Why Selective Disclosure is the Only Viable Path for Web3 Compliance

Exchanges like Coinbase and Binance enforce full KYC, creating honeypots of user data. On-chain, protocols like Tornado Cash offer privacy but face blanket sanctions. The result is a fractured ecosystem where privacy is criminalized and compliance is centralized.

• Data Breach Risk: Centralized KYC databases are high-value targets.
• Censorship Overreach: Address-based blacklists punish innocent users.
• User Friction: Mandatory doxxing kills adoption for legitimate use-cases.

Zero-Knowledge Proofs (ZKPs) enable selective disclosure. Users prove compliance (e.g., "I am not a sanctioned entity") without revealing underlying data. This is the core innovation behind projects like Aztec, Mina Protocol, and compliance-focused zkRollups.

• Minimal Disclosure: Prove specific attributes (jurisdiction, accreditation) on-chain.
• On-Chain Verification: Compliance logic becomes a decentralized, transparent smart contract.
• Future-Proof: Adapts to new regulations without redesigning the protocol.

Selective disclosure requires a trusted source of truth for user credentials. This is the role of verifiable credentials and attestation networks like Ethereum Attestation Service (EAS) and Verax. A credentialed wallet becomes a user's portable compliance passport.

• Self-Sovereign: Users control which dApp sees which credential.
• Interoperable: Credentials work across chains via LayerZero or CCIP.
• Revocable: Issuers (e.g., regulators) can invalidate credentials in real-time.

The FATF Travel Rule requires VASPs to share sender/receiver info. The TRUST solution, developed by Coinbase, Kraken, and others, uses a zero-knowledge style approach to share only the required data between regulated entities. This is a blueprint for on-chain compliance.

• Regulator-Approved: Demonstrates that selective disclosure meets legal standards.
• Industry Collaboration: Avoids the need for a single centralized ledger.
• Scalable Model: Can be extended to DeFi and cross-chain bridges like Across.

Manual, human-led compliance processes cost institutions billions annually. Automated, ZK-based compliance slashes operational overhead and unlocks new markets. Protocols that build this in natively, like Polygon ID, will capture the next wave of institutional DeFi TVL.

• Automated Screening: Real-time proof verification vs. slow manual checks.
• Global Liquidity: Enables permissioned pools without geographic restrictions.
• Developer Advantage: Compliance becomes a feature, not a legal afterthought.

The final state is Regulation-as-Code. Jurisdictions publish compliance logic (e.g., "max leverage = 10x for non-accredited") as verifiable on-chain modules. Users interact with Aave or Uniswap and automatically prove they satisfy all relevant rules. This aligns SEC goals with DeFi innovation.

• Transparent Rules: No regulatory ambiguity; code is law.
• Composable Compliance: dApps mix-and-match regulatory modules.
• Level Playing Field: Eliminates advantage of operating in gray areas.

Regulators demand identity; users demand privacy. The current choice is binary: full KYC or opaque anonymity, both of which are toxic for adoption and regulation.

• Full KYC kills pseudonymity, the bedrock of credible neutrality.
• Full Anonymity invites regulatory crackdowns, as seen with Tornado Cash.
• The result is a $100B+ DeFi market operating under constant legal threat.

Prove you're compliant without revealing who you are. Protocols like Sismo and zkPass enable users to generate ZK proofs of off-chain credentials (e.g., citizenship, accredited investor status).

• User proves they are not on a sanctions list, without revealing their passport.
• DApp/regulator gets a cryptographic guarantee of compliance.
• Enables permissioned DeFi pools and compliant RWA tokenization without doxxing all users.

Sismo builds the infrastructure for selective disclosure via ZK Badges. Users aggregate proofs from data sources (GitHub, ENS, PoH) into a single private vault.

• Data Source Agnostic: Pulls from Ethereum Attestation Service, Gitcoin Passport, or traditional oracles.
• Portable Identity: A 'Proven Trader' badge from GMX can be reused on Aave without re-verification.
• Developer Focus: Simple SDKs let any app request specific proofs, not raw data.

RISC Zero provides general-purpose zkVMs, enabling complex off-chain compliance logic to be proven on-chain. Think AML transaction monitoring executed in a black box.

• Prove a transaction batch was screened against global watchlists.
• Auditable Logic: The compliance rules (e.g., SanctionsChecker.sol) are open-source, but the input data is private.
• Institutional Pathway: Enables TradFi entities to prove regulatory adherence when interacting with MakerDAO or Ondo Finance.

Selective disclosure is critical for cross-chain messaging and bridges to avoid sanctions evasion. Protocols like LayerZero and Axelar are integrating attestation layers.

• Prove a user's origin-chain address is compliant before relaying a message to Avalanche or Solana.
• Chainlink's CCIP can incorporate proof-of-identity oracles into its cross-chain stack.
• Prevents the entire bridge from being blacklisted due to a few bad actors.

The endgame is Fully Homomorphic Encryption (FHE). Projects like Fhenix and Zama allow computation on encrypted data, enabling dynamic compliance.

• A user's encrypted balance can be proven to be above a threshold for an accredited pool.
• Regulators can run queries on encrypted ledger data with a private key.
• This moves from static proofs to a live, private compliance layer, making Monero-level privacy legally viable.