Years down the line, cryptocurrencies have altered how we transact, free of intermediaries in a decentralized world. However, this anonymity also opens them up for abuse. As a result, building a safe and compliant environment is, in turn, becoming something of a demand as cryptocurrency matures.
Now, let’s talk about KYC, or ‘know your customer,’ a regulatory process that, like everything else in crypto, aims to allow freedom while simultaneously enabling security in crypto transactions. So, how does a crypto firm put this into practice? And what is KYC, to begin with? In this guide, we’ll tell you how KYC plays a central role in crypto and how it is the gatekeeper of compliance.
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Table of contents
What Is KYC?
In simple terms, KYC is the act of verifying that your customers are who they say they are. Such a program was originally designed for the more serious, budget-minded old guard in finance, i.e., banks, but now it’s mandatory crypto. The primary aim? Preventive legal measures against criminal conduct, including money laundering, fraud, and financing of terrorism.
It was after the events of 9/11 that KYC became widely adopted, as global authorities drew attention to the need for stricter financial regulations. First used in banking centers, KYC was deployed to the cryptocurrency world to ensure transparency and protect against the use of digital currencies for illegal purposes.
For instance, when conducting a KYC process, you must enter your name, address, and date of birth, and even provide a government-issued ID. Then, several verification techniques are used to cross-check the information through document authentication and biometric data, among others, to affirm validity.
The KYC Process in Crypto: How It Works
The KYC procedure in crypto follows a structured workflow. While details may differ between platforms, crypto services generally follow three steps to implement KYC effectively.
Step 1: Collecting Personal Information
The KYC process starts when a user registers on the crypto platform. Here, the person needs to submit personal info like the person’s name, address, date of birth, and mobile phone number. Along with this, they must produce the photographic ID of a government-issued body.
This step is semi-automated for most platforms, and tools can sometimes automatically fetch ID data from IDs. Because any errors here could be compliance issues, a higher accuracy level is necessary in processing such sensitive information. This is why most of the services depend on data entry automation and tools like Optical Character Recognition (OCR) to minimize the chances of errors from human hands.
Step 2: Verifying Identity
The second phase is then to verify that the personal information is authentic. Usually, such actions go hand in hand: a check of a provision-made identification document and confirmation that the person presenting it is the person they claim to be. Typically, document verification is even performed using software solutions that can read and verify ID details.
In fact, some platforms go further by employing facial recognition technology and liveness checks (e.g., where a user has to perform an action to prove they are live), such as taking a selfie just before verification. Furthermore, data from multiple sources is cross-referenced so that the information provided is accurate and up-to-date.
Step 3: Conducting Due Diligence
In cases where a user encounters a red flag or exceeds an activity threshold, crypto firms can initiate extra checks, which are known as due diligence. The idea of this step is to check whether the customer is actually who they say they are and to determine if they pose any risk to the platform.
This may include comparing the user’s information against public records, doing background checks, and getting further verification, such as whether they provided a valid address by submitting utility bills. The checks are to ensure that the crypto platform satisfies the anti-money laundering (AML) laws and that no unlawful activity is going on in the name of a normal user.
Decision Making: What Happens Next?
Once all the syndicates are completed, the crypto platform will decide whether or not to give the user a green light to continue. If the user’s identity has been confirmed and no issues are found, the user gains full access to the platform services, including buying, selling, or transferring cryptocurrencies. On the other hand, access is denied if the platform finds any risks or discrepancies.
In addition, even when a user has been approved, the platforms will keep an eye out for suspicious behavior. But by keeping up with this ongoing surveillance, it means that if something triggers an alarm, the crypto company can scramble to stop fraud or something of that nature from occurring before too much time passes.
Why Does Crypto Need KYC?
While the crypto world is frequently praised for its ability to function outside traditional financial systems, it always comes with great risks. As a result, KYC plays a key role in mitigating these risks by providing the following benefits:
1. Compliance with Regulations
There are crypto exchanges worldwide, regulated differently in each country. In many jurisdictions, platforms must perform KYC across the platform to comply with AML and Counter Financing of Terrorism (CFT) laws. By adopting KYC, exchanges can be assured that they are operating within the boundaries of local regulations.
It can also prevent them from running afoul of authorities and being subject to penalties, legal action — including permanent closure — or even being banned from operating across the internet or in a specific market.
2. Reducing the Risk of Financial Crimes
One of the main goals of KYC is to reduce the risk of financial crime. Anonymous environments facilitate fraudulent activities such as money laundering and financing of terrorism. Due to their pseudo-anonymous nature, criminals increasingly use cryptocurrencies. KYC procedures can minimize these risks by ensuring that those who carry out transactions are legitimate and traceable.
Forbes also reported that cases of cryptocurrency fraud in the U.S. increased by 24,000% from 2016 to 2020. KYC implementations enable crypto platforms to prevent such crimes by denying service to individuals with malicious goals.
3. Trust and Transparency
Trust is an important factor in any business. Consequently, KYC establishes trust between the platform and its users by verifying their identities and ensuring that the services provided are safe. Customers are more likely to stick around when they feel the platform takes the appropriate precautions to protect their personal data, financial interests, etc.
4. Combating Identity Theft and Fraud
Cryptocurrency exchanges are a very lucrative target for hackers looking to steal or create synthetic identities to carry out illegal activities. Therefore, KYC is an effective countermeasure to such tactics. Platforms can verify user identity to detect and stop fraudulent activities before they happen. Technologies like facial recognition and liveness detection further add a layer of security, making it less likely for a scammer to use stolen or fake IDs to get in.
5. Improving the Integrity of the Crypto Market
The cryptocurrency market has a bad reputation for being volatile, where some of it originates from illegal activities. For instance, the market can be destabilized by unverified transactions and illicit money flows, making it harder for legitimate users to operate.
What KYC does is that it removes the anonymity that has fueled much illicit trade. As more exchanges accept KYC, the market at large becomes more stable and reliable, which may drive wider adoption of cryptocurrencies.
The Benefits for Crypto Companies
In addition to being a regulatory requirement, adopting KYC procedures has benefits for crypto businesses, as it helps create a safer and more sustainable environment in many ways.
1. Regulatory Compliance
The KYC procedure here involves some regulatory requirements that crypto businesses have to follow. As global regulations tighten, so do the regulations, and companies must follow KYC standards to remain compliant to avoid penalties and to keep their operational legitimacy.
2. Customer Trust and Retention
Security authentication on crypto platforms can showcase their commitment to security, hence increasing user loyalty and retention. By taking a transparent approach, crypto platforms can stand out in an increasingly competitive market.
3. Fraud Prevention
The key is KYC, which will prevent crypto firms from becoming complicit in fraudulent activities. However, this is not merely to become compliant; it also helps protect a platform’s reputation. Bad actors can continue to thrive on networks without KYC, severely damaging the platform’s and the larger crypto industry’s reputational integrity.
4. Risk Mitigation
A good KYC process can also spot zombie customers or other dubious activities at an early stage. This protects businesses in the long term by helping them reduce their risk of legal liability, financial loss, and negative publicity.
Conclusion: The Future of KYC in Crypto
KYC is far more than a regulatory checkbox; it’s the foundation for safe and transparent crypto. If you’ve watched crypto morph from the depths of the dot-com boom to where it is now, you’ll likely get that KYC regulations are only going to grow more intricate until they poke every crevice of identity verification.
Since we have seen the emergence of crypto firms, it is also advisable and compulsory for crypto businesses to go a step further and be in control of their regulatory requirements and effective KYC practices. Therefore, with a well-established KYC system, the industry would continue and still be able to allow users to trade freely, complemented by compliance, security, and trust.
