Rob Behnke
April 19th, 2023
Regulatory compliance can be a complicated issue, especially in the field of blockchain and cryptocurrency. In many cases, the fundamental definitions that underlie regulations — such as whether or not something is considered a security — have not yet been worked out.
Even if the details of regulations are not clearly defined, it’s better and safer to make an honest effort to achieve compliance. Here are three major regulatory compliance considerations to keep in mind when designing and building for the blockchain and Web3.
Regulations such as the General Data Protection Regulation (GDPR), California Consumer Privacy Act (CCPA), and many others are designed to protect their constituents’ personal data. These new regulations implement increasingly broad definitions of personal data and stringent requirements for companies to protect this data.
One of the most common methods for protecting sensitive and personal data is the use of encryption to protect it. A modern, strong encryption algorithm prevents anyone from reading data unless they have access to the private key.
However, this assumes that the encryption algorithm in use remains secure and has no exploitable vulnerabilities. At the moment, public key cryptography is in a state of uncertainty as classical algorithms will be vulnerable to quantum computers in the future, while many post-quantum algorithms are relatively untested and may have hidden vulnerabilities.
On the blockchain, where all data is public and immutable, data may be encrypted using an algorithm that is considered secure today and broken tomorrow. Since data can’t be removed from the ledger once it is placed there, a long-term compliance strategy involves not placing sensitive and personally identifiable information on the blockchain, even in an encrypted form.
One of the most visible regulatory challenges of blockchain technology is compliance with know your customer (KYC) and anti-money laundering regulations. These laws are designed to ensure that the technology can’t be used for money laundering by ensuring that companies have visibility into who is using their products and what they are doing with them.
One of the core principles of blockchain technology is ensuring privacy via anonymity or pseudonymity. Blockchain accounts are not linked directly to real-world identities, which provides their users with a modicum of privacy despite the fact that every transaction that they perform on the blockchain is visible to the world.
However, this focus on privacy and anonymity runs directly counter to the requirements of KYC/AML regulations. Projects developing financial tools for the blockchain will likely need to strip away some level of anonymity for the sake of compliance without alienating their user bases.
The regulatory landscape is constantly evolving. The enactment of the GDPR kicked off a wave of new privacy laws as various jurisdictions implemented similar laws. Also, existing laws commonly undergo updates to keep up with the latest threats and implement more effective protections for sensitive personal data.
The immutability of the blockchain’s digital ledger introduces challenges for keeping up with an ever-changing regulatory landscape. While smart contracts can be designed to be upgradeable, data stored on the blockchain remains there forever.
When designing and implementing blockchain-based projects, it’s important to consider not only current regulatory requirements but also where they may go in the future. For example, erring on the side of minimizing the data stored and used on-chain may be a wiser long-term strategy.
Many compliance requirements boil down to security requirements. The big incidents that result in audits and fines typically are caused by a vulnerability that an attacker exploits to steal data, money, etc.
Halborn offers in-depth security audits that help to ensure that code actually functions as intended. For more information on auditing your smart contracts and to find out how Halborn can help with your blockchain project’s compliance needs, get in touch with our experts today.