SEC commissioner advocates zero-knowledge proofs instead of KYC

SEC Commissioner Hester Peirce calls for a fundamental overhaul of the current system for customer identification and anti-money laundering controls. According to Peirce, financial institutions are accumulating ever more personal data without effectively stopping criminals. She advocates cryptographic alternatives such as zero-knowledge proofs, with which compliance with rules can be demonstrated without sensitive personal data being stored or repeatedly shared.

In brief:

• Peirce criticises the KYC/AML system as expensive, ineffective and a threat to the privacy of ordinary citizens.
• She advocates zero-knowledge proofs and attribute-based verification as modern alternatives.
• In addition, she defends the SEC’s new Innovation Exemption, which temporarily gives tokenized securities access to automated trading platforms.

KYC and AML: a mountain of data with little result

In a speech for the SIFMA Digital Assets Conference, published on the SEC’s website, Peirce describes the current KYC and AML system as a framework that relies on accumulating ever-larger piles of data. Financial institutions are required to collect customers’ names, dates of birth, addresses and identification numbers and to continuously monitor transactions. In the case of suspicious or threshold-exceeding activities, they must submit reports to regulators.

Peirce argues that the costs of this system far outweigh the benefits. Moreover, innocent citizens and businesses invisibly bear the burden: their data are tracked, stored and at risk of data leaks or misuse, without their knowledge. She thus describes the financial sector as a kind of panopticon, a system of permanent surveillance.

“The approach does not work particularly well, and technology has overtaken our outdated method,” Peirce says. She points to the transparency of public blockchains as an argument that more data collection is not the only route to effective supervision.

Zero-knowledge proofs as a privacy-friendly alternative

Peirce advocates a different approach: zero-knowledge proofs and attribute-based verification. With these cryptographic techniques, a user can prove that they meet certain requirements, such as holding a valid identity document or not appearing on a sanctions list, without the underlying personal data being shared or stored. Compliance with rules is thus demonstrated without creating a large central data collection.

She acknowledges that her statements are her own opinion and not the position of the SEC as a whole. Nevertheless, her speech makes clear that within the regulatory landscape there is growing doubt about the sustainability of the current model.

Innovation Exemption offers temporary room for tokenized securities

In addition to her criticism of KYC and AML, Peirce also explains the recently announced Innovation Exemption. This temporary exemption, limited in scope, offers tokenized securities the possibility of being traded via automated market-maker platforms on crypto networks. The aim is to prevent foreign markets from being the first to offer tokenized access to US stocks, while no domestic alternative yet exists.

The exemption acts as a bridge to permanent regulation. Peirce indicates that she hopes the SEC will start the regulatory process as soon as possible, so that the temporary measure does not remain in force any longer than necessary. The broader interest in digital assets from major financial players makes clear that pressure on regulators to provide clarity is only increasing.