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…I'm not sure how that mechanism works you're suggesting, but if you get a piece of text in the end, that you can store as a password using the API. This would only require changing parts of the Activiti-explorer (user-creation and authentication) which is less drastically than altering user-management. If it's a more complex approach, you'll have to override the identity-stuff, indeed.
The explorer-app is intended as a "demo app", a good place to start. This is the reason why we're not putting in effort for password-encryption because this depends on the required implementation…….