Distributed Ledger Technology and Digital Identity: Prospects and Pitfalls Ahead

Distributed Ledger Technology (DLT), often referred to as blockchain, has garnered a lot of attention in the past few years. Is it just “a solution in search of a problem” or, does it offer answers for real-world policy questions such digital identity and remittances? This six-blog series, by Rodrigo Mejia Ricart and Camilo Tellez, aims to foster a better understanding of the technology. The first three blogs discuss what is DLT, the debate around key stated benefits and the evidence around different use cases. The last three blogs discuss DLT for digital identity, supply chain and remittances in detail.

Digital identity and the digital economy

Growing connectivity and technology-enabled business models are reshaping the production, trade and consumption of goods and services. The digital economy has broken down barriers, opened up new markets, and connected supply and demand often by collapsing geographical distance. This new era of technological change is revealing new landscapes of economic and financial opportunity to women, men and children all around the world. However, for millions of people without reliable forms of identity, the opportunities presented by the digital economy remain severely limited or inaccessible. Frequently, a central cause of this exclusion is the challenge many individuals face proving their identity by digital means. Conversely, according to a recent paper by the World Bank and the G20 Global Partnership for Financial Inclusion (GPFI), digital identity supports financial inclusion by:

• Making it easier for the unbanked to open a transaction account, simplifying documentation requirements.
• Making it easier and cheaper to onboard customers, including remotely.
• Strengthening the financial sector by making it easier to provide additional services to individuals.

The McKinsey Global Institute reports digital ID-enabled processes have the potential to reduce customer onboarding costs for FSPs by up to 90%. Further, it found that over half of the potential economic value of digital identity accrues to individuals, making it a powerful key to inclusive growth, though capturing the economic value of digital identity is not automatic.

Omidyar Network, a philanthropic investment firm, highlights that while obtaining a digital ID can help people unlock and accelerate new opportunities, it can also unlock new risks and challenges. Specifically, Thea Anderson from the Omidyar Network notes “how an ID system is designed, rolled out, and managed can include and protect individuals with privacy, security, and choice or it can reinforce power imbalances, exclude, discriminate, and support surveillance.” To bridge that gap, Omidyar Network has introduced the term “Good ID” as a normative framing for digital identity. Anderson asserts “to be considered a Good ID it must be inclusive, offer significant personal value, and empower individuals with privacy, security and choice.” Good ID must apply to not only national identity systems and identifiable data trails from digital channels, but also for those who opt for using sovereign technologies to self-assert and protect their identities.

The reality in many countries is that existing identification systems still have significant shortcomings that prevent millions of people from accessing the digital and formal economies, and thus achieving their full potential. According to the World Bank’s ID4D, over 1.1 billion people globally lack official proof of legal identity. While 6 billion do have some form of ID, many of these people rely on paper-based systems that do not enable access to the digital economy, reinforcing the digital divide. For example, 20% to 30% of the roughly 1.7 billion people globally without a bank account attributed the situation to a lack of necessary identification documents.

The absence of reliable and seamless digital identification system hinders the ability of private and public institutions to adopt innovative service delivery approaches and greatly reduces the amount and quality of data available for best-practice data for policymaking. These challenges are most felt in emerging economies, particularly in Sub-Saharan Africa and South Asia. The lack of access to ID disproportionately impacts women, poor people and other marginalized groups, such as refugees. As many as 45% of women in low-income countries lack access to an ID, compared with 30% of men. Almost half of the poorest 20% in low-income countries do not have access to any form of foundational ID, compared to around a quarter of the richest 20%. The challenge many refugees face is especially severe; 70% of Syrian refugees lack access to ID and are unable to renew or apply for their state-issued identification documents from their country of origin. UNHCR’s new report “Displaced and Disconnected” notes that displaced persons continue to face legal barriers to accessing SIM cards and opening bank and mobile money accounts in their own names.

Can Distributed Ledger Technology help solve the digital identification challenge?‘

Interest in pairing distributed ledger technology (DLT) with other innovations such as biometric data and mobile technologies is growing. Many consider that the combination of these technologies presents a valuable opportunity to rethink how identification systems work in the digital era. DLT-based systems are distinctive from other systems in three main ways:

• Their distributed architecture means they are not controlled by a single central authority, but based on consensus. This feature may be particularly appealing for cross-border verification of identity for individuals engaged in cross-border trade, seasonal migrants, or individuals displaced by conflict or humanitarian disasters.
• They provide an immutable record of transactions which are time-stamped, providing users with a reliable record of interactions.
• They create transparent records of transactions that can be validated by any participant in the network. This transparency can empower users by ensuring they can access the log of transactions at all times.

Proponents of DLT-based digital ID argue that digital wallets of individuals connected to these distributed systems are able to hold not only personal and biometric data for identification purposes, but also transaction accounts, financial and transaction history, asset ownership records (including land), and medical and academic records. Such an advance would enable individuals to prove who they are, what assets they own, their levels of education and past economic activity, facilitating their social and economic integration.

Sierra Leone and UNCDF recently launched a pilot to test a DLT-based digital identification system designed to provide users with greater control over their personal, transaction and credit information. The ultimate objective of the system is to support financial inclusion of every resident in the country.

As of January 2018, as many as 100,000 refugees in Jordan received World Food Programme (WFP) cash assistance through the Building Blocks DLT-based system. According to WFP, this has reduced the costs of disbursing humanitarian cash assistance, better protected beneficiary data and improved overall organizational performance. WFP is working to expand DLT-based operations to disburse assistance to all 500,000 refugees in Jordan using UNHCR ID and exploring the potential of this platform to facilitate broader coordination and harmonization across all UN humanitarian assistance. WFP provided cash assistance to 19.2 million people in 2018, many of whom are refugees. If the initiative is able to gain traction, millions could see their economic prospects substantially improved.

The potential benefits that a global, borderless and open digital identity would have in terms of financial inclusion are hard to overstate. By way of example, UNHCR is exploring the use of DLT directly to support self-managed digital wallets for refugees and introduce Document Verification Registers. BanQu, a startup, is testing another DLT-based approach that provides refugees, farmers, workers and micro-businesses in Kenya and Zambia with a means of identification and financial inclusion through digital records of their economic output as well as their personal and financial transactions. This data, validated by third parties, serves as a trustworthy digital ID and expands access for smallholder farmers to critical financial services.

Finally, Omidyar Network invests in mission-aligned startup companies that leverage privacy-enhancing technology to empower individuals, including those that use DLT. Anderson notes that “our global investments in Digi.me, Learning Machine, Terbium Labs and the Bharat Inclusive Technologies Seed Fund will accelerate a paradigm shift in the data economy by establishing new markets and business models. We directly invest in early-stage technology and crowd-in others to do so to ensure people have more and better choices in how they manage their digital identities.” Omidyar Network’s most recent investment is in RegTech startup Cambridge Blockchain offering a trusted privacy-protecting identity platform for financial institutions to meet strict data privacy rules, eliminate redundant identity compliance checks, and improve customer experience. Cambridge Blockchain combines blockchain technology with an off-chain personal data service and its software is now being deployed across 600,000 end users, including several large European financial institutions.

DLT’s identity problems

For all the excitement, DLT-based approaches to digital identification still have significant challenges:

• Third-party verification: The foundation of strong identity verification systems is third-party issued credentials, not self-asserted credentials. Prof. Louis de Koker, an expert on managing the relationship between financial inclusion and Anti-Money Laundering and Combating the Financing of Terrorism regulations, pointed out that FATF’s 40 recommendations require that financial institutions verify their customers’ identities using “reliable, independent source documents, data or information.” He noted that self-asserted credentials would generally not meet the bar of reliability and independence required by the FATF standards. For financial services, DLT-based digital identity solutions cannot eliminate the need of trusted institutions. Instead, they should rely on institutions to verify identity claims similar to public-sector led collaborative customer due diligence models. “In which case, do we really need the complexity of a distributed ledger?” asked Prof. de Koker.
• Cross-border identity recognition: It is often observed that DLT-based digital ID solutions could help vulnerable groups, such as refugees, prove their identity and qualifications across borders. However, a key challenge for cross-border ID usage is that most entities will not accept an ID issued by or in another country. This is a problem DLT is unlikely to solve, as it is a governance problem rather than a technology problem.
• Record-keeping: DLT solutions are often championed for the resilience of the record-keeping they enable. However, while the record of transactions may be very secure, personal data remains vulnerable to any system weaknesses of the respective digital wallets and the protocols of the DLT in use.
• Transparent log of transactions: Transaction logs cannot be housed on public blockchains due to privacy risks, and so records of transactions must be housed on private blockchains. In the alternate, centralized identity systems can be designed so as to provide users with transaction logs through mobile apps (as is taking place in India—see this ID4D case study for details). So it is not clear that a distributed architecture is necessarily needed to achieve this goal.
• Inclusion: A key challenge of digital inclusion lies beyond questions of the data architecture of a given system, and instead relates to questions of access to the services and skills needed to operate the digital system in the first place. These issues raise questions related to the digital divide and user capabilities, including about how users interact with technology and how key management for a DLT-based system will take place.

In light of these challenges, it is reasonable to ask whether DLT can play a role in solving the digital identity challenge. DLT undoubtedly has some appealing attributes. Notably, the resilience of the transaction ledger can serve as a stepping stone for innovative creditworthiness appraisals, providing access to financial services for the unbanked. Moreover, in an age of frequent privacy breaches, DLT solutions make a compelling case for allowing the user to regain control over their personal data in the digital world.

However, it remains an open question whether DLT can successfully scale, meet users’ needs consistent with their capabilities, and overcome key governance challenges (i.e., in particular, operate within consistent legal frameworks, and have clear recourse and accountability mechanisms). At the same time, there is a task ahead for DLT proponents to explain effectively why distributed solutions make more sense than other digital technologies.

The jury is still out on whether DLT will play a key role in meeting the digital identity challenge. What is certain is that by pushing us all to redefine the realms of the possible, DLT is spurring new thinking on how to solve one of humanity’s most pressing problems.

READ THE BLOCKCHAIN SERIES

• Introduction: Framing of our blog series on distributed ledger technology
• Blog 1: Distributed Ledger Technology: What Is It and Why Do We Care?
• Blog 2: Distributed Ledgers: Looking Past the Hype
• Blog 3: DLT: Keep Calm and Let the Evidence Speak
• Blog 4: Distributed Ledger Technology and Digital Identity: Prospects and Pitfalls Ahead
• Blog 5: Distributing Production: Can Distributed Ledgers Fuel a New Wave of Supply-Chain Innovation?
• Blog 6: Paying across borders - Can distributed ledgers bring us closer together?