Cracking the Code: Addressing Data Privacy and Legal Challenges in the Blockchain Industry

Today I'm speaking with Mike Antoniuk, Co-Founder of Swisstronik. In this interview, we will explore the various challenges faced by the blockchain industry and uncover strategies to navigate the intricate landscape of data privacy while ensuring compliance with legal frameworks. 

Join us as we unravel the mysteries surrounding this rapidly evolving field and shed light on the crucial aspects of protecting user data and maintaining legal integrity in blockchain applications.

Introduce yourself and tell us what you do.

My name is Mike Antoniuk. I've been working as a blockchain developer since 2017 and, among other things, participated in the development of CBDC for the European Central Bank. 

Today, I'm a Co-founder at Swisstronik - the first platform that lets anyone build compliant yet private dApps with minimum coding and zero legal expertise.

How can blockchain companies balance preserving data privacy and meeting regulatory requirements for Know Your Customer and Anti-Money Laundering?

Firstly, if you're not obligated by law to internally store users' data, it is recommended that you don't do it. 

Why? Because you would have to work with external providers for KYC checks anyway (unless you have the required license yourself), why create several access points to users' data? Letting the KYC provider store it on their end is more secure.

However, if you have to store users' data, it is crucial to do it wisely. Instead of holding and processing the data as it is, it is advised to use advanced encryption techniques like Zero-Knowledge Proofs. Using such methods, data can be processed, verified, and utilized without exposing sensitive information. 

For example, with ZKP, a KYC issuer can process users' sensitive data and then share public proof that confirms the user has successfully passed the KYC check. Anyone can see this proof, but the underlying user's data remains hidden.

In addition, rather than directly working with a KYC issuer, it is recommended to integrate a DID (Decentralized Identifier) module to handle user data and verifications. The key advantage of a DID framework is that users have greater control over their data and can selectively share specific data without revealing unnecessary information. 

DIDs can also leverage cryptographic proofs and decentralized technologies like blockchain to establish trust and integrity in the verification process. Adopting a DID approach can enhance privacy and security while maintaining user control over their data.

However, while some of these devices are easy to implement, others require some coding and/or higher budgets. But luckily, some user-friendly and affordable solutions for crypto startups are being launched - like the one I'm currently working on. 

With them, you can combine user privacy and compliance and achieve it in a decentralized way - which is highly valued by the crypto community.

In the event of a data breach or privacy violation in a blockchain network, what are the legal implications and responsibilities for the involved parties?

Is the blockchain network fully decentralized and autonomous, or does a specific legal entity run some centralized parts?

You need to determine if it indeed has centralized pieces to it, where is this legal entity registered, and in which status. The most tricky part here is assessing the decentralization level of the network and figuring out which laws apply in a particular case, given the patchwork nature of the legal landscape in crypto. 

So while it's impossible to describe all possible scenarios here, for example, if it resulted from a technical bug in the network and the network is centralized to some extent. 

Its developers (the company) are probably to blame. But if it was a social engineering attack - it may be considered entirely the user's fault. But sometimes, the company may be blamed for not taking the required precautions that led to this. 

Regarding KYC and AML procedures in the blockchain business, what are some best practices for undertaking continuous monitoring and risk assessment of customers?

Again, this depends on the jurisdiction and the technical solutions you use, but here are a few thoughts that should apply to everyone.

It would help if you determined the limitations on who can use your products and implemented the procedures that ensure "the wrong users" don't get on board. You should also put in place a transparent system for running user verifications: understand in which cases you need to verify user identities and run AML checks, how you (or your contractors) will run these checks, how the data will be processed and stored, and so on. 

It's also helpful to assess their risk level by tracking suspicious behavior. You can use unique systems that automatically monitor large or frequent transactions and transactions from high-risk areas.

Another good tip is to take extra precautions for customers who may pose a higher risk, such as people with political connections or those from risky locations. 

How do international data transfer regulations impact the blockchain industry, and what measures should companies take to comply with cross-border data privacy requirements?

Rules about transferring data across borders, like the GDPR, greatly affect the blockchain industry. 

Blockchain's way of working, with data spread out and unable to be changed, makes it difficult to follow the rules for protecting data when it's sent across different countries.

To comply, companies can take several measures:

Firstly, they can store minimal personal data on the blockchain by encrypting sensitive information, ensuring that only necessary and protected data is stored.

Secondly, it is crucial to obtain explicit consent from individuals before storing their data and provide clear information on data usage and international transfers. This helps in maintaining transparency and respecting individuals' privacy rights.

Thirdly, anonymizing or pseudonymizing personal data is recommended to protect privacy while still allowing for necessary data processing. This approach balances the need for data utilization with privacy safeguards.

Appropriate data transfer mechanisms, such as Standard Contractual Clauses (SCCs) or Binding Corporate Rules (BCRs), must ensure lawful international data transfers while adhering to relevant regulations.

Lastly, engaging with data protection authorities to seek guidance and ensure compliance with evolving regulations is advisable. Collaboration and communication with authorities contribute to maintaining a compliant and responsible approach to data protection.

How can regulators and policymakers strike the right balance between fostering innovation in the blockchain industry and protecting the data privacy rights of individuals?

This is a tricky question because we don't have that many cases to judge upon. However, in my opinion, there are several important aspects to it: 

First, we need clear legal frameworks and, ideally, guidelines on operating in between them. These frameworks should guide data handling, consent, anonymization, and encryption, considering the decentralized nature of blockchain. 

Also, they should avoid imposing overly prescriptive regulations that stifle innovation. Instead, it's better to focus on outcomes and principles, allowing flexibility for blockchain solutions to evolve while ensuring data privacy rights are respected.

Second, they could encourage adopting and developing privacy-enhancing technologies within the blockchain ecosystem, such as Zero Knowledge Proofs.

Third, the governmental bodies should also take care of education so that both blockchain companies and users become well aware of these issues and their respective responsibilities. This can help empower individuals to make informed decisions and foster a culture of privacy- and compliance-conscious blockchain practices.

How can blockchain technology facilitate transparent auditing while still maintaining data privacy?

When some data needs to be audited, it cannot stay fully private per se. However, a few things can be done to mitigate the risks connected to sharing users' data: 

It's important to remember that blockchain can provide transparency by allowing authorized auditors to access specific data. Therefore, auditors can be granted read-only access solely to the relevant transactions and associated information. This arrangement enables them to verify data integrity and conduct audits without obtaining all information about the individual user.

In addition, blockchain platforms can incorporate privacy-enhancing techniques like the previously mentioned ZK proofs or selective disclosure mechanisms. These mechanisms enable users to disclose only the necessary information for auditing purposes while keeping other sensitive data confidential.

Another approach involves using private or permissioned blockchains, where access to the blockchain network is restricted to known participants. Such networks can enforce stringent access controls and encryption mechanisms, ensuring only authorized parties can participate in auditing processes while maintaining data privacy. 

However, it's important to note that private or permissioned blockchains also have drawbacks. By implementing these measures, blockchain platforms can balance transparency and privacy, allowing for effective audits while safeguarding sensitive information.

What role can decentralized identity solutions play in improving the efficiency and effectiveness of KYC and AML processes in the blockchain industry?

Decentralized identity solutions use blockchain technology to let individuals control their data. They securely store it on the blockchain and only share relevant information when needed. 

This means people don't have to repeatedly give the same data, making it easier for users and businesses to get started. These solutions also protect privacy by reducing reliance on a single database and lowering identity theft risk. 

They make it easier for different organizations and platforms to work together, ensuring secure data exchange and better compliance with regulations. Overall, decentralized identity solutions are efficient, secure, and protect privacy for users and the blockchain industry.

How can collaboration between blockchain companies, regulatory bodies, and financial institutions enhance the effectiveness of KYC and AML integration?

It will help produce clear regulations on how these checks need to be run, how data should be stored, and how particular blockchain-based services can be rendered. If regulatory bodies from different states join this discussion, it would potentially bring us close to streamlining the activities on the jurisdictions' borders. 

This is extremely important given that the crypto community is inherently global and borderless, so a fragmented regulation would not fully address all its needs.

Are there any emerging technologies or trends expected to significantly impact KYC and AML processes in the blockchain industry in the future?

Sure. For example, Artificial Intelligence and Machine Learning. They could automate risk assessments and transaction monitoring and improve the efficiency of KYC and AML checks. But on the other hand, they can also enable fraud - for example, with deep-fakes, which can undermine digital KYC checks.

Tokenization of assets also opens up new opportunities. It enables streamlined identity verification, transaction tracking, and compliance monitoring.

And finally, technologies like zero-knowledge proofs and homomorphic encryption preserve privacy while enabling secure identity verification and transaction analysis on the blockchain.