SEC Commissioner Calls for Replacing KYC/AML With zkProof

Key Insights

• Hester Peirce argues that excessive KYC and AML data collection makes financial crime harder to detect.
• Zero-knowledge proofs could enable privacy-preserving compliance without exposing sensitive customer information.
• The SEC's Innovation Exemption opens a temporary pathway for tokenized stock trading on crypto networks.

SEC Commissioner Hester Peirce says the financial system's appetite for personal data is making illicit activity harder to catch.

The remarks came in her penultimate week as a commissioner, and days after the SEC unveiled a tokenization exemption.

Peirce Challenges Traditional KYC and AML Surveillance

Peirce said KYC and AML frameworks rest on a simple theory. Collect enough data on enough people, and criminals eventually surface. She argued that ever-bigger haystacks make finding the needles harder.

Financial firms verify names, birthdays, addresses, and identification numbers for every customer. They also file Currency Transaction Reports and Suspicious Activity Reports packed with personal details.

The cost of this system, Peirce said, appears to dwarf its effectiveness against bad actors. Every extra data field raises the odds that someone mishandles it, accidentally or deliberately. Innocent customers carry the burden, often without knowing their information is tracked. According to Peirce,

“For decades, the approach to ferreting out illicit finance and uses of the financial system to facilitate other illicit activity has been the same: collect more and more data. The approach is not working particularly well, and technology has outpaced our legacy approach, so it is time for a change. Public ledgers are more transparent and more difficult to alter than any paper record ever was. Cryptography allows us to be confident that a fact is true without knowing the underlying data.”

She criticized "data go up" thinking among regulators, mirroring crypto's "number go up" fixation. Efforts to curb collection, she said, often meet puzzled resistance.

Peirce framed the moment as a crossroads for financial regulation. One path brings more data collection and intermediary surveillance. The other catches criminals while collecting less personal information than ever.

Zero-Knowledge Proofs Could Change Crypto Compliance

Zero-knowledge proofs let someone prove a statement is true without revealing the information behind it. Think of showing a verified "over 21" badge instead of handing over your driver's license.

Peirce pointed to attribute-based credentials, which attest to specific facts without disclosing the data that established them. Examples include age, citizenship, accredited investor status and absence from sanctions lists.

A zero-knowledge proof can tell a counterparty that a person meets its requirement. The counterparty never learns the person's name, income or address. She said the tools already exist, but the regulatory framework encouraging their adoption is missing.

Peirce wants rules that move away from prescriptive collection and toward attribute-based verification wherever technologically feasible. Public blockchains create permanent, auditable ledgers. Law enforcement can analyze them using increasingly sophisticated forensics tools, she noted.

She also urged making it easier for firms to rely on third-party identity checks. Today, each regulated entity must verify customers independently, copying sensitive data across dozens of institutions.

SEC's Innovation Exemption Opens a Path for Tokenized Stocks

Peirce also addressed the Innovation Exemption, which the SEC issued on September 17. She described it as a temporary, size-limited measure for trading tokenized securities through automated market makers on crypto networks.

The order exempts Tokenized Securities Venues from the Exchange Act's definition of "exchange." These venues can trade tokenized National Market System stock using permissioned liquidity pools.

Conditions include limits on the number of symbols and trading volume. Smart contracts must be auditable, public, and deployed on a permissionless ledger. Venues must halt trading whenever the underlying stock halts on its primary listing exchange.

The order also gives liquidity providers a temporary exemption from the "dealer" definition. The exemptions expire five years after publication, and the SEC is seeking public comment.

SEC Chairman Paul Atkins called the measure a bridge toward durable rulemaking. Peirce said tokenization is coming, and she would rather it happen in the United States than overseas.

Peirce added that she shares SIFMA's wish to start formal rulemaking soon. Whether her colleagues carry that privacy push forward after her departure remains uncertain.