Whether you’re launching financial products in new markets or onboarding new customers, the need to conduct the necessary compliance and regulatory checks such as Anti-Money Laundering (AML), Know-Your-Customer (KYC), and Know-Your-Business (KYB) is more important than ever.
After onboarding, effectively managing risk becomes paramount for companies in this industry. By implementing essential tools like transaction monitoring, fraud detection, and open banking applications, you can efficiently navigate risk across various levels and promptly respond when necessary. As increased focus on regulatory scrutiny and difficult macroeconomic conditions cause businesses to fail and consumers to default, compliance and identity verification will become even more important as these entities will want to ensure they’re entering into agreements and signing partnerships with solvent users.
Identity verification and compliance are seeing increasing interest from fintech investors and highlighted by many top-tier venture funds as a thematic focus area for 2023, including Unusual Ventures in our 2023 fintech trends post. For good reason, too! Financial institutions and other entities want a 360-degree perspective of their customers that provides a comprehensive view of their profile as they evaluate risk.
Identity verification includes authentication and access, biometric authentication, authorization, and identification and onboarding. For the purposes of this blog post, we’ll focus on identity verification and onboarding to identify the customers and/or businesses you’re interacting with. Many of the modern solutions below leverage automation and machine learning to provide instant verifications without humans in the loop.
Mapping the identity verification sector and sizing the market
Billions of dollars have poured into the sector and the global identity market is projected to grow massively. In Europe, the compliance and risk management software market is expected to be worth $70bn by 2027, driven by factors such as increasing regulatory pressure, rising financial crimes, and the need for more sophisticated identity verification and monitoring solutions.
While identity verification is a massive market, in reality, it’s also a market where companies offer competing products that are largely seen as a commodity. You as an entity pay some amount to verify that the entity or individual you’re interacting or doing business with is legitimate. Aside from proprietary datasets and unique underwriting models, it will largely be a race to the bottom as these entities will seek to win on price of verification, speed of verification (which is often instantaneous), and/or better verification (better data on more enhanced views of underwriting and risk).
Biggest pain points in the identification industry and who will win
The identity verification space faces several significant pain points that pose challenges for users. There continues to be growing sophistication of identity fraud, with cybercriminals using advanced techniques that can outwit traditional verification methods. There are also many complexities and inefficiencies in the process as there is a lack of universal and a standardized approach to identify verification across industries and jurisdictions. This often leads to manual review and human intervention in certain cases, which slows down the verification process further.
Identity verification across borders presents even more challenges that make the market more complicated. Varying regulatory frameworks and data protection laws across countries complicate the verification process, as businesses must navigate complex compliance requirements to ensure legal compliance. There are also differences in identity document formats, naming conventions, and cultural practices that lead to more complexity. Verifying identities across borders often requires collaboration between multiple entities, such as governments, financial institutions, and technology providers, which can lead to coordination challenges and delays. In the E.U., there is GDPR, which aims to protect the privacy and personal data of E.U. citizens, but also adds another layer of complexity for identity verification.
Organizations must ensure compliance with GDPR’s data protection requirements when handling and processing personal data for identity verification purposes. However, there is no centralized identity database or unified digital identity framework across E.U. member states, meaning each country has its own procedures, document requirements, and authentication methods, leading to inconsistencies and delays. There have certainly been some efforts, including the launch of the European Electronic Identity and Trust Services (eIDAS) Regulation, to facilitate cross-border electronic identification. While it lays the foundation for standardized cross-border identity verification, there are still ongoing efforts to create full harmonization across the sector.
We’ve also found that many of these identity verification solutions are very strong in one market (typically where they start), but then are playing catch-up compared to other providers as they seek to enter new markets. A great example is Alloy, which has gained significant adoption in the U.S. with over 300 companies and has announced their plans to expand globally. Alloy uses more than 150 data sources to automate identity decisions during account origination and then continues to monitor those accounts on a recurring basis. While the U.S. has one set of rules and standards, it’s much more fragmented in Europe, where different countries have different sets of regulations and data sources stored in different places.
There are two approaches that startups are taking today in the broader onboarding and compliance space: be the source of truth for KYC, KYB, etc. or create an orchestration layer that aggregates various data sources together into one platform. Many startups have opted to become that source of truth, compiling data that will allow fintechs and other entities to efficiently onboard their clients. Many of these businesses take public data sources and combine them with their own proprietary data, models, etc. to create a unique onboarding experience. Many of these startups saw massive growth when COVID relief and the SVB banking crisis encouraged customers to open new accounts or pursue actions that required KYC/KYB checks. Many of these providers are strong in one or several countries, but are often behind when looking at other data providers. For any entity that is looking to onboard customers or perform compliance checks across borders, they will have to partner with multiple startup providers and/or partner with a legacy provider that may not have the most technologically advanced processes.
The other strategy is to build an orchestration platform that connects the best-in-class providers across geographies into one infrastructure platform. This is a great customer acquisition strategy as users can sign a partnership with one platform and then immediately have access to the best-in-class KYC, KYB, and/or AML provider in each geography. All else equal, these orchestration platforms have lower margins compared with the actual data providers themselves, but can guarantee users have the best solutions in a given geography instantly without having to negotiate new contracts with other players.
While orchestration platforms offer great customer acquisition strategies, this cannot be their long-term strategy to win. These solutions will need to become the de facto infrastructure that any company can easily use to onboard, monitor, and manage their various users. Over time, these orchestration platforms can roll out additional products including credit scoring, open banking, value-based pricing, etc. Orchestration platforms can enable customers to create dynamic onboarding flows that can be scaled seamlessly across multiple markets without worrying about local compliance regulations nor integrating new service providers.
Orchestration platforms will empower teams to create a tailored onboarding experience and customer reporting solution for AML and user management. This is why we’re so excited about our recently announced investment in Bits Technology. The Bits team has strong founder-market fit in engineering, product, and sales, having worked at leading tech companies including Tink/Visa, AWS, and Klarna. They have shown great success in hiring a world-class founding team.
What is the future of identity verification and LLMs?
Given the rise of Large Language Models (LLMs), it’s only a matter of time before they could significantly disrupt the field of identity verification. LLMs could be used to analyze and interpret various forms of identity-related data including documents, images, and biometric information to detect potential fraud or discrepancies. Many fintech startups in the application layer have initially focused on automating the compliance and regulatory documents and processes that are required. LLMs can also much more quickly process and cross-reference large datasets that can be used to identify patterns and anomalies that may indicate fraudulent activities. This can be done through the automation of the verification process that can reduce the need for manual review and expediting the overall procedure.
Startups in the identity verification space are already starting to package AI signals into their identity verification products. Soups Ranjan, CEO of Sardine, mentioned how he’s packaging Intrinsic AI signals (such as how you hold your phone, how you type, etc.) into their fraud and identity verification products. As more progress is made in this space, additional startups will adopt LLM solutions to strengthen their fraud and identity products.
As LLMs become more mainstream, there likely will be ethical considerations and responsible practices that will need to be enacted in the development of LLMs. Identity verification could be required to ensure that the researchers and developers adhere to these guidelines and ensure that the AI principles they are enacting are fair and are unbiased in the use of the technology.
If you are building in the identity verification or onboarding space, it’d be great to hear from you! Email me at tyler@unusual.vc.
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