and data formats.
3. Clarifying responsible parties and basic mechanisms for dispute resolution.
Mainly addressing responsibility bearing and dispute resolution mechanisms.
Clarifying the compliance obligation bearer (The Gatekeeper Problem). For Special Purpose Vehicles (SPVs) / legal entities, RWA initiators (such as real estate companies, bond issuers) or core developers of the protocol establish regulated entities (such as Centrifuge's entity registered in the US) to fulfill KYC/AML as statutory responsible persons. For permissioned DeFi protocols, the protocol itself needs to be designed to require permission for joining (nodes, liquidity providers must undergo KYC), such as certain enterprise-grade blockchain solutions (like Fnality). Additionally, reliance on third-party compliance service providers is also necessary, such as delegating licensed institutions (like trust companies, payment institutions) to handle user due diligence and transaction monitoring.
Jurisdiction and legal applicability. Real estate RWA is primarily governed by the law of its physical location, that is, the law where the asset is located. In some scenarios, the law of the user's location applies and must comply with financial regulations in the user's residence/nationality (like US FATCA, EU AMLD). At the same time, the protocol is required to transparently design and clearly announce the applicable laws, regulatory agencies, and user rights.
4. Balancing privacy and efficiency by combining technology and law.
Integrating privacy computing technology, decentralized identity technology, recognized RegTech, and smart contracts.
Deep application of Zero-Knowledge Proofs (ZKP). KYC credentials can prove that user information is valid and not blacklisted without disclosing specific content. AML screening can also be conducted, where the user runs screening software locally to generate a ZKP proving 'my counterparty is not on the latest blacklist', without exposing the counterparty's address to the protocol/counterparty. Additionally, transaction compliance proofs can be generated, and complex transactions can produce ZKP proving they meet all preset rules (such as single investor limits).
Decentralized Identity (DID) and Verifiable Credentials (VCs). Users have complete control over their identity data (stored in personal digital wallets) and selectively disclose specific information to specific parties (such as only disclosing 'annual income > $100,000' proof to the RWA pool when needed). Improves interoperability and reduces redundant KYC.
The combination of RegTech and smart contracts. Programmable compliance, such as directly coding AML rules, investment limits, lock-up periods, etc., into smart contracts for automatic execution. Providing regulators with 'read-only' API regulatory sandbox interfaces to monitor overall risks without needing to view privacy details of each transaction.
5. Moving forward amidst continuous challenges and resolutions.
The eternal tension between privacy and compliance, namely how to maximize the protection of user financial privacy while meeting regulatory real-name requirements. ZKP/DID is the direction, but large-scale applications require more mature practices.
Cross-jurisdictional coordination is also a significant challenge. There is a lack of a unified regulatory framework for crypto assets/DeFi globally, and RWA protocols face fragmented compliance requirements.
Ambiguity in defining responsibilities. If smart contract vulnerabilities lead to violations, how do we allocate responsibilities among developers, nodes, users, and SPVs? The law urgently needs to catch up. Agreements can be made in the design phase.
Trust and security of Oracles. The on-chain integration of critical off-chain data (AML lists, asset prices) must be highly secure and reliable; otherwise, it becomes a single point of failure or a target for attacks.
The challenge of sanction enforcement. How to effectively freeze assets of specific sanctioned addresses on a permissionless underlying blockchain? The technical implementation is extremely difficult and needs to rely on front-end/inflow and outflow channel controls, combining on-chain and off-chain.
Despite significant challenges, the compliance path for RWA in DeFi is being explored in practice through projects like Centrifuge, MakerDAO (RWA collateral), and Ondo Finance (tokenized government bonds). This is not just about legality; it is the key to unlocking trillion-dollar liquidity for RWA—compliance is the necessary path for DeFi to go mainstream, not an obstacle.