One of the most discussed topics in the Bitcoin space today is regulation and compliance. Two days ago Ben Lawsky, New York State’s Superintendent of Financial Services, stated:

“The bank industry is colliding with the tech industry.”

Banking authorities, who have been regulating financial industries for decades, are looking for new ways to apply those same regulations to the emerging Bitcoin economy.

Lawsky was right about what matters most: consumer protection.

“…the collapse of the unregulated virtual currency exchange in Japan known as Mt.Gox … where 100 of millions of dollars worth of consumer’s Bitcoins essentially vanished over night … underscored the risk customers run when trusting their money to an unregulated financial institution…”

He further pointed out that:

“…effective and appropriate government oversight can play an important role in reducing the risk of fraud mismanagement and abuse for financial consumers. Moreover … poorly run exchanges and the doubts they foster among consumers are a serious threat to the wider adoption of virtual currencies.”

To do so, regulations require collecting sensitive information about the consumer in order to being able to comply with Know-Your-Customer (KYC) policies.

At the same time, sensitive data has been compromised over and over again. In a recent case, JP Morgan Chase estimates there was unauthorized access to 76 million household and 7 million small business accounts.

Financial institutions invest large amounts of capital into cyber security, which is not preventing these breaches. According to Paul Tiao, partner at Hunton & Williams LLP and former adviser to the director of the Federal Bureau of Investigation:

“This is one of the biggest national-security challenges that we have.”

Also, vulnerabilities such as Heartbleed, Shellshock or most recentlyPoodle show weaknesses exist in cyber-security today.

Storing sensitive data online does not seem to be a secure solution in the age of constant cyberattacks. But what if we don’t need to? For the first time in history we have the opportunity to leverage, what I believe is, the world’s most powerful dataset, known as the block chain.

Partial snapshot of a block of Bitcoin transactions.

In the block chain all transactions performed on the Bitcoin network are recorded and distributed across all nodes, ensuring their validity. This allows a closer examination of a single bitcoin address, understanding its relationship to other addresses and performance inside the network — leading to what I refer to as Bitcoin’s trust layer.

This layer of trust facilitates interactions between consumers, financial institutions and authorities, all without exposing sensitive information to attackers.

Creating an expectation of a customer’s transactional behavior and determining the risk in terms of propensity to commit money laundering or terrorist financing is important. Doing this without having to tie that information to an actual identity will be key to protecting privacy in the future.

Apart from regulatory implications, monitoring consumer transactions against expected behavior and their peers opens new opportunities for businesses to deal with risk and fraud challenges.

In the next post I’ll be talking about further applications of the trust layer and how it will allow seamless transactions between actors in the Bitcoin network.