What is KYC and Why is it Important for Crypto Exchanges?

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The crypto space is historically rife with scams and suspicious products that aim to make a quick buck from unsuspecting investors and everyday folk, and so it seems natural for there to be some skepticism toward this new digital frontier. 

Public and political fears over the legitimacy of cryptocurrency have proven themselves to be stifling for the industry. Whilst crypto and blockchain have somewhat of an anti-establishment vibe to them, they can’t be taken seriously or treated as legitimate products without the approval of the said establishment. 

Cryptocurrency exchanges and brokers represent the frontline of cryptocurrency, they provide access to digital assets and allow you to sell those assets for traditional money, otherwise known as ‘fiat’. 

With so many hacks, scams, money laundering schemes, and other nefarious activities, governments around the world called for some semblance of regulation, and one of the most important introductions into the world has been Know-Your-Customer, which is otherwise referred to as KYC.

In this piece, we’ll guide you through what KYC is, how it benefits you, as well as why it’s important not just for traders and investors, but the entire world of crypto and blockchain technology.

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The Drive to Comply

Cryptocurrency technologies need to comply with the law, this is a massive wall that if not overcome could prove dire for the crypto industry at large.

Sure, many of the amazing innovations and technologies to emerge out of this rather provocative industry are fantastic, world-changing marvels, they are still in rather infantile stages. In addition to this, cryptocurrencies are inherently global, and so creating a universal code of conduct and practice for each project would be detrimental to the evolution of the technology.

So how can this new technology, at least for the moment, be regulated in a way that protects people as well as the industry at the same time?

For years, blockchain platforms the world over have been bound in red tape and shut down because they fail to make a convincing argument that their platforms or products meet up to the necessary legal and regulatory standards.

There is also the issue of over-regulation, which if not handled properly could completely undermine the goals and innovations brought forth by blockchain technology, and so a fine line must be walked by both public, private, and government entities.

Forming lasting relationships that aid in bringing crypto out of the dark and into a state of mass adoption will prove to be a much need remedy to the issue.

What is KYC?

Financial institutions must ensure they are complying with AML/CFT regulations by implementing the Know Your Customer process. This includes identifying customers, understanding their businesses, and pursuing any suspicious activity that could indicate criminal or terrorist financing links.

The conventional KYC process involves a range of due diligence measures, along with ongoing screening and monitoring as customers engage with the services that a particular firm offers. KYC is important in financial contexts because criminals employ a range of strategies to evade AML/CFT controls: by building a rich, and accurate risk profile of each individual customer, financial service providers are much better equipped to detect customers that are misusing their services and to prevent crimes like money laundering and terrorism financing. 

Behind every single industry and sector are regulations that act as the official rules of play, they determine best practices and aim to guide the behaviors of industry participants. 

Regulations are typically brought in to stamp out foul play, market manipulation, improve consumer/worker safety, and so on; with that in mind, let’s explore what Know-Your-Customer (KYC) is, and why it’s an incredibly important regulatory element for crypto and blockchain technologies.

KYC is a globally-recognized standard of due diligence process used (typically) by financial institutions as well as other financial services companies, platforms, and so on. It allows firms and governments alike to monitor and assess customer risk, as well as verify a customer’s identity.

There are three main components to the KYC process, namely: ID verification, face verification, and document verification. Whilst for some this is intrusive, it is no more or less what you would need to sacrifice in order to gain access to banking, financial tools, or even a job. 

There are many ways to purchase, trade, and send cryptocurrency without the need to give up your identity (as you would with your bank). But many crypto companies, such as cryptocurrency exchanges, have opted to go along with this type of regulation, as it not only allows them to carry out their business in multiple nations and jurisdictions but also protects their customers. 

What does KYC mean in crypto exchanges?

Risk-based compliance: Following Financial Action Task Force (FATF) recommendations, crypto exchanges should adopt a risk-based approach to KYC compliance. Risk-based compliance requires firms to perform risk assessments of individual customers, and then implement a proportionate AML/CFT response. If an assessment finds that a customer is a high risk, the crypto exchange should deploy more intensive compliance measures – as opposed to simpler measures for low-risk customers. Risk-based compliance enables crypto exchanges to deploy their AML/CFT resources more efficiently, while protecting customers from negative experiences, as far as possible. 

In practice, digital KYC compliance means that ‘traditional’ KYC practices should be adjusted for the specific challenges that crypto exchanges face – and include the following measures and controls:

  • Identity verification: In order to build accurate risk profiles, crypto exchanges should be able to build accurate risk profiles for their customers. With that in mind, exchanges must obtain and verify identifying information from their customers, including names, addresses, birth dates, and relevant corporate information.
  • Customer monitoring: Exchanges should monitor their customers’ transactions on an ongoing basis, paying special attention to signs of criminal activity – which may include unusual transaction patterns, or transactions involving high-risk customers and locations. 
  • Screening: Exchanges must screen their customers to ensure that they are not subject to international sanctions, or that they are politically exposed persons (PEP), and therefore at higher risk of being involved in money laundering. 
  • Adverse media: Customer risk profiles may be informed by adverse news stories before the same information appears in official sources. Exchanges should screen on an ongoing basis to detect customer involvement in adverse media. 

What are the benefits of KYC in crypto?

Despite the operational changes and challenges that come with KYC regulations, crypto exchanges stand to gain substantive benefits by ensuring regulatory compliance, including:

Improved customer transparency and trust

Verifying user identities can both improve transparency and build customer trust — when users are confident your crypto exchange is taking proactive and precautionary measures to protect their accounts, they’re more likely to continue using your service.

Reduced potential for money laundering and other scams

As noted by Forbes, more than 80,000 instances of cryptocurrency fraud occurred in the United States last year — up 24,000% from 2016. Robust identity verification can significantly reduce fraudulent activity and boost market reputation.

Reduced legal risk

With legal expectations continually evolving, implementing robust KYC policies can put companies ahead of the curve — instead of running to catch up, they can focus on improving conversion rates, streamlining transactions, and ensuring compliance with evolving international guidelines. By demonstrating KYC due diligence, companies can reduce their risk of legal challenges or regulatory penalties.

Enhanced stability of the crypto market

The crypto market is notoriously volatile, in part thanks to anonymous transactions that are potentially suspect or criminal. Increased identity verification as part of KYC programs can help stabilize the market at large and boost its market value.

A Necessary Evil

Though it may fly in the face of the anti-establishment ethos driving cryptocurrencies, KYC is an incredibly necessary component of this industry.

In order to prevent, or at least minimise, the misuse of cryptocurrency for money laundering, illegal crime, or even terrorist financings, KYC puts customer identification front and center, allowing institutions, governments, regulators, and companies to have a better overview of their user-base. 

Consider this, if KYC had not been introduced into the crypto space, crypto-related crimes would likely continue to rise until governments outright ban the technology. Furthermore, and perhaps most importantly, KYC also means that the platform and service that you use is following regulations closely, meaning that your funds are more secure than they would be on a platform without KYC. 

If a cryptocurrency exchange, broker, or service provider has no KYC, you should be sure to do a lot of research into that company to see if it’s a scam-in-the-making. With no regulatory/government oversight, any crypto-related platform can simply disappear with all of your funds, and though it may be illegal to do so, it’ll be incredibly hard to catch them, especially if they don’t follow the most basic of regulations. 

That isn’t to say that you, as an individual, shouldn’t also do your own due diligence on the platform you are signing up to. Whilst most companies have a very strict and clear outline of how they use KYC data, it’s important to note that not every single regulated entity has good intentions at heart. 

Be sure to read over the KYC policy that governs your chosen platform, and if the company doesn’t have an in-depth explanation of how your data is collected and used, you should probably start looking elsewhere.

Conclusion

KYC for crypto is here to stay — and regulatory expectations are increasing worldwide as the volume and velocity of cryptocurrency transactions ramp up. As a result, crypto exchanges can’t afford to wait on deploying and integrating best-of-breed KYC solutions.

KYC regulations are now mandatory for major cryptocurrency exchanges as it ensures they comply with the law and regulatory rules. 

The aim of KYC, as mentioned, is to minimize illicit activities, alert authorities to suspicious behavior, and protect both businesses and individuals. 

Without KYC, cryptocurrency exchanges, brokers, or crypto-related financial platforms will be held liable when a user commits and gets away with committing a crime. On the other side of this, consumers are also at risk, as not only could governments decide to shut down a crypto firm without any care for customers a crypto platform can also disappear with little to no consequences.

Name Price
Bitcoin (BTC)
$29,256.00
Ethereum (ETH)
$1,943.23
BNB (BNB)
$320.86
XRP (XRP)
$0.401366
Cardano (ADA)
$0.51
Solana (SOL)
$48.82
Polkadot (DOT)
$9.95
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