When Web3 and Blockchain Meet Digital Identity and Banking

KEY TAKEAWAYS

Reporting from the Fintech Connect conference in London, Nicole Willing looks at how Digital Identity is the missing jigsaw piece for Web3 and future, trusted finance.

The next generation of the internet, Web3, promises decentralization, transparency, and enhanced security based on blockchain networks and digital tokens. This will allow users to take more control over their data and how it is used.

As the world becomes more interconnected and every system is digitalized, new possibilities open up for users to have a secure and reliable digital identity (ID).

Speakers and panelists at the recent Fintech Connect conference in London explored the role that Web3 can play in shaping the future of digital ID and its implications for money and banking.

Replacing Outdated Paper Systems

“The system we have now is Victorian — it’s based on paper systems,” said David Palmer, Blockchain Lead at UK mobile network provider Vodafone.

“The idea of a paper passport or a paper document means absolutely nothing because all the back-end systems are digital. So why can’t I have digital credentials which are verified on digital systems?”

Jacob Mendel, Head of Cryptography and Cybersecurity at State Street, agreed, noting that registering for a school, utility, mobile phone service, and so on requires several forms of paperwork to verify identity rather than a single document.

“When we are talking about digital identity and the future of Web3…we are trying to solve the most fundamental problem of username and password. We moved to multi-factor authentication, and then we stopped,” Mendel said.

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“Regardless of any multi-factor communication we are using — face recognition on a mobile device, software that generates tokens to log in to identify ourselves —this is the limit today. We want to move forward to the next generation of identity.”

Traditional identification methods tend to rely on centralized authorities and are not transferable across systems. They can also expose users to the risk of data breaches and identity theft.

READ MORE: The 10 Biggest Data Breaches Of All Time

Web3, built on decentralized systems operating on blockchains, distributes identity verification across a network of nodes. This changes the way individuals manage their identity digitally and reduces the risk of a single point of failure, enhancing trust as users have greater control over their personal information.

The concept of self-sovereign digital identity in a Web3 ecosystem involves each individual having issued credentials, which are assigned by validated trusted issuers.

Once issued, the individual owns their credentials and can give service providers and others permission to verify them. For instance, with open banking allowing financial institutions to share customer data via application programming interfaces, consumers can share their digital ID across institutions, streamlining the process of dealing with multiple accounts and services.

Web3 promotes interoperability, allowing different platforms and applications to communicate seamlessly.

One Identity Wherever You Are

A Web3-based digital ID would ensure users can carry their identity across different applications, streamlining the user experience. The World Wide Web Consortium (W3C), the international standards organization for the web, has created standards for decentralized identifiers (DIDs) and verified credentials that enable users to hold a verifiable, decentralized digital identity.

And the applications for zero-knowledge (zk) proofs on blockchain networks include the ability to confirm specific attributes of a user’s identity without revealing any other personal data.

READ MORE: What Institutions Need From Cryptocurrencies

“This system, technically and on merit, is great because it scales; the identity credentials, payment credentials, etc., are owned by the individual, and you don’t need to present it multiple times — you can have it issued once and verified many times. So, from a scale potential, we’re increasingly moving into this digital class, and it makes a lot of sense regarding adoption,” Palmer said.

“Decentralized digital identity is a killer application for blockchain. Blockchain proves the trust; it provides the link with cryptography to make it happen, but we haven’t seen any traction,” Palmer added.

“I think the reason we haven’t seen any traction is because you need big organizations or governments to move into it. In terms of how we move forward, I do believe that there is a middle ground, and maybe the middle ground is things like phone numbers and other credentials which could be used to sort of get some traction.”

“We’re moving towards an increasingly digital world now. This generation will go down in history as one of the generations facing the world’s biggest technological advancements and change. You’ve got artificial intelligence (AI), Web3, metaverse, all of these things are happening at the same time, and as a result, the digital footprint is increasing dramatically,” Palmer said.

“So where you start to have a presence on multiple platforms, you must somehow manage that. You can’t have paper credentials everywhere you go. We need KYC and AML, but the more digitally oriented and more real-time methods, the better for interoperability.”

The Role of Digital Wallets

Central to the widespread adoption of digital identity is the use of digital wallets, which will primarily be accessed via mobile phones or, alternatively, web-based interfaces. Forecasts indicate that there will be 8 billion mobile phones in use and 5.6 billion digital wallets globally by 2030, Palmer said.

The combination of multi-factor communication and a secured digital wallet on a mobile phone will become a powerful tool that will facilitate the use of a digital ID to adopt new technologies, including central bank digital currencies, Mendel said.

Digital wallets today store the user’s private key and provide a public key to which they can send funds. Smartphones that support the capability can store the private key, or users can store it with an exchange or other custodian. This technology may evolve in the future in the same way that phones have developed over time, from the basic cell phones of the late 1990s to the advanced smartphones we have today.

There are currently around 4 billion digital wallets issued by companies like Apple, Google, and Samsung, which store users’ payment card details to complete transactions and negate the need to carry physical cards for contactless or online payments. These could be expanded to become identity wallets that contain a richer set of credentials.

Verifying the users of digital wallets will be key to the rollout of central bank digital currencies (CBDCs), which governments and central banks worldwide are exploring.

“In order to adopt CBDCs, one of the missing links is digital identity,” said John Ho, Head of Legal, Financial Markets at Standard Chartered. “We need to ensure that the identity is enabled online and verified in real-time by trusted, verifiable sources that will enable money to be moved at scale.”

The European Union last month finalized legislation for an EU Digital Identity Wallet as a step towards its Digital Decade 2030 targets on the digitalization of public services. Singapore is moving towards introducing an e-wallet that will incorporate the user’s verifiable identity.

One of the motivations for governments in pursuing retail CBDCs is the potential to increase financial inclusion.

1.4 Billion Unbanked Citizens

More than 1.4 billion adults worldwide do not have access to traditional banking services, which limits their ability to access savings and loans. CBDCs can provide unbanked populations with a stable way to access digital financial services.

“If you get a mobile phone and you can attach an identity to it, and then you can attach money of some sort to it, you’re doing a lot to help prosperity,” said David Cunningham, Head of Strategy and Partnerships for Digital Assets, Treasury and Trade Solutions at Citibank.

One of the limitations of Web3 wallets when it comes to the potential for widespread adoption is the importance of securing the cryptographic keys and the inability to recover a key once the seed phrase for the wallet is lost.

READ MORE: How To Set Up a MetaMask Wallet in 10 Minutes

However, there are developments such as WalletConnect, which allows users to link to different wallets, and account abstraction technology, which allows users to have externally-owned wallets.

“Account abstraction is a really big deal in the Web3 community,” Palmer said.

“There’s been a lot of work by financial institutions like Visa to extract abstract away gas fees, for example, which makes interacting with blockchains easier, because you don’t have the issue of sanctions, where you’re paying a gas fee, and you don’t know who’s benefitting from it.

“If Visa can abstract it away, these major corporations can start to use it. That puts it in the mainstream, it starts to set up this technological foundation for the convergence of digital wallets and crypto wallets.”

Estimates indicate that the number of cryptocurrency accounts could reach 320 million by 2030, and the number of metaverse users could reach 700 million, pointing to much lower adoption rates than mobile phones and digital wallets.

“It’s clear that for Web3 and metaverse to have adoption, they need to work with digital wallets and they need to work with the mobile phone,” Palmer said.

The Importance of Cybersecurity When Identities are Digitalized

While there are advantages to decentralized digital IDs when it comes to security, there is still the risk of an individual’s identity becoming compromised.

“You don’t want to put one point of failure in the system,” Mendel said. And when you’re talking about Web3 in digital identity, the fundamental part of all of this starts with the cybersecurity issue. If we do not solve the cybersecurity and the role of trust, we cannot rely on the system.”

Web3 empowers users to store and secure their digital keys for themselves, but they are liable for what happens to the key. If their mobile phone is lost or stolen, or their computer hard drive fails, they need to have a robust backup in place.

Artificial intelligence is helping financial institutions to detect fraudulent activity with a customer’s digital identity. Still, it is also assisting hackers to become more sophisticated in their attacks, noted Klaus Xhaxhiu, Money Laundering Reporting Officer (MLRO) at Germany-based Aion Bank.

The challenge is monitoring all kinds of identities from third-party banking partners in real-time, as consumers increasingly expect to open and use a new account within minutes. This would not be possible without new technologies such as AI, Xhaxhiu said.

Issues such as scalability and regulatory compliance will need to be addressed for the widespread implementation of digital IDs.

Consumer education will also be important, particularly at a time when social media users post details of their lives on social media platforms that could result in their accounts becoming compromised by malicious attackers. Striking a balance between decentralization and regulatory compliance will require collaboration between technology policymakers, technology developers, and service providers.

The Bottom Line

Web3 will allow individuals to use a digital identity system based on decentralization, security, and user control, in line with the evolving needs of our increasingly digitalized world.

Digital mobile wallets could provide the “killer app” that drives the widespread adoption of blockchain technology, as Layer 1 protocols and zk proofs offer the security and scalability needed to support verifiable identity credentials. This would enable the next stage of technological adoption of financial services, crypto, metaverse, and other new applications.

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Nicole Willing

Nicole Willing has two decades of experience in writing and editing content on technology and finance. She has developed expertise in covering commodity, equity, and cryptocurrency markets, as well as the latest trends across the technology sector, from semiconductors to electric vehicles. Her background in reporting on developments in telecom networking equipment and services and industrial metals production gives her a unique perspective on the convergence of Internet-of-Things technologies and manufacturing.