The Application of ZK in Compliance and Auditing

Why Do Regulatory Audits Need ZK?

The core dilemma in traditional on-chain audits is:

• Blockchain is public and transparent → accessible to everyone
• Financial compliance requires detailed verification → but institutions are reluctant to expose internal data

This makes regulatory requirements and privacy protection almost inherently opposed.

ZK offers a new approach: prove “I comply with the rules,” without disclosing the sensitive information behind those rules.

Example:
• Prove “this wallet has completed KYC,” without revealing the real identity
• Prove “funds are from legitimate sources,” without exposing all transaction records
• Prove “asset reserves > circulating tokens,” without disclosing the asset list (Proof of Reserves)

ZK creates the first feasible space for reconciling regulation and privacy.

How Is ZK Used for KYC / AML?

Mainstream compliance solutions currently suffer from excessive data exposure:
• KYC requires submissions of too much personal information
• Banks and exchanges must store sensitive materials
• Both users and institutions bear huge privacy risks

ZK’s solution: ZK-KYC — only proves “verification passed,” without revealing identity.

Process

1. The user completes a one-time verification at a trusted identity institution (such as a financial entity or compliant merchant)
2. The identity institution generates a proof → “user has passed KYC”
3. The user submits only the ZK proof on-chain or within the app, with no personal information disclosed
4. Smart contracts can verify “this person is trusted,” without knowing their real identity

Compliance requirements are met, privacy remains intact.

Use Cases
• Regulated exchanges (such as those operating under US or EU MiCA frameworks)
• Institutional liquidity pools in DeFi (Aave, Curve credit pools)
• Stablecoin payment networks (enterprise accounts for USDC, USDT)
• Cross-border capital flow verification

ZK for “Controllable Privacy”: Selective Disclosure

The future of regulation isn’t “full transparency” or “total privacy”, it’s user-driven control over what data is shared, and with whom.

ZK’s role in controllable privacy:

1. Selective Disclosure

• No need to reveal all transaction records
• Only disclose specific details to regulators when necessary
• Disclosures can be based on time, amount, or purpose

2. Regulator Key

Institutions can hold a type of key that allows them to decrypt certain private information only under specific conditions.

This is not a backdoor, it is:
• User-driven choice
• Designed for institutional accounts
• Operates alongside ZK proofs

3. Compliance Proofs

Examples include:
• AML Proof (Anti-Money Laundering)
• Address Screening Proof
• Source of Funds Proof

Project teams and financial institutions can meet regulatory requirements without disclosing full datasets.

How Is ZK Used in Auditing (Proof of Reserves & Proof of Liabilities)?

Historically, audits for exchanges or stablecoins have faced issues like:
• Lack of transparency in holdings
• Non-public audit processes
• Users are unable to assess the actual risk

ZK provides a way to prove financial health without revealing asset details.

Common Models

Proof of Reserves (PoR)
Prove: reserve assets > user liabilities
No need to disclose specific assets, addresses, or amounts.

Proof of Liabilities (PoL)
Verify every user’s assets are fully accounted for using cryptographic commitments without exposing balances.

Bidirectional Proof: PoR + PoL Combined
In the future, exchanges and stablecoin issuers may adopt models that:
• Meet regulatory compliance reviews
• Don’t expose internal asset structures
This is the clearest and most definitive direction for ZK in financial infrastructure.

Circle / USDC’s Off-chain Compliance + On-chain Privacy Exploration

Source: https://www.circle.com/

As the issuer of USDC, Circle must satisfy global compliance requirements while addressing enterprise clients’ privacy needs. To achieve this, Circle has partnered with multiple compliance modules to test ZK-KYC prototypes, aiming to create a model where “compliance is completed off-chain → compliance proofs are provided on-chain.”

Key Approaches

1. Off-chain KYC / KYB Completion

Users or businesses submit identity and company data to Circle or partner institutions, these details are never put on-chain.

2. Generating ZK Compliance Proofs

After approval, a ZK proof is created stating: “this address has passed KYC/KYB,” without disclosing identity information.

On-chain contracts only need to verify compliance status, not specific identities.

3. On-chain Private Payments

When businesses pay with USDC:
• They can prove regulatory compliance
• Without exposing transaction sizes or financial details
• Can selectively disclose information to regulators if needed

Use Cases
• Enterprise-level USDC payments
• Stablecoin settlement and cross-border trade
• On-chain accounts for banks/payment institutions
• Regions with high regulatory standards (US, EU MiCA)

Circle’s ZK-KYC experiment represents a future direction: stablecoins achieving “privacy-enabled compliance,” protecting enterprise data while meeting regulatory demands.

Zcash: Pioneer of Private Transactions

Source: https://z.cash/

Zcash is one of the first cryptocurrencies to deploy zk-SNARKs at scale on the mainnet, allowing users to freely switch between “public” and “private” transactions. With the privacy narrative resurging in 2025, ZEC saw rapid growth as the market revisited its potential for “selective disclosure” in compliance.

Key Approaches

1. Selective Privacy (Selective Disclosure)

Zcash’s core mechanism lets users hide:
• Sending address
• Receiving address
• Transaction amount

But users can selectively reveal transaction details to institutions or auditors when necessary.

2. Privacy Transactions Powered by zk-SNARKs

Private transactions use zero-knowledge proofs to ensure:
• Data stays confidential
• Transactions remain verifiable
• Network security and consistency aren’t compromised

This is the earliest live deployment of a ZK-powered private transaction system.

3. Compliance Exploration: Auditable Privacy

The Zcash Foundation works with regulatory advisors to explore:
• How enterprises can use ZEC “private accounts”
• How to retain selective disclosure capabilities under compliance rules
• How private transactions can remain visible for regulatory oversight

This evolution shifts Zcash away from being a “fully anonymous coin” toward “compliant privacy.”

4. Market Significance

In 2025, amid renewed interest in privacy, ZEC surged severalfold, reminding the market that privacy isn’t an adversary, it’s an essential capability for enterprise payments, cross-border settlements, and user protection.

Zcash’s selective privacy model proves that ZK-powered privacy can be compliant—meeting regulatory needs without sacrificing confidentiality.