The regulatory framework around cryptocurrencies has shifted significantly in recent years. Exchanges and other digital asset companies must implement Know Your Customer (KYC) processes to prevent money laundering and terrorism financing using digital assets.
Therefore, if you are a digital asset trader looking to enter this space swiftly, gaining the interest of leading organizations, financial firms, and brands, you should learn about KYC processes.
So, what is KYC? This article will dive into the intricate details of KYC processes. It will uncover the reasons behind this stringent requirement by many digital asset trading platforms and why people must verify their identities.
What is Know Your Customer (KYC)?
Know Your Customer (KYC) is the first step in customer onboarding. It ensures that one remains compliant with the global anti-money laundering laws seeking to curtail financial crimes.
A financial institution can assess a customer’s risk profile with KYC processes. When a KYC process is done well, cryptocurrency exchanges, wallet providers, decentralized finance (DeFi) platforms, and non-fungible token (NFT) marketplaces will avoid onboarding clients who can manipulate their platforms to cause financial harm.
The history of KYC guidelines dates back to 1970 when the US government adopted the Bank Secrecy Act to curtail money laundering. These regulations have been in place for years, mandating firms to supervise customer behavior.
There is no exemption to compliance with KYC laws, and any financial service company must create a KYC strategy to engage with customers.
The Components of KYC
The KYC process can be comprehensive, but it only takes a short while for a customer to be verified, depending on the processes and systems put in place by a platform. The KYC process involves the following:
Customer Identification Program
The Customer Identification Program (CIP) is the first component of KYC processes. This process involves garnering information about a customer, including their name, date of birth, address, and identification number.
The digital asset trading platform will then start screening to ensure a customer is not on a sanctions or terrorism list.
Customer Due Diligence (CDD)
The second part of the process is the Customer Due Diligence (CDD), in which the financial firm classifies the information collected from a customer.
The objective is to secure ample information about a customer to verify their identity and assess their risk level.
The CDD process does not happen once. Instead, it is a gradual process. Financial firms will continually monitor a customer’s financial transactions to detect any unusual increase in activity. Changes in the sanctions lists will also be used to verify customers periodically.
KYC in the Crypto Industry
KYC in the crypto industry describes a list of steps cryptocurrency firms should follow during the onboarding process. It entails verifying a customer’s identity and conducting due diligence to understand their risks and financial activities.
A crypto company must collect details like the legal name, date of birth, address, and government identification number during the KYC process.
The company will then use its identity verification service to ensure the information you provide is accurate. This typically involves a biometric process like capturing your real-time picture.
The information that you provide the exchange during the verification process will be retained. Sharing KYC information with a crypto company is usually safe as these companies use advanced security technology to preserve the information.
KYC is also part of the anti-money laundering (AML) guidelines, which involves creating and implementing crypto policies.
Accounts must be screened against sanctions lists, watchlists, etc., to ensure that an exchange remains compliant with the systems set in place.
Regulatory Landscape for KYC in the Crypto Industry
When Satoshi Nakamoto published the Bitcoin whitepaper in 2008, he envisioned a revolutionary financial landscape that operated outside the confines of the control of governments and central banks.
During the early years of the crypto market, crypto firms implemented lax KYC processes as there was limited regulatory oversight.
However, this has changed significantly over the years, with companies needing to abide by the same guidelines governing traditional firms.
Crypto firms operating in the US are mandated to comply with AML and KYC guidelines. Crypto exchanges are defined as money service businesses (MSBs) under federal law, making them compliant with the Bank Secrecy Act.
The non-compliance of some US crypto exchanges has caused some of them to land in regulatory trouble.
For instance, the founder of the world’s largest cryptocurrency exchange, Binance, Changpeng Zhao, was sentenced to four months in a US prison for failing to enforce compliance on the platform.
The European Union (EU) is also implementing one of the most robust regulatory frameworks around crypto assets, the Markets in Crypto Assets (MiCA) laws.
The MiCA laws target virtual asset service providers (VASPs), requiring them to register with the relevant authorities and safeguard investors.
Benefits of KYC in the Crypto Industry
The KYC process can be challenging for some customers. Submitting personal information can lead to skepticism over how such information will be protected and not fall into the hands of threat actors.
Nevertheless, this process benefits cryptocurrency exchanges, users, and the entire industry. Below are the benefits of KYC in the crypto sector:
Increased transparency
The first benefit of KYC processes is increased transparency. When an exchange verifies the identity of customers, it will protect all the other customers on the platform. Moreover, it will also show that the exchange is taking proactive measures to safeguard accounts.
Anti-money laundering
Money laundering scams have been prevalent in the global financial industry. Some of the funds laundered include the billions that have been lost to crypto scams and hacks.
When exchanges implement solid KYC measures, it will prevent money laundering, consecutively reducing scams and hacks.
Market stability
The crypto sector is notorious for volatile price actions. In some cases, the volatility of prices can spike because of negative news such as regulatory enforcement, etc.
However, with KYC processes, the crypto market becomes more regulated, which boosts overall stability and value growth.
Low legal and regulatory risk
Crypto businesses implementing robust KYC processes can also remain ahead of the curve. Such platforms have fewer instances of fake identities, money laundering, and heightened customer risk.
With these processes, businesses can lower legal and regulatory risks by being compliant.
The Challenges of KYC in Crypto
While there are apparent benefits to implementing KYC processes in the crypto industry, the challenges also exist. Some of these challenges include the following:
Private and security concerns
Security concerns are one of the main challenges of KYC processes in the crypto industry. When customers submit their names, email addresses, and other personal details with an exchange, such information will be preserved with the exchange for a long time.
Threat actors are always looking for ways to steal such information. Over the years, there have been several instances of customer data being stolen.
Therefore, before you open an account with any cryptocurrency exchange, assess the security measures put in place. You should also check if an exchange has been hacked in the past.
User resistance
The crypto industry pays much attention to decentralization and gives users control and privacy over their financial information. While this was why the industry was created, compliance with financial laws has become necessary.
Moreover, the Know Your Customer process on some crypto exchanges might affect the overall user experience. Nevertheless, despite the challenges, the KYC process carries many benefits with the potential to promote value growth.
In Summary – Know Your Customer (KYC)
The cryptocurrency industry continues to witness solid growth, attracting regulators’ attention. Firms seeking crypto products and services must comply with anti-money laundering and counter-terrorism (AML/CTF) guidelines.
To achieve compliance, crypto businesses must implement Know Your Customer guidelines on their platforms.
They can accomplish this by encouraging customers to share their official names, addresses, government-issued identification, etc.
FAQs
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What does KYC stand for?
KYC stands for Know Your Customer. It is a regulatory requirement for businesses to verify customers’ identities on their exchanges.
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Why is KYC important in crypto?
KYC is important in the cryptocurrency industry as it helps prevent the use of digital assets to commit financial crimes like money laundering and terrorism financing.
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What documents do I need for KYC verification?
The process of KYC verification differs from one crypto firm to another. The documents needed include a government-issued identification document such as a national ID, passport, or divers license. You must also submit a document showing proof of address and a selfie or video for biometric verification.
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How long does the KYC process take?
The KYC process differs from one exchange to another. Sometimes, it could take minutes or hours; in others, it could take days.
