Author: Zhu Weisha
After the introduction of the Hong Kong "Stablecoin Regulation," I have conducted relevant analyses in five articles, including "Conceptual Confusion and Clarification Triggered by Hong Kong's Stablecoin Regulation" (see Chainless website). This article continues the idea of "clarification," focusing on the core challenge of stablecoin regulation: balancing compliance requirements with technical characteristics.
Some viewpoints (such as Huang Lichong's "Hong Kong is only 'Web2.5' and not Web3") argue that the Hong Kong Monetary Authority (HKMA) has overly stringent requirements for KYC (Know Your Customer) and AML (Anti-Money Laundering), such as requiring "real-name penetration + data retention + T+1 redemption." We will discuss the necessity of these requirements later. It must be clearly recognized that when stablecoins are anchored to real assets and integrated into the traditional financial system, regulatory upgrades are an inevitable and necessary choice. This article will argue the irreplaceability of KYC/AML from three aspects: credit foundation, the dilemma of non-bank institutions, and the advantages of on-chain technology, and explore a regulatory optimization path based on transparency—namely, fully leveraging the role of KYT (Know Your Transaction).
1. Clarifying Misconceptions: Privacy Rights, Anonymity, and Regulatory Necessity
Privacy is not secrecy, and anonymity is not the goal
Eric Hughes pointed out in the 1993 "Cypherpunk Manifesto": "Privacy is necessary for an open society in the electronic age. Privacy is not secrecy. Privacy is the power to selectively reveal oneself to the world. Secrecy is the power to keep things hidden from everyone." Anonymity is a means to protect privacy, not the ultimate goal.
Satoshi Nakamoto's design (using public key addresses instead of real identities for public transactions) aims to avoid directly exposing the identities of traders to the public ledger, aligning with Eric Hughes's philosophy. The core of this philosophy is that privacy is a personal right, and individuals should have the right to choose under what conditions and to whom they disclose information. Users can choose whether to exchange necessary information (such as meeting KYC requirements) for services, while service providers have the obligation to protect user privacy and prevent information leakage to third parties.
The practical reasonableness of "real-name penetration"
It is crucial to handle the relationship between real-name authentication and public transparency well. The requirement for "real-name penetration" (i.e., tracing to the ultimate beneficiary) is not unacceptable within the financial regulatory framework; it is a basic rule that has long operated in the real world (Web2). Numerous successful Web2 projects have proven that reasonable real-name registration has not led to user loss; the key lies in the regulation and protection of information use.
Limitations and paradoxes of existing privacy protection
Current privacy protection mechanisms in cryptocurrencies have structural flaws: during an on-chain transfer, both parties can see each other's entire asset balance. If the trading counterpart is an acquaintance, personal financial status is fully exposed. The risk of exposing financial information to acquaintances is far greater than disclosing it to banks bound by strict confidentiality clauses. Banks have internal regulations prohibiting the disclosure of customer asset information, while acquaintances do not have such constraints. If the Web3 ecosystem hopes to achieve large-scale applications ("growing Web3") but refuses to relinquish some privacy rights when necessary, it will fall into an irreconcilable practical paradox.
2. KYC and AML: The Cornerstone of Modern Financial Order
Definitions and Core Values
KYC (Know Your Customer): The core process for financial institutions to verify customer identities and assess risk status, serving as the starting point for establishing trustworthy business relationships and preventing identity fraud.
AML (Anti-Money Laundering): A defensive system to block the use of illegal funds for "cleaning" through the financial system, crucial for maintaining the safety, integrity, and judicial justice of the financial system.
KYC: The Anchor for Building Financial Trust
The credit of Bitcoin stems from the transaction traceability brought about by its "public ledger." Similarly, the foundation of any financial activity is trust. In the traditional financial system:
Identity verification is the trustworthy starting point: Customers must provide government-issued identification (passport, ID card, etc.) when opening an account and undergo "face-to-face" verification and strict checks (address proof verification, form filling) to ensure the authenticity of the documents and the match with the holder. This forms the most basic trust anchor.
Credit transmission relies on verified identities: Banks collect information and assess risks based on this trustworthy identity, becoming trusted nodes in the financial network. Subsequent credit assessments and transaction monitoring are built upon this. Meeting KYC standards is a prerequisite for effectively implementing AML.
In the era of online banking, technologies like facial recognition partially replace face-to-face verification, but challenges remain in the integrity and security of credit transmission (such as the risk of fraud), often requiring supplementary measures like bank account binding (utilizing the high-intensity KYC already completed by banks). This further confirms the core position of a robust KYC mechanism.
3. The KYC/AML Compliance Dilemma of Non-Bank Institutions
The Hong Kong "Stablecoin Regulation" allows qualified non-bank institutions to issue stablecoins, but they face significant structural challenges in meeting KYC/AML requirements equivalent to those of traditional banks:
Lack of infrastructure and experience: Banks have mature customer authentication systems, risk assessment models, professional compliance teams, and mechanisms for regulatory engagement. Non-bank institutions (especially startup tech companies) face high costs and long timelines to establish equally effective systems.
Limited access to identity verification: Although strong identity verification infrastructure has been established in places like China (e.g., Ministry of Public Security interfaces), access is usually limited to authorized institutions (mainly banks) and is not fully open to the public or all types of enterprises. Non-bank institutions find it difficult to obtain high-assurance identity verification services conveniently and at low cost. Decentralized identity (DID) technology has great potential, but its current development is uneven and costly, and large-scale application will take time.
The defensive logic of "penetration, retention, T+1": These requirements are core defenses against the unique risks of stablecoins:
Real-name penetration: Ensures transparency of the ultimate beneficiary, preventing anonymous transfers of large illegal funds.
Data retention: Meets the needs for post-event audits and judicial investigations.
T+1 redemption: Provides risk buffers and verification time to address potential run risks.
These measures aim to ensure the robust operation of the system, not to impose arbitrary restrictions. Therefore, under the current identity authentication system and technological conditions, requiring non-bank institutions to independently bear KYC/AML obligations as stringent as those of banks is extremely challenging. Related complaints reflect the real operational dilemmas.
There is a reason why the U.S. only allows banks to issue stablecoins.
Historical experience shows that the early radical "crypto-anarchist" creed has been corrected in practice. However, the balance between privacy and regulation remains. We need a trustworthy (whether centralized or decentralized) and transparent public service platform. Users need to relinquish some privacy rights to this platform, just as they relinquish some rights to the government in exchange for order and security.
4. KYT: Regulatory Innovation Driven by On-Chain Transparency
On-Chain Transparency: From Challenge to Advantage
Traditional fiat currency transactions: opaque → rely on post-event audits.
Cryptocurrency transactions: publicly traceable on-chain → support real-time risk monitoring.
KYT (Know Your Transaction) leverages the inherent transparency of blockchain data to analyze public ledgers and track the flow of funds in real-time.
Core functions: Utilize big data analysis and artificial intelligence to monitor on-chain transaction activities in real-time, identify abnormal patterns (such as interactions with high-risk addresses, use of mixers, unusually rapid large transfers), and assess transaction risks.
Regulatory Value:
Meet compliance requirements: Assist exchanges, wallet service providers, etc., in meeting AML regulations, efficiently identifying and reporting suspicious activities, and reducing legal risks.
Enhance regulatory effectiveness: Provide regulatory agencies with a more comprehensive, real-time market overview, empowering precise regulation and proactive policy formulation.
Strengthen risk management: Help institutions analyze and assess counterparty credit risks based on historical transaction data, effectively preventing money laundering and illegal transactions.
Business Value:
Automated monitoring significantly improves operational efficiency.
Demonstrates compliance commitment, enhancing customer trust.
Optimizes products and services based on data analysis.
The Unique Value of KYT: Bridging the Gap for Non-Bank Institutions
The core advantage of KYT lies in its full utilization of the transparent nature of on-chain data, which can significantly bridge the relative disadvantage of non-bank institutions in the initial stage of customer identity due diligence (KYC), making subsequent transaction monitoring and risk analysis more efficient. In certain scenarios, tracking transparent on-chain transactions can even be more feasible than tracking opaque traditional fiat currency transactions.
5. Conclusion and Recommendations: Embrace Transparency, Optimize Regulatory Details
Reaffirm the cornerstone: KYC/AML is irreplaceable. KYC and AML are the cornerstones of maintaining the integrity, stability, and security of the financial system. In the uniquely risky field of stablecoins, their importance should not be diminished but rather emphasized.
Acknowledge differences and explore pragmatic paths: It is essential to recognize the structural difficulties non-bank institutions face in implementing high-intensity KYC/AML. The design of regulatory details should:
Explore diversified identity verification solutions: Research how to safely and compliantly broaden non-bank institutions' access to authoritative identity verification services or recognize new high-assurance verification technologies (such as mature and reliable DID solutions).
Implement risk-based differentiated regulation: Set practical and tiered compliance standards based on institution type, business scale, and risk level.
- Leverage the native advantages of crypto: KYT should be a core tool: The core innovation of Hong Kong's stablecoin regulatory details should be to fully understand and utilize the transparency characteristics of blockchain transactions, avoiding the simple application of regulatory models designed for opaque fiat systems:
Clarify the core position of KYT: The details should clearly encourage and require issuing institutions to adopt robust KYT systems for real-time transaction monitoring and risk management, explicitly including it as a core requirement for meeting AML compliance.
- Build a "transparency-based" regulatory framework: The design of regulatory requirements (such as suspicious transaction reporting standards, audit scope) should fully consider the availability and analytical potential of on-chain data. The "principled" orientation of relevant U.S. legislation (though it may seem "broad") leaves room for innovation, while also formulating more refined and forward-looking rules in Hong Kong regarding the utilization of transparency advantages.
In summary:
The strict requirements of KYC and AML are the cornerstone of financial stability and cannot be compromised. Supporting controllable anonymity (i.e., allowing for moderate anonymity at the transaction level after meeting regulatory baselines like KYC) in Web3 applications is the only way to closely integrate with the Web2 ecosystem and achieve true large-scale adoption.
The core challenge faced by the HKMA in stablecoin regulation lies in designing a practical and feasible path for non-bank institutions that can uphold compliance baselines (KYC/AML) while fully leveraging the transparency characteristics of crypto assets through KYT as a compliance requirement. Future regulatory details should aim to build an "innovation framework based on transparency" that effectively controls risks while strongly promoting the prosperity and healthy development of Hong Kong's Web3 ecosystem.
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