Cryptocurrency, often referred to simply as crypto is a digital currency (as opposed to physical conventional money) that uses cryptography to secure transactions. There usually exists a central issuing and regulating authority for all physical fiat currencies, e.g. the Federal Reserves for the American Dollar. Cryptocurrency however has no such central issuing or regulating authority. It uses a decentralized system for the issuing of new units and the recording of transactions. With crypto, encryption is used to verify transactions.
Since crypto is an asset that can be exchanged for conventional money, it is highly important to know the persons involved in crypto transactions. This is where cryptocurrency exchanges are saddled with the responsibility of conducting Know Your Customer (KYC) exercises for persons who make use of their platforms.
KYC entails verifying the identity of customers, conducting some background checks on them and continuously monitoring their transactions to ensure that they are not involved in financial crimes such as money laundering, terrorist financing or trafficking in persons. Conducting KYC protects businesses and limits their exposure to criminal liability when a customer uses their platform for illegal activities.
What Are Cryptocurrency Exchanges?
A cryptocurrency exchange (sometimes known as Digital Currency Exchange) is an online platform where buyers and sellers of crypto meet to trade crypto. A cryptocurrency exchange is like a marketplace for the trading of crypto. Cryptocurrency exchanges provide an online platform and serve as intermediaries between the buyers and sellers of crypto on the platform provided.
Is KYC Necessary In Crypto?
Billions of dollars worth of crypto has been traded by millions of persons across the globe since the inception of cryptocurrency. By its nature of providing anonymity for traders, crypto is vulnerable to fraud and can be easily used to illegally move money around and commit serious financial crimes without leaving obvious digital footprints behind.
This defeats the goal of Anti-Money Laundering (AML) laws and regulations. It is because of this that governments of different countries and their regulatory agencies have ensured that cryptocurrency exchanges adopt and conduct KYC processes for their customers.
In fact, since cryptocurrency exchanges have been defined and categorized as Money Service Businesses (MSBs) by federal regulations, KYC has become mandatory for most crypto exchanges. The large volumes of financial transactions they process have made regulatory agencies put in place rules and regulations to guide the operations of cryptocurrency exchanges.
What Are Some Benefits of KYC In Crypto?
Some of the benefits of KYC in crypto include:
1. It Helps To Detect And Track Criminal Activities
Anonymity is one privilege that crypto traders enjoy a lot. Cryptocurrency provides privacy for all the transactions of its traders. Persons have hidden under the cover of anonymity and privacy in crypto to perpetrate financial crimes. Without KYC in crypto, these financial crimes will not be easy to detect, track and report to the relevant authorities. If such should continue, the crypto industry will be marred by a lot of fraudulent financial activities.
2. It Paints The Cryptocurrency Industry In A Better Light
People have had serious reservations about crypto, especially in its early days. One of the major concerns of people was the fact that cryptocurrency exchanges did not have sufficient information about the people that trade on their platforms, hence making the platforms prone to scams and hacks with little or no means of identifying culprits.
But with the adoption of KYC in crypto, people have more confidence in the crypto industry, knowing that cryptocurrency exchanges now conduct KYC processes before allowing customers to trade on their platforms. This boosts transparency, builds user trust and paints the crypto industry in a better light.
3. Cryptocurrency Exchanges Are Held To A Higher Standard Of Compliance
By ensuring that crypto exchanges comply with KYC requirements, some level of compliance and safety standards are placed on them. This makes cryptocurrency exchanges work towards living up to such expectations to avoid any penalties that may arise due to violation. Without KYC in crypto, cryptocurrency exchanges would be held to almost no standard of compliance at all.
4. Reduced Legal Risk For Cryptocurrency Exchanges
Demonstrating their due diligence in KYC and AML practices can help crypto exchanges mitigate the risk of facing legal disputes or regulatory fines. Even when attempts at fraudulent activities have been made on their platforms, their exposure to criminal liability is greatly reduced, as long as they are compliant with KYC and AML regulations.
This allows crypto companies to prioritize improving their conversion rates, making transactions more efficient, and adhering to evolving global regulations instead of spending time and resources on court cases, regulatory fines and penalties.
5. Provides More Protection To Crypto Traders
The deployment of KYC in crypto has greatly reduced the potential for money laundering and other fraudulent financial activities capable of plaguing cryptocurrency exchanges.
The introduction of KYC in crypto has therefore guaranteed more protection for traders on KYC-compliant cryptocurrency exchanges. In the event of any hacks that lead to loss of money, the exchanges can easily track persons involved based on the information and details obtained during KYC processes.
What Are The Challenges Of KYC In Crypto?
As beneficial as the deployment of KYC in crypto is, cryptocurrency exchanges are faced with certain challenges in the course of implementing KYC processes. Some of these challenges include:
1. Tendency of Violating Data Privacy Laws And Regulations
As crypto exchanges collect and verify the information of their customers during onboarding, they need to be extremely careful in how they store, handle and process such information (especially Personally Identifiable Information) so as not to breach or violate existing data protection laws and regulations.
2. Reduced Anonymity In Cryptocurrency
A lot of cryptocurrency traders have expressed their unease at the introduction of KYC in crypto. Most users believe the implementation of KYC in crypto has stripped the digital currency of its major feature of anonymity, which was what made it attractive to several users. These concerns have made some crypto enthusiasts shy away from the crypto industry.
3. The Complex And Cumbersome Nature Of KYC
The different stages and components of KYC are not easy tasks that can be walked over. Crypto exchanges are having to brace up and look for ways to ensure they are not overwhelmed by the often complex and cumbersome requirements of KYC. Those who have adopted automation and the use of KYC solutions can easily surmount this challenge.
For more on KYC Automation, read: Digital Customer Onboarding Process: Why You should Automate your Customer Onboarding Process
How Does KYC Work In Crypto?
Just like KYC conducted by banks and other financial institutions, the process for KYC in crypto can be broken down as follows:
i. Cryptocurrency exchanges collect personally identifiable information (PII) of their customers such as name, date of birth, address and ID number at the point of the customer's registration with the crypto exchange.
ii. The crypto exchanges request valid means of identification from the customers, especially government-issued IDs such as National Identity Cards, Driver's Licences or International Passport.
iii. The cryptocurrency exchanges then compare the personally identifiable information (PII) collected during registration with the means of identification submitted by the customers. This is to confirm and verify the identities of customers.
Recommended: Identity Verification Questions - Frequently Asked Questions On Identity Verification
iv. The crypto exchanges conduct searches in official databases of Politically Exposed Persons, watchlists and sanctioned individuals to determine the individual risk profiles of customers and the likelihood of their involvement in financial crimes.
v. The cryptocurrency exchanges continuously monitor the transactions of customers for suspicious and unusual transactions to report to the necessary regulatory authorities and help law enforcement agencies to track criminal financial activities.
Conclusion
As much as ensuring anonymity and protecting the privacy of crypto traders is at the core of cryptocurrency, verifying customers' identity, conducting due diligence and monitoring customers' transactions continually are crucial KYC requirements that must also be considered.
When the requirements of KYC in crypto are adopted and upheld by cryptocurrency exchanges, their processes become more standard and safe. People would have more confidence in a crypto exchange that conducts KYC than in one that does not.
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