Following the enactment of Hong Kong’s “Stablecoin Ordinance,” I have analyzed related issues in five articles, including “Conceptual Confusion Caused by Hong Kong’s Stablecoin Regulations and Clarification Thereof”see Chainless.hk for details. This article continues the “clarification” approach, focusing on the core challenge of stablecoin regulation: balancing compliance requirements with technological characteristics.
Some perspectives (such as those expressed by Wong Lip Chong of Infini Capital in”Hong Kong is ‘Web2.5’ not Web3” argue that the requirements imposed by the Hong Kong Monetary Authority (HKMA) regarding KYC (Know Your Customer) and AML (Anti-Money Laundering) are overly stringent. Specific criticisms target requirements like “real-name penetration + data retention + T+1 redemption”. We will later discuss the necessity of these specifically.
It must be clearly understood: when stablecoins are pegged to real-world assets and integrated into the traditional financial system, enhanced regulation is an inevitable and necessary choice. This article will argue for the indispensability of KYC/AML from three perspectives—the foundation of credit, the dilemmas faced by non-bank institutions, and the technological advantages of on-chain systems—and explore an optimized regulatory path based on transparency, namely, fully leveraging the role of KYT (Know Your Transaction).
I. Clarifying Misconceptions: Privacy Rights, Anonymity, and Regulatory Necessity
Privacy is Not Secrecy, Anonymity is Not the Goal
Eric Hughes succinctly articulated in the 1993 “Cypherpunk Manifesto”: “Privacy is necessary for an open society in the electronic age. Privacy is not secrecy. A private matter is something one doesn’t want the whole world to know, but a secret matter is something one doesn’t want anybody to know. Privacy is the power to selectively reveal oneself to the world.” 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) aimed to avoid directly exposing trader identities on the public ledger, aligning with Eric Hughes’ philosophy. The core of this philosophy is: Privacy is an individual right; individuals should have the power to choose under what conditions and to whom they disclose information. Users can choose whether to disclose necessary information (such as meeting KYC requirements) in exchange for services, while service providers bear the obligation to protect user privacy and prevent information leaks to third parties.
The Practical Rationale of “Real-Name Penetration”
Managing the relationship between real-name verification and public transparency is crucial. The “real-name penetration” requirement (i.e., tracing to the ultimate beneficiary) is not unacceptable within the financial regulatory framework; it is a fundamental rule long established in the real world (Web2). Numerous successful Web2 projects demonstrate that reasonable real-name registration does not lead to user attrition; the key lies in the standardized use and protection of information.
The Limitations and Paradox of Current Privacy Protection
Current cryptocurrency privacy protection mechanisms suffer from structural flaws: a single on-chain transfer allows both transacting parties to see each other’s entire account balance. If the counterparty is an acquaintance, one’s personal financial situation is completely 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 strictly prohibiting the leakage of customer asset information, while acquaintances have no such constraints. If the Web3 ecosystem aspires to achieve mass adoption (“scaling Web3”) yet refuses to cede some privacy rights when necessary, it falls into an irreconcilable practical paradox.
II. KYC and AML: The Cornerstones of Modern Financial Order
Definitions and Core Value
KYC (Know Your Customer): The core process through which financial institutions verify customer identity and assess risk profiles. It is the starting point for establishing trustworthy business relationships and preventing identity fraud.
AML (Anti-Money Laundering): A defensive system that blocks the “laundering” of illicit funds through the financial system. It is crucial for maintaining the security, integrity of the financial system, and judicial justice.
KYC: Anchoring Financial Trust
Bitcoin’s credit stems from the “public ledger,” which ensures transaction traceability. This is the cornerstone of Bitcoin’s trust.
Similarly, the foundation of any financial activity is trust. In the traditional financial system:
1. Verified Identity is the Trusted Starting Point: Customers opening accounts must provide government-issued identity documents (e.g., passport, ID card), undergo “in-person verification” and strict validation processes (e.g., address proof verification, form completion) to ensure document authenticity and holder matching. This constitutes the most fundamental trust anchor.
2. Credit Transmission Relies on Verified Identity: Banks and other institutions use this verified identity as a foundation to collect customer information, conduct risk assessments, and become trusted nodes within the financial network. All subsequent credit evaluations and transaction monitoring are built upon this verified identity information. Meeting KYC standards is a prerequisite for effective AML execution.
In the era of online banking, technologies like facial recognition partially replace in-person verification, but challenges remain regarding the integrity and security of credit transmission (e.g., risks of forgery). They often require supplementary measures like bank account linkage (leveraging the bank’s already completed high-strength KYC). This underscores the core importance of robust KYC mechanisms.
III. The KYC/AML Compliance Dilemma for Non-Bank Institutions
Hong Kong’s “Stablecoin Ordinance” permits eligible non-bank institutions to issue stablecoins. However, they face significant structural challenges in meeting KYC/AML requirements of the same stringency as traditional banks:
1. Lack of Infrastructure and Expertise: Banks possess mature customer authentication systems, risk assessment models, professional compliance teams, and established mechanisms for interfacing with regulators. For non-bank institutions (especially startup tech companies), building systems of equivalent effectiveness is costly and time-consuming.
2. Limited Access to Identity Verification: Although robust identity verification infrastructure exists in places like China (e.g., Ministry of Public Security interfaces accessible to authorized institutions), access is typically restricted to authorized entities (mainly banks), not fully open to the public or all types of businesses. Non-bank institutions struggle to access high-assurance identity verification services as conveniently and cost-effectively as banks. Decentralized Identity (DID) technology holds promise but is currently unevenly developed, costly, and requires time for large-scale adoption.
3. The Defensive Logic of “Penetration, Retention, T+1”: These requirements are core defenses against stablecoin-specific risks:
Real-name Penetration: Ensures ultimate beneficiary transparency, preventing anonymous transfer of large illicit funds.
Data Retention: Meets needs for post-event audits and judicial investigations.
T+1 Redemption: Provides a risk buffer and verification time to address potential run risks.
These measures aim to ensure system robustness, not arbitrary restrictions.
Therefore, under the current identity verification systems and technological conditions, expecting non-bank institutions to independently shoulder KYC/AML obligations as strict as banks presents immense practical difficulty. Related complaints reflect genuine operational challenges.
There’s a reason the US only allows banks to issue stablecoins.
Historical experience shows that the early radical creed of “crypto-anarchy” has been revised in practice. However, the issue of balancing privacy and regulation persists. We need a trustworthy (whether centralized or decentralized in architecture) and transparent public service platform. Users must cede some privacy rights to this platform, just as we cede some rights to the government in exchange for order and security.
IV. KYT: Regulatory Innovation Driven by On-Chain Transparency
On-Chain Transparency: From Challenge to Advantage
Traditional Fiat Transactions: Opaque → Reliant on post-event audits.
Cryptocurrency Transactions: Publicly visible on-chain → Enables real-time risk monitoring.
KYT (Know Your Transaction) leverages the inherent transparency of blockchain data to track fund flows in real-time by analyzing the public ledger.
Core Function: Utilizes big data analytics and artificial intelligence to monitor on-chain transaction activity in real-time, identifying abnormal patterns (e.g., interactions with high-risk addresses, mixer usage, unusually rapid large transfers), and assessing transaction risk.
Regulatory Value:
Meeting Compliance Requirements: Helps exchanges, wallet providers, etc., comply with AML regulations, efficiently identify and report suspicious activities, reducing legal risk.
Enhancing Regulatory Efficiency: Provides regulators with a more comprehensive, real-time market overview, enabling precise supervision and forward-looking policy-making.
Strengthening Risk Management: Helps institutions assess counterparty credit risk (based on historical transaction analysis) and prevent money laundering and illicit transactions.
Business Value:
Automated monitoring significantly boosts operational efficiency.
Demonstrates commitment to compliance, enhancing customer trust.
Optimizes products and services based on data analytics.
KYT’s Unique Value: Compensating for Non-Bank Institution Shortcomings
KYT’s core advantage lies in: It fully utilizes the transparent nature of on-chain data, significantly compensating for the relative disadvantage non-bank institutions face during the initial customer identity due diligence (KYC) phase. This makes their subsequent transaction monitoring and risk analysis more efficient. In certain scenarios, tracking transparent on-chain transactions is even more feasible than tracking opaque traditional fiat transactions.
V. Conclusion and Recommendations: Embracing Transparency, Optimizing Regulatory Details
1. Reaffirming the Foundation: KYC/AML are Indispensable. KYC and AML are the cornerstones for maintaining the integrity, stability, and security of the financial system. Their importance in the uniquely risky stablecoin sector should not be diminished but rather emphasized.
2. Acknowledge Differences, Seek Practical Paths: The structural difficulties non-bank institutions face in implementing high-intensity KYC/AML must be recognized. Regulatory detail design must confront this reality:
Explore Diversified Identity Verification Solutions: Research how to securely and compliantly broaden non-bank institutions’ access to authoritative identity verification services, or recognize new high-assurance verification technologies (e.g., mature and reliable DID solutions).
Implement Risk-Based, Differentiated Supervision: Set practical, tiered compliance standards based on institution type, business scale, and risk level.
3. Leverage Crypto-Native Advantages: KYT as the Core Tool: The core innovation point of Hong Kong’s stablecoin regulatory details should lie in fully understanding and utilizing the transparency characteristic of blockchain transactions, avoiding simply copying regulatory models designed for opaque fiat systems:
Establish KYT’s Core Position: Details should clearly encourage and require issuers to adopt robust KYT systems for real-time transaction monitoring and risk management, explicitly incorporating this as a core component of meeting AML compliance requirements.
4. Build a “Transparency-Based” Regulatory Framework: The design of regulatory requirements (e.g., suspicious transaction reporting standards, audit scope) should fully consider the availability and analytical potential of on-chain data. The “principles-based” approach of relevant US legislation (though perhaps “coarse”) reserves space for innovation. Hong Kong can learn from this flexibility while tailoring it to local realities, formulating more refined and forward-looking rules for leveraging transparency advantages.
In Summary:
The stringent requirements of KYC and AML are the bedrock of financial stability and non-negotiable.
Supporting Web3 applications with controlled anonymity (i.e., anonymity at the transaction level after satisfying regulatory baselines like KYC) is key to their seamless integration with the Web2 ecosystem and achieving true mass adoption.
The core challenge facing the HKMA in stablecoin regulation is designing a practical path for non-bank institutions that both upholds compliance bottom lines (KYC/AML) and fully utilizes the transparency characteristics of crypto assets—specifically by incorporating KYT into compliance requirements. Future regulatory details should strive to build an “transparency-based” innovative framework that effectively manages risks while vigorously promoting the prosperity and healthy development of Hong Kong’s Web3 ecosystem.
