When RWA connects to DeFi: Implementation paths and challenges of KYC/AML Compliance

Real World Assets (RWA) are accelerating their entry into the DeFi space, bringing liquidity transformation to TradFi. However, in practice, the anonymity of DeFi conflicts with the strong regulations of traditional finance, especially KYC/AML. Achieving compliance is not simply a matter of transplantation; it requires innovative architecture and technological integration.

The integration of RWA and DeFi is not a simple "access", but rather gives rise to a new type of financial infrastructure. A successful KYC/AML Compliance program must necessarily be a hybrid architecture: off-chain identity verification and legal entities as the foundation, and on-chain efficient, privacy-friendly verification and execution through ZKP, DID, and programmable compliance. Regulators need to embrace innovation and clarify adaptive rules under the principle of "same risk, same regulation". Technology developers should view compliance as a core design goal rather than a post-facto patch.

1. Decoupling Identity and Transaction Setting Layered Architecture

Layout from two aspects: blockchain identity and contract access.

Off-Chain/On-Chain Hybrid Identity (. Users complete strict KYC/AML verification through off-chain professional KYC providers such as Circle (the issuer of USDC), Fractal ID, and Parallel Markets. Biometric checks, document verification, and risk database screening are all conducted in a secure off-chain environment. At the same time, based on on-chain verifiable credentials, zero-knowledge proof (ZKP) credentials (such as Polygon ID) or soulbound tokens (SBT) are generated to prove that the user has 'passed KYC' or is 'not on the sanctions list' without exposing specific identity information. The credentials are bound to the user's wallet address.

Compliance Access Layer ) Gated Access / Permissioned Pools (. Specific RWA funding pools for DeFi protocols (such as Centrifuge, Goldfinch) are set based on credential-based access control rules. Users must provide valid credentials to participate (deposit, borrow, trade specific RWA assets). When KYC status expires or is revoked, the credentials automatically become invalid, triggering the pre-set dynamic credential management rules within the protocol (such as prohibiting new investments and initiating exit processes).

2. Real-time Trading Monitoring and Automated AML Screening Challenges

In terms of dynamic regulation, multiple measures are taken through off-chain data integration, on-chain transaction behavior monitoring, and suspicious activity reporting.

On-Chain Transaction Monitoring ). Wallet historical transactions and associated addresses (such as interaction with the dark web and mixers) can be analyzed using tools like Chainalysis and Elliptic to generate address risk scores. In addition, anomaly detection can monitor large, frequent, and unusually sourced/directed transactions (such as suddenly transferring a large amount of funds to immediately invest in RWA).

Off-chain AML database integration. Integration of real-time screening APIs such as ComplyAdvantage and LexisNexis. The key challenge is to associate wallet addresses with off-chain identities (relying on the aforementioned credential system) for the screening to have legal validity. However, on the other hand, how can on-chain smart contracts securely and reliably obtain updates to the off-chain AML list? There is a need to develop specific solutions for a decentralized oracle network (such as Chainlink).

Suspicious Activity Report (SAR) on-chain and off-chain linkage. Protocols or monitoring services have detected high-risk transactions that need to be reported to regulatory authorities/compliance teams through a compliance interface with encrypted transaction data + associated identity information. The key challenges are the standardization of the reporting process, responsible entities, and data formats.

3. Clarify the Responsible Parties and Basic Mechanism for Dispute Resolution

Mainly solve the mechanisms for liability assumption and dispute resolution.

Clarify Compliance Obligations Bearer (The Gatekeeper Problem). For Special Purpose Vehicles (SPV) / Legal Entities, RWA initiators (such as real estate companies, bond issuers) or core developers of the protocol establish regulated entities (such as Centrifuge’s registered entity in the U.S.) to act as legal representatives to fulfill KYC/AML. For Permissioned DeFi Protocols (Permissioned DeFi), the protocol itself needs to be designed to require permission to join (both nodes and liquidity providers need KYC), similar to some enterprise-level blockchain solutions (like Fnality). Additionally, it is also necessary to leverage third-party compliance service providers, such as the protocol entrusting licensed institutions (like trust companies, payment institutions) to handle user due diligence and transaction monitoring.

Jurisdiction and Legal Applicability. Real estate RWA is mainly governed by the law of its physical location, namely the law of the asset's location. In some scenarios, the law of the user's location applies, requiring compliance with the financial regulations of the user's residence/nationality (such as the US FATCA and EU AMLD). At the same time, it is required that the transparent design of the agreement clearly announces the applicable laws, regulatory agencies, and user rights.

4. Balancing Privacy and Efficiency by Combining Technology and Law

Integrating privacy computing technology, decentralized identity technology, and recognized regulatory technology with smart contracts.

Zero-Knowledge Proof (ZKP)'s deep application. KYC credentials can prove that user information is valid and not on the blacklist, without disclosing specific content. It can also conduct AML screening, where users locally run screening software to generate ZKP proof that "my counterparty is not on the latest blacklist," without exposing the counterparty address to the protocol/counterparty. Additionally, it can generate transaction compliance proof, where complex transactions can generate ZKP proof that they comply with all preset rules (such as single investor limits).

Decentralized Identity (DID) and Verifiable Credentials (VCs). Users have complete control over their identity data (stored in personal digital wallets) and can selectively disclose specific information to specific parties (such as only disclosing the proof of 'annual income > 100,000' to the RWA pool when needed). Enhances interoperability and reduces redundant KYC.

**Regulatory Technology (RegTech) combined with smart contracts. Programmable Compliance, such as directly encoding **AML rules, investment limits, lock-up periods, etc. into smart contracts for automatic execution. Providing regulatory agencies with a "read-only" API regulatory sandbox interface to monitor overall risk without needing to view the privacy details of each transaction.

5. Progressing through Continuous Challenges and Resolutions

The eternal tension between privacy and compliance, that is how to maximize the protection of users' financial privacy while meeting regulatory real-name requirements. ZKP/DID is the direction, but large-scale application requires more mature practices.

Cross-jurisdictional coordination is also a major challenge. There is a global lack of a unified regulatory framework for crypto assets/Decentralized Finance, and RWA protocols face fragmented compliance requirements.

Ambiguity in Responsibility Definition. Smart contract vulnerabilities leading to violations, how to allocate responsibilities among developers, nodes, users, and SPV? Legal frameworks urgently need to follow up. Agreements can be made in advance during the design phase.

Trust and Security of Oracles. The on-chain transfer of off-chain critical data (AML lists, asset prices) requires high security and reliability; otherwise, it becomes a single point of failure or a target for attacks.

Challenges of Sanctions Enforcement. How to effectively freeze assets of specific sanctioned addresses on a permissionless underlying blockchain? The technical implementation is extremely difficult, relying on front-end/inflow and outflow channel controls, combining on-chain and off-chain.

Despite the significant challenges, the path to compliance for RWA in DeFi is being explored in projects such as Centrifuge, MakerDAO (RWA collateral), and Ondo Finance (tokenized government bonds). This is not only about legality but is also the key to unlocking trillions of dollars in liquidity—compliance is a necessary pathway for DeFi to go mainstream, rather than an obstacle.