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KYC is the acronym for Know-Your-Customer. It is an essential process in verifying an investor’s identity.
This is a vital step in beginning one’s crypto transactions. If you are a crypto beginner, make sure to learn all you need about the Know-Your-Customer (KYC) process.
Let’s get started with this blog post that will explain about KYC in the simplest terms possible.
Know-Your-Customer (KYC) Definition
The Know-Your-Customer (KYC) is a process that financial institutions execute to validate the identities of their users. It is a form of background check to ensure that participants who want to use their financial services are legit and have no criminal records. Hence, it plays a role in preventing fraudulent activities that can disrupt a business.
It is also in compliance with the programs that prevent anti money laundering (AML). Know-Your-Customer (KYC) policies began in the United States in 1990 to combat money laundering and identity theft.
Anti-money laundering policies have been enforced since the implementation of the Bank Secrecy Act of 1970. AML protocols aim to deter criminals from laundering cryptocurrencies using a crypto exchange.
KYC Process in Crypto Exchanges
Based on the recommendations from the Financial Action Task Force (FATF), crypto exchanges must adopt a risk-based approach to KYC compliance. Risk-based compliance requires crypto exchanges to conduct a risk assessment for each of their clients. Then, enforce an AML or CFT appropriate action.
When the risk-based KYC evaluation discovers that a client is high risk, the crypto exchange will resort to more exhaustive compliance measures. Through risk-based compliance, crypto exchanges can implement their AML/CFT policies efficiently while shielding their customers from negative transactions.
What is the Know-Your-Customer (KYC) Procedure?
All in all, there are three steps in the KYC procedure.
First, the crypto exchange asks for the personal information of their customers. Some of the required data are the customer’s name, place, date of birth, and address.
Second, the crypto exchange verifies the identity of the customer through the government-issued identification that they submitted. It could either be a passport, driver’s license or utility bill.
Third, the customer’s identity is further checked against official databases that contain the relevant data.
Benefits of KYC in Cryptocurrency
Less legal risks
There is always constant change when it comes to legal requirements in the business sector. Strictly implementing KYC policies will help crypto companies prevent the proliferation of fake identities and money laundering. Furthermore, practicing KYC due diligence allows crypto companies to avoid legal problems and regulatory penalties.
Moreover, instead of spending so much time trying to catch up with every update on legal policies, crypto businesses can instead focus on raising their conversion rates, making transactions hassle-free, and maintaining 100% compliance.
Improved market stability
The anonymity of cryptocurrency transactions makes it suspicious to the public and financial authorities. This also contributes to the highly volatile and unpredictable nature of the crypto market.
Through KYC implementation, identity verification of the investors becomes easier. This increases confidence among crypto users. Hence, this increased confidence will lead to higher trust within the crypto community.
Better Customer Trust
If clients know that the cryptocurrency exchange they use goes to extreme lengths to protect their assets, they will be more motivated to use the said crypto exchange. Also, the good feedback from clients regarding security will work as an effective marketing tool that will increase the users of an exchange.
Reputations can be Protected
Cryptocurrency exchanges that fully follow KYC programs have a better chance of preventing fraud and crypto scams, and safeguarding their reputations in case a hack or breach happens. They can quickly close and freeze accounts that look suspicious or maybe linked to criminal activities.
Conflict with Crypto Exchanges
KYC clashes with the decentralized nature of the cryptocurrency network. Most of the exchanges who allow crypto trading or investment cannot actually identify the true identities of their users.
It is part of a decentralized system that they allow their participants to remain anonymous. However, the steady insistence from financial regulators resulted in crypto exchanges gradually adopting the Know-Your-Customer (KYC) requirement in their operations.
Therefore, crypto exchanges had no other choice but to integrate the Know-Your-Customer (KYC) process.
For example, Binance, the world’s largest cryptocurrency exchange in terms of trading volume, announced in August 2021 that they will require new clients to submit a government-issued ID and undergo facial verification before making trades or investments.
As a result, U.K. and Japan no longer allowed Binance to operate in their countries.
BitMEX is another crypto exchange that implemented KYC authentication. They asked new customers to provide their trading experience or history together with personal identification. Previously, new users only needed an email address to create a BitMEX account.
It is important to note that decentralized exchanges (DEX) do not need KYC compliance. Investors who execute trades via smart contracts instead of using a central trading desk need not reveal their true identities. Decentralized exchanges (DEX) are not financial counterparties or intermediaries. Therefore, trades happen directly among their users.
Are There Any Risks for KYC Implementation?
The cryptocurrency space is highly digital and comprises new technology. This is why enforcing the Know-Your-Customer (KYC) policy can be a bit tricky.
We know that transaction speed is of utmost importance in crypto exchanges. but, these exchanges need to make sure that the required AML/CFT checks are all accomplished before they approve the fund transfer.
Additionally, money launderers dodge the honest reporting of their thresholds by carrying out transactions in small amounts via various accounts. Crypto exchanges should regulate the creation of multiple accounts. They also need to be aware of the structuring strategies that the launderers use and share this data with other financial service providers. This way, they can combat money laundering more efficiently.
Another problem is the money mules. These are participants that money launderers coerce or incentivize to carry out crypto transactions for them. Crypto exchanges also need to double down on these mules by checking their activities and profiles rigorously. If their profiles do not match their expected wealth or financial activities, they should be flagged and sanctioned in some way.
In conclusion, the Know-Your-Customer (KYC) process may be a hassle for some but it is necessary to prevent financial crimes from happening especially in the cryptocurrency space.
Hackers have stolen large amounts from crypto exchanges. Losing money in millions and billions does not bode well for crypto exchanges because not only do they lose digital assets, they also lose the trust of their clients.
The KYC is beneficial to both clients and exchanges as it helps build trust and encourages transparency.