Know Your Customer or KYC is the process of getting information from your clients about who they are, what they do, what kind of transactions they will be doing. KYC is used to protect a finance institution or company along with its other clients from fraudulent and illegal activities including money-laundering. We can say that KYC under anti-money laundering (AML) strategies, but there are more strategies other than KYC when it comes to AML.
READ: Know the Risks, Know the Clients
And when the US declared that all crypto exchanges are defined as money service, KYC then became a requirement for all crypto activities. That said, KYC for physical finance vs virtual institutions are different from one another. And we’ll further discuss those in this blog.
READ: ABCrypto: The basics of digital assets
Why is KYC important?
As of 2021, ransomware victims paid close to $350 million worth of crypto assets to attackers. That is a 311% increase in comparison with its previous year’s data. This data is according to the Chainalysis Data Crime Report 2021.
Other than ransom attack payments, crypto can also be used to fund and transact illegal activities like money laundering, funding terrorism, tax evasion, and others. But with the KYC process, it helps institutions raise flags for suspicious accounts and crypto transactions.
Brief history of KYC in Crypto
Based on a joint statement issued by the Financial Crimes Enforcement Network (FinCEN), the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) in 2019, cryptocurrency exchanges was defined as money service businesses (MSBs), thus making them subject to AML and KYC regulations under the Bank Secrecy Act in the US. Before 2019, no specific law that regulates KYC for the protection of crypto and virtual money was in place making the industry insecure and a high target for the black market.
And since 2019, new regulations have followed. And other countries made their own laws or updated their regulations too. It is also best to know that each country has its own law that covers KYC in crypto.
Latest updates on KYC compliance for crypto transactions (2022)
As mentioned above, each country has its own law that covers KYC in crypto. Listed are the updates for KYC in crypto based on its country
Most of the countries above updated their AML laws to include digital trading and cryptocurrencies in regulation and crime prevention; as well as further defining what covers cryptocurrencies and digital assets. Unlike China, who has completely banned crypto mining and trading since 2019.
So what kinds of info is asked during the KYC process in crypto?
Just like the KYC processes in physical financial institutions, KYC processes in virtual worlds vary from which and what jurisdiction they run in. But in most cases, they do require the same basic information when creating accounts or making transactions, such as:
- source of funds
- address or physical presence
What differs is the exact type of documentation which will change if the account owner is a person or a legal identity. Other than that, creating a crypto account usually asks for those top three info mentioned above.
So what happens if no KYC is done?
While some may be concerned about sharing their identity to a virtual trading platform, as well as questioning the ethics of sharing identities in a supposedly decentralised trading ecosystem, there will be countries that require KYC process and will be required to be followed. In those cases, it would also be best to look into the platform’s data and privacy policies before engaging in it.
It’s also best to note what happens when KYC is done and vise versa. According to Shapeshift, a crypto exchange platform, it lost 95% of its users as a result of the KYC measures it was forced to implement.
However, there are platforms that let users create an account without the KYC process but are limited to using their platform from trading or withdrawing crypto funds. While there are platforms that let users who did not go the KYC process able to withdraw funds, but on a certain limit.
Also, there are also platforms that allow crypto trading without KYC, but such action is risky as there was no assessment done on every possible profile accessing the platform.
Traditional KYC vs Virtual KYC
Aside from adjusting the identity verification to adapt to the virtual system from the traditional physical system, there are several differences between traditional vs virtual KYC. Some of the are listed below:
- ensuring the accuracy of identity proof
- adjusting virtual transaction verification processes
- detecting virtual money mules
KYC risks in Crypto
Crypto and digital assets exchange platforms, as well as fund managers and administrators, use systems and algorithms or tools to look into transactions and make sure that they are KYC compliant. Here are what to look for according to Financial Action Task Force (FATF):
- Anonymous transactions
- Transaction speed
- Structured transactions
- Money muling
- Transaction Type
- Transaction Pattern
- Senders and Recipients
- Source of Funds
- Geographical Risks
Benefits of KYC in Crypto
That said, there are benefits of applying KYC due diligence in crypto. This is why countries and regions like the EU are imposing it and are looking into improving it. Ensuring that KYC process is well executed and applied, it provides:
- customer or client transparency
- enhanced stability and sound crypto market
- enhanced customer trust
- reduced risk for money laundering activities
Each country and jurisdiction have set their own rules based on their own rules on how to apply KYC in Crypto. At the end of the day, these KYC in crypto laws and its updates are made to secure the financial structure that digital assets hold on to.
There are also slight differences between KYC processes for physical and digital assets like crypto that digital assets exchange platforms and fund managers or administrators use to manage cryptocurrencies.
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