Despite the ubiquity and convenience of big tech’s digital offerings, from email to social media, more internet users are questioning their over-reliance on centralized solutions for data storage. News of high-profile data breaches and allegations of mishandling user information have made web users even more apprehensive of the current corporate-controlled ID system.
One proposed solution to these security concerns aims to use blockchain tech to construct self-sovereign “decentralized digital identities.” Although the technology behind decentralized identities is in its early stages, a few innovations are already reshaping how users share sensitive info online.
What is decentralized identity in blockchain?
Decentralized identity is a new framework for storing, sharing, and verifying personal identification on blockchains rather than relying on centralized entities. It aims to empower web users to manage their digital lives by creating unique, blockchain-based IDs called decentralized identifiers (DIDs) and receiving tokenized representations of verifiable credentials (VCs) from trusted issuers (e.g., a credit score from a credit reporting agency, a diploma from a university, or medical records from a doctor).
Using the cryptographic public and private key model, people who hold these ID tokens selectively reveal their credentials to online platforms to take advantage of digital services without entrusting details to a third party. At all verification stages, crypto users hold their DIDs and VCs in a self-custodial crypto wallet, ensuring they have the final say over when to show their data to Web3 protocols.
How does decentralized blockchain identity work?
Like sending and storing crypto, decentralized identity uses technologies like blockchain, distributed ledgers, and cryptographic keys to give users custody over their virtual ID data.
Creating decentralized identities has yet to be standardized, but the World Wide Web Consortium (W3C) defined DIDs as the central component in this emerging identification system. According to W3C, DIDs are globally recognized and cryptographically secured identifiers that individuals or entities create on distributed ledgers rather than through a third-party intermediary like a big tech firm. These DIDs contain a unique string of characters and have an associated pair of cryptographic keys. As an illustration, W3C gave the following sample DID address:
- did:example:123456789abcdefghi
When individuals or organizations create their DIDs, they can access the private and public keys with their wallet addresses to encrypt and decrypt data. Both keys are interrelated, but only the private key gives holders the authority to confirm transfers on the blockchain. The public keys link back to the private key data, but they’re safe to share with others since they obscure the private key data with cryptographic technology.
Another aspect, which is VC, is similar to virtual certificates issued by trusted institutions (e.g., governments, universities, and banks), which prove some aspect of a user’s digital blockchain identity. For example, a university might issue VC tokens after graduation, and students use these tokens to verify their prior experience on future job applications.
Soulbound tokens (SBTs) are an example of credentials-based cryptocurrencies that mimic the properties of unique non-fungible tokens (NFTs) but can’t be transferred out of a user’s crypto wallet address. If someone holds an SBT in their wallet proving info like their credit score, driving safety record, or educational background, it stays in their DID as proof of their identity.
For enhanced privacy, some decentralized verification protocols also use technologies such as zero-knowledge proofs (aka ZK rollups), which let users confirm a credential in their DID without revealing their identity. ZK proofs use advanced off-chain cryptographic algorithms to prove a claim’s validity without requiring users to share their specific details with other entities. Advancements like ZK rollups make it possible to reliably confirm CVs in DIDs without giving away the holder’s identity, offering users an efficient way to interact with Web3 services while preserving user privacy.
Why is decentralized identity important?
Decentralized identity introduces a paradigm shift from a corporate-dominated online experience (aka Web2) to a more user-centric version of the internet. By giving web users control of their data rather than forcing them to surrender it to big tech firms, DIDs alter how individuals and institutions think about data storage, privacy, and interaction with online services.
Sovereignty over personal data
A major benefit of decentralized identity is that it gives holders control over their digital information rather than entrusting this personal data to centralized entities.
With a DID, users hold the cryptographic keys to their online identity and have the power to both guard their information and choose when and what to reveal to web services.
Reduced risk of identity theft and fraud
Blockchains have security advantages over centralized ID storage systems, including no single point of attack, 24/7 uptime, and tamper-proof, transparent records. These safety features reduce the risk of identity theft and fraud since users don’t have to worry about counterparties potentially manipulating or mishandling user accounts.
Improved privacy
With the addition of blockchain solutions like ZK proofs, people with DIDs can verify their credentials without giving away their sensitive details. These new technologies provide enough information to confirm the data Web3 users share with other parties is authentic without linking these personal details to a specific crypto wallet.
User-friendly Web3
Instead of fumbling to remember the passwords and emails for different online accounts, DIDs provide a single verification badge for every online application. Although not every website welcomes DIDs today, the idea of using one account to access countless decentralized applications (dApps) significantly boosts usability across Web3.
Challenges for decentralized identity in blockchain
Despite the many proposed benefits of decentralized identity, concerns over its security and efficiency exist. Decentralized identity protocols must overcome multiple hurdles before becoming the mainstream form of digital ID.
Requires high responsibility from users
Although DIDs give users the keys to their digital personas, people also have to keep this info secure. Web3 users can’t rely on insurance protections or third-party custodians to watch over their data, and any mistakes in handling private keys may block people from their DIDs.
Lack of identity recovery protocols
There’s no way to recover IDs or credentials if users lose their private keys or a hacker breaks into an account. Since no centralized institutions or insurance protections exist for Web3 users, there’s no customer support line to turn to if someone loses this essential information.
Interoperability issues
Tools like crypto bridges and the Ethereum Virtual Machine (EVM) make networks more compatible, but many gaps still prevail in how decentralized blockchains exchange information (aka the interoperability problem). Until developers perfect interoperability solutions, it’s not seamless for Web3 users to share their decentralized identities across multiple chains.
Unclear regulatory standards
Decentralized identity challenges the existing regulatory norms and centralized frameworks for issuing and verifying identities. Users will be more likely to embrace decentralized identity solutions only when governments establish clearer regulations from organizations like W3C and the Decentralized Identity Foundation.
Discover more details on decentralization on dYdX Academy
Decentralized systems are changing how industries and individuals interact with the internet. For the latest news on innovations and opportunities in Web3 and educational articles on crypto, trading, and blockchain tech, check out dYdX Academy. dYdX also offers a secure decentralized trading platform for eligible traders looking to add crypto perpetuals to their portfolios. Find out more about how trading derivatives on dYdX works on our official blog, and start trading on dYdX today.
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