Why DeFi Isn’t As Anonymous As You Think, But Definitely Becoming More Private As Web3 Evolves
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The words “decentralized finance” or “DeFi” are among the most talked-about topics these days, especially if you’re an active member of the blockchain and crypto communities.
DeFi (short for decentralized finance) is an umbrella term that covers a diverse range of “decentralized” financial products and services. Powered by blockchain and distributed ledger technology (DLT), DeFi cuts out the intermediaries and service providers prevailing across traditional financial services models.
Despite the hype, a lack of privacy has emerged as one of the biggest challenges for the evolving DeFi sector. By design, blockchain records all transactions on distributed ledgers. These records are immutable and can be accessed by anyone. While most of the user’s details remain private, it is still possible to identify transactions and trace them back to users, implying that DeFi isn’t quite as anonymous as previously thought.
Currently, DeFi trading strategies are single-use. Once someone executes a profitable trade, it is recorded on the ledger for the world to see. As the DeFi market expands, so do wallet monitoring capabilities and the number of analytics platforms, leading to a perpetual cycle of investors and traders stalking on-chain transactions. This, in turn, has impacted deep-pocketed players, like the whales and institutional investors, who now have to go to extreme lengths (like splitting their assets across multiple accounts) to keep their strategies private.
For DeFi to reach mass adoption levels, privacy is critical. At the same time, it is also important to realize that privacy and anonymity are two different things. Privacy is good, anonymity not so much. Blockchain technology must achieve the right balance between privacy and anonymity in a manner whereby users exert more control over their data while still ensuring they are answerable (and traceable) when it comes to country-specific anti-money laundering (AML) and know your customer (KYC) regulation.
But is that even achievable? In short, yes. A new wave of privacy-focused solutions for DeFi and Web3 is already designing and delivering end-to-end privacy on-chain.
Privacy Layer For On-Chain Transactions
Built on Polkadot, Manta Network is a privacy-focused solution for the DeFi and Web3 ecosystems. The platform uses cryptographic technologies like zkSNARKs and Groth16 to add the much-required privacy layer for various on-chain activities.
Founded in 2020, Manta Network is a layer-1 scaling solution. Unlike layer-2 solutions, Manta’s privacy-preserving feature is part of the network’s core architecture and not sitting on top of some other blockchain. The platform has already rolled out multiple protocols for privacy-preservation in the DeFi space, including MantaSwap -the AMM (automated market maker) DAX (decentralized anonymous exchange), and MantaPay – the DAP (decentralized anonymous payment) protocol with built-in privacy. In addition, the Manta team is also developing a private lending feature and a synthetic asset protocol, both of which will be released later this year.
Manta is the only privacy-preserving DeFi product that uses cryptography to provide security and integration with mainstream assets, such as stable coins. Compared to existing privacy solutions like Monero or ZCash, Manta offers seamless cross-chain interoperability by leveraging Polkadot’s features.
Balancing Security, Privacy, And Compliance For Investors
While platforms like Manta are focused on preserving end-to-end privacy and anonymity, the growing need for regulatory compliance is another core area that the DeFi ecosystem needs to tackle. Institutional investors are held back from entering the world of DeFi, primarily due to regulatory concerns.
However, crypto projects may have found the solution for this lingering problem as well. For instance, Alkemi Network, the platform that has successfully bridged CeFi (centralized finance) with DeFi, aims to solve some of the most pressing problems of the nascent DeFi sector:
Alkemi Network is the first decentralized liquidity network supporting KYC-permissioned and permissionless liquidity pools. Founded in 2018, Alkemi’s institutional-grade liquidity solution is aimed at institutional investors, offering direct access to “verified” DeFi while enabling clients to generate yields for a range of ERC-20 assets.
Alkemi is removing the barriers for CeFi institutions to enter the world of DeFi using blockchain technology. With the platform’s KYC-permissioned digital asset pool titled Alkemi Earn, institutions gain compliant access to a trusted-counterparty environment. The Alkemi Network also supports advanced risk management features, institutional-grade reporting, and multi-signature wallet functionalities, each of which are designed to simplify institutional onboarding.
Another similar project, Centre, an open-source solution developed by Circle and Coinbase, recently launched a set of shared decentralized identity protocols called “Verite.” The Verite project is intended to give crypto users and institutions total control over their personal information.
With the transition to Web3 happening quicker than ever, decentralized identifiers (DIDs) will play a key role in preserving on-chain privacy. To that extent, Verite protocols will enable people and organizations to keep complete track of their personal data and even control how service providers see and use this data.
The idea of shared, decentralized identity management has received backing from some of the most prominent players in the blockchain ecosystem, including FTX, Alkemi Network, Solana Foundation, Coinbase, Ledger, Hedera Hashgraph, Algorand, Compound Finance, Stellar, ConsenSys, and several others.
The Power To Control (And Monetize) Your Personal Data
In today’s digital economy, data is power. Data fuel almost everything, be it marketing initiatives, product research, or targeted hacking attacks. The concept of Web3 is highly focused on decentralization and restoring data control to the user community by removing centralized authorities and intermediaries.
According to recent research, the consumer data market in the existing internet infrastructure (Web2) is more than USD 839 million. Unfortunately, end-users never receive a penny from it, while big tech companies always take their cut.
Profila, a cardano based project, has developed a solution that restores consumers’ power over their own valuable data to overcome this reality. Connecting privacy law, big data, and advertising, Profila allows users to sell their personal information to companies. On top of it, users can dictate the terms of the contract to ensure that the data collected is exactly what the user wants and for however long they wish.
Essentially, Profila ensures that users get paid for their valuable data while retaining full control over it. At the same time, it also ensures that businesses receive genuine and accurate data. This win-win model has played a critical role in helping Profila position itself as a leading platform for modern data exchanges.
Achieving The Right Balance
There are always tradeoffs when it comes to decentralizing formerly centralized activities, and anonymity has often been a casualty of blockchain’s current reality, especially in the DeFi arena. However, as the above projects demonstrate, there are novel approaches that can restore a semblance of privacy to DeFi, and, by extension, put users back in the driver’s seat when it comes to controlling their data along with its visibility and use.
