Enabling Blockchain-Based Identity Passports

Essential Regulatory Tweaks — March 12, 2025

The current U.S. identity verification system lags behind modern capabilities, creating friction in financial services and introducing security vulnerabilities. Blockchain-based identity passports offer a secure, decentralized solution, but minor regulatory updates are needed to fully realize this innovation. Here's how policymakers can unlock the potential of on-chain identity credentials while preserving robust compliance standards.

The Regulatory Gap

Under Section 326 of the USA PATRIOT Act, financial institutions must verify customer identities through a Customer Identification Program (CIP). Current rules:

• Rely heavily on repeated, manual KYC checks across multiple institutions.
• Store sensitive data in many separate databases, increasing security risks.
• Drive up compliance costs and create onboarding friction.

By recognizing decentralized identifiers (DIDs) and verifiable credentials on a secure blockchain, institutions can share reliable KYC results—reducing redundancy and better protecting user data.

Proposed Regulatory Tweaks

1. Amend CIP Rules: Explicitly permit DIDs/verifiable credentials as valid components of a financial institution's CIP program. This leverages blockchain's immutable nature to strengthen, not weaken, identity verification.
2. Enhance Reliance Provision: Expand the reliance framework to accept cryptographically verified on-chain "reliance letters." If a user's identity was already verified by one institution, others can securely confirm via blockchain.
3. Create a Safe Harbor: Provide liability protections for institutions that adopt qualified blockchain-based identity solutions. As long as they follow set best practices and verify token issuer authenticity, they remain shielded from undue enforcement.
4. Clarify Data Privacy & Security: Permit zero-knowledge proof–based identity tokens on blockchains in line with Gramm-Leach-Bliley Act (GLBA) standards. Regulators can integrate blockchain-specific cybersecurity guidance into FFIEC handbooks.

Technical Model: DIDs & Verifiable Credentials

The system relies on three pillars:

• Decentralized Identifiers (DIDs): Unique user-controlled IDs, not tied to any single centralized database.
• Verifiable Credentials: Digital claims (e.g. "Identity Verified") issued by regulated entities that can be cryptographically proven.
• Blockchain: An immutable ledger for storing reliance letters or credential proofs, ensuring shared verification without exposing raw personal data.

Benefits for All Stakeholders

Consumers: Less friction in accessing financial services, fewer points of data breach, and more control over personal info.

Financial Institutions: Lower compliance costs, faster onboarding, and reduced fraud risk. Reliance on shared identity passports fosters easier collaboration.

Regulators: Enhanced oversight with robust audit trails. Blockchain's immutability ensures consistent application of verification standards while preserving a clear record for supervisory review.

Implementation Strategy

Agency guidance—rather than lengthy legislation—could pave the way. FinCEN and the federal banking regulators can jointly issue interpretive letters or FAQs clarifying CIP acceptance of blockchain credentials. Industry groups (e.g., Chamber of Digital Commerce) can help draft best-practice frameworks. Meanwhile, pilot programs under regulatory sandboxes allow real-world testing before broad adoption.

Conclusion

By recognizing blockchain-based identity solutions and updating CIP rules accordingly, regulators can foster a more secure, efficient, and inclusive financial system. This approach doesn't lower standards—it leverages modern technology to streamline compliance, reduce data vulnerabilities, and enhance oversight. Let's modernize our identity verification framework and usher in the next era of secure digital finance.