What is KYC and What Does it Mean for Crypto?
Financial service providers must identify and authenticate their consumers through the Know Your Customer (KYC) policies. They constitute an important part of the AML/CFT (Anti-Money Laundering/Combating the Financing of Terrorism) compliance. With bitcoin and other digital currency exchanges getting increasingly popular, Know Your Customer (KYC) practices have already become the norm.
According to KYC requirements, crypto exchanges should collect and verify user information to prevent illicit activities. These checks help financial service companies manage their risks and establish credibility. Some, however, argue that it eliminates the privacy and decentralization that crypto is known and loved for.
The major KYC rules
If you’ve ever registered an account with a cryptocurrency exchange, then you’re probably aware of how a KYC process works. During onboarding, customers should verify their identity, which can be done, for example, through bank statements. Under certain circumstances, accounts can be registered without the KYC process, although their functionality will be limited.
Users may be requested to supply the following information when completing KYC:
- Government-issued ID
- Valid driver’s license
It’s also crucial to authenticate customer location and address. Identity cards provide basic information such as the name and date of birth, but some extra information is required to establish the tax residence, for example. There’s a good chance that customers will have to go through more than one step of KYC. Plus, financial companies are required to regularly re-verify their customers’ identities.
KYC policies, as well as AML regulations in general, help fighting against money laundering, terrorism financing, fraud, and unauthorized transfers.
Who is in charge of ensuring KYC compliance?
Although country-specific KYC requirements exist, they are fundamentally similar. The problem lies in regulating KYC compliance because regulatory landscapes are fragmented practically in any location. In the US, most of the AML and KYC processes are controlled by the Bank Secrecy Act and the 2001 Patriot Act.
Countries in other parts of the world have formed their own legislation, but it’s usually identical to the one used in the United States. For the EU countries, these policies are regulated by the EU Anti-Money Laundering Directive (AMLD) and PSD2 laws.
There are also international efforts put into unifying the regulatory approach to AML/KYC practices. The Financial Action Task Force (FATF) is a global organization that oversees how the requirements are followed in different jurisdictions and promotes international cooperation in fighting financial crime.
Why are KYC policies required in the crypto world?
Due to its anonymous nature, cryptocurrency is frequently used for money laundering and tax evasion. Improving cryptocurrency regulation can boost its reputation and ensure that taxes for crypto gains are properly paid.
In the bitcoin sector, KYC checks are necessary for three reasons:
- Transactions based on the blockchain are irreversible. If you make a mistake, funds can be stolen or relocated and not recovered.
- Cryptocurrency provides a high level of privacy. To open a crypto wallet, you do not need to provide any personal information.
- In most countries, the issues regarding taxation and the legal status of cryptocurrencies are still up in the air.
Although KYC makes it slower to open an account, it provides advantages to both crypto businesses and customers. KYC has a significant impact on keeping users’ money safe and preventing fraud, while also solidifies the reputation of crypto in general.
What are the advantages of adopting KYC policies?
KYC practices can do a lot more than merely fight fraud:
- Establishing customer identity and financial history allows lenders to more quickly and efficiently assess their risks.
- These policies make it harder for cybercriminals to perform identity theft and other illegal activity.
- As a preventative step, KYC rules lower the possibility of money laundering.
- They establish the credibility of financial service providers and tell about their dedication to security.
Disadvantages of using KYC policies
Although KYC requirements offer evident advantages, its adoption is nevertheless considered controversial. For bitcoin and other digital currency enthusiasts, there are several concerns connected to KYC:
- Conducting KYC checks brings additional costs, which are sometimes passed on to customers in the form of fees.
- Some people lack the necessary documents for KYC checks or may not have an established address. They can be left out.
- Data security will anyway remain a pressing issue, and hackers will continue stealing crypto by improving their techniques. Crypto platforms should regularly update their security measures to address this.
- Some people claim that KYC is generally incompatible with cryptocurrency because the latter should be different from other assets: it should be kept anonymous, decentralized, and less governed by authorities.
The nature of crypto and Know Your Customer (KYC) practices
Since the introduction of crypto, decentralization has been promoted as its major benefit that makes it stand out and attract users. As we’ve mentioned, anyone can create a wallet and buy cryptocurrency without submitting any personal information.
While privacy-related features of crypto are seen as its biggest perks, they also represent the biggest threats for the industry. Crypto has become a popular means of money laundering because of its anonymity.
Different authorities in different jurisdictions require crypto exchanges to conduct regular customer KYC checks. We can expect a more unified approach coming to the world of crypto, as well as just more regulations and laws applicable to purchasing, trading, and using crypto for other purposes.
For cryptocurrency exchanges and any other crypto-related businesses, the adoption of KYC procedures is the industry standard. KYC plays a crucial role in the battle against money laundering and other types of criminal activity in general and in the world of digital currencies in particular. KYC checks may seem inconvenient or contradictory to the very nature of crypto, but they give a high level of protection to both businesses and customers.