Setting Up a Decentralized Identity (DID) System for KYC

Decentralized Identity (DID) systems replace traditional, custodial KYC with user-controlled credentials. A DID is a globally unique identifier, such as did:ethr:0xabc123..., anchored to a blockchain. It is controlled by the user via cryptographic keys, not a central database. Users collect Verifiable Credentials (VCs)—digitally signed attestations from issuers like governments or banks—and store them in a personal wallet. To prove KYC compliance, they present a Verifiable Presentation, allowing selective disclosure without revealing the underlying raw data.

The core technical stack involves three layers. First, the DID Method defines how identifiers are created and resolved on a specific blockchain (e.g., did:ethr for Ethereum, did:ion for Bitcoin). Second, the VC Data Model (W3C standard) structures the credential's claims, proof, and issuer. Third, a holder wallet (like SpruceID's didkit or Veramo) manages keys and creates presentations. For developers, the initial setup requires choosing a DID method library and integrating a VC issuance service. A common starting point is using the did:key method for testing, which doesn't require on-chain transactions.

Here is a basic example using the did:key method and @veramo/core to create a DID and a simple credential:

javascriptCopy
import { createAgent } from '@veramo/core';
import { DIDManager } from '@veramo/did-manager';
import { KeyManager } from '@veramo/key-manager';
import { CredentialPlugin } from '@veramo/credential-w3c';
// Agent setup for key management and credentials
const agent = createAgent({
  plugins: [
    new KeyManager({ /* config */ }),
    new DIDManager({ /* config */ }),
    new CredentialPlugin(),
  ],
});
// Create a DID
const identifier = await agent.didManagerCreate({ provider: 'did:key' });
console.log('User DID:', identifier.did);

For a production KYC flow, an issuer service (e.g., a regulated entity) must sign credentials. This involves creating a JSON-LD or JWT VC with claims like "kycStatus": "verified" and a cryptographic proof. The user's wallet requests this VC, stores it, and later generates a Verifiable Presentation for a verifier (e.g., a DeFi protocol). The verifier checks the presentation's signature and the issuer's DID against a trust registry or revocation list (like a smart contract or the Iden3 Reverse Hashmap) to ensure the credential is valid and not revoked, all without contacting the issuer directly.

Key architectural decisions include choosing a public permissionless blockchain (Ethereum, Polygon) for maximum decentralization versus a private/permissioned ledger (Hyperledger Indy) for compliance. You must also design the trust model: who are the authorized issuers? How are their DIDs and public keys distributed? Implementing selective disclosure using zero-knowledge proofs (ZKPs)—via protocols like zkSnarks or BBS+ signatures—is crucial for advanced privacy, allowing users to prove they are over 18 without revealing their birth date. Frameworks like anoncreds-rs facilitate this.

The main challenges are user experience (key management), interoperability between different DID methods, and legal recognition of VCs. However, implementations are growing. The European Digital Identity Wallet (EUDIW) is built on these standards, and projects like Civic and SpruceID offer SDKs for integration. By implementing a DID-based KYC system, you enable portable identity, reduce liability from data breaches, and create a foundation for compliant, privacy-first applications in DeFi, gaming, and enterprise.

A decentralized identity system for KYC requires a foundational understanding of core Web3 concepts. You should be familiar with public-key cryptography, as DIDs are fundamentally based on decentralized identifiers and verifiable credentials (VCs). Understanding the W3C DID Core specification and the Verifiable Credentials Data Model is essential. For developers, proficiency in a language like JavaScript (Node.js) or Go is recommended for interacting with DID libraries and blockchain networks. A working knowledge of RESTful APIs or GraphQL is also necessary for building the issuer and verifier services that will create and check credentials.

The system architecture demands specific software components. You will need access to a DID method implementation, such as did:ethr for Ethereum, did:key for simple key pairs, or did:web for web-hosted documents. A credential wallet (like SpruceID's Credible or Trinsic's ecosystem) is required for users to store and present VCs. For the verifiable data registry, you must choose and connect to a supported blockchain or decentralized network; options include Ethereum, Polygon, or the ION network on Bitcoin for did:ion. Development environments typically use testnets like Goerli or Sepolia before mainnet deployment.

Operational and security prerequisites are critical for a production KYC system. You must establish a trust framework defining the policies for issuing, holding, and verifying credentials. This includes legal agreements between issuers (e.g., banks) and verifiers (e.g., DeFi platforms). Secure key management for your issuer's DID is non-negotiable; the private key must be stored in a hardware security module (HSM) or a cloud KMS. Furthermore, you need to design the credential schema for the KYC data, specifying which claims (e.g., name, dateOfBirth, countryOfResidence) will be included and whether they will be selectively disclosed using zero-knowledge proofs.

For development and testing, set up a local environment with the necessary tools. Install a DID library such as SpruceID's DIDKit or Microsoft's ION SDK. Use a local blockchain instance like Ganache or Hardhat Network for testing did:ethr interactions. You will also need a way to simulate the credential flow; tools like the Trinsic Studio platform provide a sandbox for prototyping the entire issuance and verification pipeline without immediate blockchain costs. Ensure your stack can handle JSON-LD contexts and produce cryptographic proofs (JWT or LD-Proofs) for the verifiable credentials.

Finally, consider scalability and interoperability requirements from the start. A KYC DID system must be designed to integrate with existing enterprise identity systems via standards like OpenID Connect (OIDC) or SAML. Plan for credential revocation, which can be managed through status lists (e.g., W3C Status List 2021) or smart contract registries. Estimate the transaction cost and throughput of your chosen blockchain network, as issuing and revoking credentials on-chain incurs gas fees. The system should also comply with relevant regulations like GDPR, which impacts how personal data within VCs is processed and stored.

A decentralized identity (DID) system for KYC replaces centralized credential storage with user-controlled verifiable credentials (VCs). The architecture is built on three core layers: the Identity Layer (W3C DIDs and VCs), the Verification Layer (trusted issuers and verifiers), and the Application Layer (dApps and services). This separation ensures users hold their own credentials in a digital wallet, while issuers (like banks) cryptographically sign attestations, and verifiers (like DeFi protocols) can check these proofs without accessing raw personal data.

The user journey begins with credential issuance. A user submits documentation to a regulated entity (the Issuer), which performs traditional KYC checks. Upon approval, the issuer creates a Verifiable Credential—a JSON-LD or JWT-formatted document containing the attested claims (e.g., "isKYCVerified": true). This VC is cryptographically signed with the issuer's private key and the corresponding Decentralized Identifier (DID) is embedded. The signed VC is then delivered to the user's identity wallet, such as MetaMask with Snap capabilities or a specialized wallet like SpruceID's ssi-wallet.

When accessing a service requiring KYC, the verification process is initiated. The verifier (e.g., a dApp) presents a verifiable presentation request, specifying the required credentials. The user's wallet constructs a Verifiable Presentation (VP), which includes the relevant VCs and a proof from the user's DID. Crucially, this can employ zero-knowledge proofs (ZKPs) via circuits (e.g., using Circom) to reveal only that a credential is valid without exposing the underlying data. The verifier checks the cryptographic signatures against the public keys listed on the issuers' and user's DID Documents, which are typically resolved via a DID method like did:ethr or did:key.

Key infrastructure components include a VC Issuance API (often built with frameworks like Veramo or Serto), a DID Resolver to lookup DID Documents, and revocation registries (e.g., using smart contracts or the W3C Status List 2021) to manage credential status. For Ethereum-based systems, EIP-712 signatures provide a user-readable standard for signing structured data during presentation. This architecture minimizes data leakage, shifts liability from service providers to accredited issuers, and creates a portable, user-centric compliance model.

A Decentralized Identifier (DID) is a new type of globally unique identifier that an individual, organization, or device controls without reliance on a central registry. Unlike traditional identifiers (like an email address), a DID is anchored to a verifiable data registry, typically a blockchain or distributed ledger. This creates a portable, self-sovereign identity foundation. For KYC, the DID becomes the user's root identity key, to which verified credentials (like proof of address) can be cryptographically linked.

The process begins with DID Method selection. A DID method defines the specific operations (create, read, update, deactivate) for a particular ledger. Common choices include did:ethr for Ethereum-compatible chains, did:key for simple, offline key pairs, or did:ion for scalable Sidetree-based networks on Bitcoin. Your choice dictates the underlying blockchain, transaction costs, and recovery mechanisms. For a production KYC system, consider sovereignty, cost, and interoperability with existing verifier ecosystems.

Creating a DID involves generating a cryptographic key pair and writing its public key to the chosen registry. Here's a conceptual example using the did:ethr method with Ethereum: const provider = new ethers.providers.JsonRpcProvider(RPC_URL); const wallet = ethers.Wallet.createRandom(); const ethrDid = new EthrDID({ identifier: wallet.address, provider, registry: '0xdca7ef03e98e0dc2b855be647c39abe984fcf21b' });. This code creates a wallet, then uses the ethr-did library to instantiate a DID object anchored to the Ethereum mainnet.

DID Documents (DID Docs) are the machine-readable descriptions of a DID, containing public keys, service endpoints, and verification methods. After creation, your system must resolve the DID to fetch its DID Doc. This is done via a DID Resolver, a universal library that routes requests to the correct method's resolver. For example, the did-resolver library paired with the ethr-did-resolver can resolve did:ethr:0xabc... to its current public key and service endpoints, enabling trust in subsequent interactions.

Management is critical. You must implement secure key storage for the user's private key, often via encrypted browser storage (e.g., localStorage or IndexedDB) or dedicated custody solutions. Plan for key recovery; methods like did:ethr allow adding/delegating additional keys to the DID Document, enabling social recovery or guardian-based schemes. Without this, lost keys mean a lost identity. Your KYC application's onboarding flow should guide users through backup and recovery setup immediately after DID creation.

Finally, this DID becomes the anchor for Verifiable Credentials (VCs). A KYC provider (the issuer) will sign a credential (e.g., "Verified Customer") with their DID and issue it to the user's DID. The user stores this VC in a digital wallet and can later present cryptographically verifiable proof to any service (the verifier). The entire trust model relies on the immutability and verifiability of the root DID established in this first step.

A Verifiable Credential (VC) is a tamper-evident digital credential whose authorship can be cryptographically verified. For KYC, this typically contains attested claims like a user's name, date of birth, and residency status. The core components are the credential metadata (issuer DID, issuance date, expiration), the credential subject (the user's DID and claims), and the proof (the digital signature). You define the structure using a JSON-LD context and a credential schema, which acts as a blueprint for the data, ensuring all issued credentials for a given use case are consistent and interoperable. Popular schemas for identity include those from the W3C VC Data Model.

Before issuing, you must create the credential's payload in JSON-LD format. The issuer's DID (from Step 1) is placed in the issuer field, and the user's DID is the id of the credentialSubject. The actual KYC data goes into the credentialSubject object. It's critical to only include necessary claims to minimize data exposure. Here's a simplified example of a credential payload before signing:

jsonCopy
{
  "@context": ["https://www.w3.org/2018/credentials/v1"],
  "type": ["VerifiableCredential", "KYCCredential"],
  "issuer": "did:ethr:0x1234...",
  "issuanceDate": "2024-01-15T00:00:00Z",
  "credentialSubject": {
    "id": "did:ethr:0xabcd...",
    "name": "Jane Doe",
    "residencyCountry": "US"
  }
}

The final step is generating a cryptographic proof to make the credential verifiable. This involves creating a hash of the credential data and signing it with the issuer's private key corresponding to their DID. The proof is then attached to the credential. For a did:ethr DID, you would use the eth_signTypedData method. The resulting VC includes a proof object with the signature, proof type (e.g., EcdsaSecp256k1Signature2019), and the verification method (the public key linked to the issuer's DID). This allows any verifier to check the signature against the issuer's public key on the blockchain or DID document, confirming the credential's authenticity and integrity without contacting the issuer.

After issuance, you have two primary distribution methods. You can return the signed VC directly to the user's application, allowing them to store it in a digital wallet (a secure, user-controlled app). Alternatively, for a custodial model, you might store the VC on your backend and provide the user with a unique identifier. The user then presents the VC for verification, typically by sharing the signed JSON-LD document. The verifier's system will validate the proof, check the issuer's DID document for status (ensuring it hasn't been revoked), and confirm the credential schema matches expectations. This entire flow enables selective disclosure, where a user could, with advanced VC types, prove they are over 21 without revealing their exact birth date.

In a traditional system, credential revocation is centralized: an authority maintains a list of invalidated IDs. For a decentralized identity (DID) system, this model fails. Instead, revocation status must be verifiable without relying on a single point of control or failure. The standard approach uses revocation registries, which are cryptographic data structures, like a Merkle tree, published to a verifiable data registry such as a blockchain. The credential itself contains a revocation registry identifier and a revocation index, allowing any verifier to check the current status.

The most common implementation follows the W3C Revocation List 2020 specification. Here, the issuer creates a bitstring (a long string of bits) where each bit corresponds to a credential's revocation status (0 for active, 1 for revoked). The hash of this bitstring is anchored to a blockchain, providing tamper-proof evidence. When a user presents a verifiable credential, the verifier fetches the latest revocation list from a known endpoint and checks the bit at the credential's specific index. This method is private, as the list reveals no information about other credentials.

For a KYC system, you must decide on the registry's update frequency and governance. Will revocations be batched daily or happen in real-time? Who has the authorization to sign revocation updates—is it a multi-signature wallet controlled by compliance officers? Smart contracts on chains like Ethereum or Polygon can enforce these rules. For example, a RevocationRegistry contract could have an updateRevocationList(bytes32 newRoot) function that only executes when signed by 3 of 5 designated issuer keys.

Here is a simplified code snippet illustrating the verification logic a relying party (e.g., a DeFi platform) would run using the @spruceid/didkit library:

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const credential = { ... }; // The presented Verifiable Credential
const revocationListUrl = credential.credentialStatus.statusListCredential;
// Fetch the revocation list credential
const statusListCredential = await fetch(revocationListUrl).then(r => r.json());
// Check the bit at the credential's index
const isRevoked = await didkit.checkRevocationStatus(credential, statusListCredential);
if (isRevoked) {
  throw new Error('KYC credential has been revoked.');
}

Beyond technical implementation, consider the legal and user experience implications. A user must be notified if their KYC credential is revoked and understand the reason, which may be required by regulations like GDPR. The system should support selective disclosure for revocation proofs, allowing a user to prove non-revocation without revealing their entire credential. Furthermore, plan for the credential's lifecycle end—expiration is different from revocation and should be handled via the expirationDate field in the credential itself.

Finally, evaluate trade-offs. On-chain registries offer maximum transparency and auditability but incur gas fees. Off-chain registries with periodic blockchain anchoring are cheaper but introduce a slight trust assumption in the issuer to publish the list. For high-stakes KYC, a hybrid model using an optimistic rollup or a zk-proof of non-revocation may be optimal, balancing cost, speed, and security. The chosen mechanism must align with your compliance framework's requirements for audit trails and immediacy of revocation.

The core of a functional DID-based KYC system is the permission mapping layer. This is the logic, typically encoded in a smart contract or a verifiable credential's credentialSubject, that interprets the claims within a verified credential and grants corresponding on-chain rights. For example, a credential proving a user is over 18 and a resident of Country X might map to permission to interact with a regulated DeFi pool. This mapping must be deterministic and publicly auditable to ensure fairness and compliance.

Implementing the Mapping Logic

You can implement this mapping in several ways. A common pattern uses a registry contract that stores permission flags linked to a user's did:ethr or other decentralized identifier. An off-chain verifier (like a KYC provider) signs a message granting a specific role, and the user submits this signature to the registry. The contract verifies the signer's authority and updates the user's on-chain status. Alternatively, you can use Soulbound Tokens (SBTs) or verifiable credentials with specific types (e.g., KYCAMLAttestation) that gatekeeping contracts check directly using a library like Veramo.

The mapping must handle granularity and revocation. Permissions should be specific (e.g., canTradeSecurities, depositLimitUSD > 10000) rather than binary. Smart contracts must also check the credential's validity period and revocation status, often by querying a revocation registry or checking the issuer's on-chain status. This ensures that lapsed credentials or those revoked by the issuer immediately invalidate the associated on-chain permissions, maintaining the system's integrity.

Here is a simplified Solidity example for a registry-based approach:

solidityCopy
contract KYCRegistry {
    mapping(address => mapping(bytes32 => bool)) public permissions;
    address public trustedIssuer;

    function grantPermission(
        address user,
        bytes32 permissionKey,
        bytes memory signature
    ) external {
        bytes32 messageHash = keccak256(abi.encodePacked(user, permissionKey));
        require(
            messageHash.recover(signature) == trustedIssuer,
            "Invalid issuer signature"
        );
        permissions[user][permissionKey] = true;
    }

    // A gated contract checks this modifier
    modifier onlyKYCd(bytes32 requiredPermission) {
        require(permissions[msg.sender][requiredPermission], "KYC required");
        _;
    }
}

This contract allows a trustedIssuer to grant specific permissionKey flags to users via signed messages.

Finally, consider privacy-preserving techniques like zero-knowledge proofs (ZKPs). Instead of revealing all credential data on-chain, a user can generate a ZK proof that they hold a valid credential satisfying the mapping rules (e.g., age >= 18). Protocols like Semaphore or zkSNARK-based credential libraries allow contracts to verify these proofs without exposing the underlying data, aligning with data minimization principles essential for compliant KYC systems.

You have now implemented a foundational DID-based KYC flow. The system uses W3C Verifiable Credentials to create portable, user-controlled credentials, and Selective Disclosure protocols like BBS+ signatures to minimize data exposure. By anchoring DIDs on a blockchain like Ethereum (via did:ethr) or Polygon ID, you ensure decentralized resolution and verification without relying on a central database. The next step is to enhance this system for production, which involves rigorous security auditing, implementing credential revocation, and designing a seamless user recovery process.

For production deployment, several critical areas require attention. First, conduct a formal security audit of your smart contracts and backend services, focusing on signature validation and key management. Implement a revocation registry, such as the one defined in the W3C Status List 2021 specification, to allow issuers to invalidate credentials if needed. You must also design a robust key recovery mechanism for users, potentially using social recovery or hardware security modules (HSMs) for institutional backup keys, to prevent permanent identity loss.

To extend the system's capabilities, consider integrating with existing frameworks. The Decentralized Identity Foundation (DIF) provides specifications for interoperability. You can use libraries like Veramo or Sphereon's SSI-SDK to add support for multiple DID methods and credential formats. Explore zero-knowledge proof circuits (e.g., with Circom) to enable advanced verification scenarios, such as proving one is over 18 from a credential without revealing their birth date. The European eIDAS 2.0 regulation and projects like walt.id offer valuable blueprints for compliant architecture.

The final step is planning for real-world adoption. Develop clear user onboarding flows that explain key custody. Engage with legal experts to ensure your credential design satisfies AML/KYC regulations in your target jurisdictions, potentially mapping claims to the OWL ontology for legal clarity. Monitor the evolving standards from W3C and DIF. Start with a pilot program, gather feedback on usability, and iterate. By building on open standards, you create a system that is not only compliant and secure but also interoperable with the growing ecosystem of decentralized identity.