Do you know who your clients are? In any case, you ought to. If you are a business that deals with monetary transactions. There’s a high probability of you facing hefty fines, penalties, and reputational damage. If you end up doing business with a terrorist or a money launderer. More importantly, Know Your Customer (KYC) is an essential practice for safeguarding your organization from numerous frauds. Losses that could result from handling illegal cash and transactions.
Generally, KYC includes several steps taken by financial institutions for:
- Accurately identifying customer identity through official documents
- Understanding the true nature of their activities (To ensure that the source of customer’s funds are legitimate)
- Making background checks on the customer base to assess money laundering risks (also known as AML or Anti-Money Laundering)
The Significance Of KYC
KYC is a mandatory process for financial institutions that enables them to comply with the global. National anti-money laundering (AML) standards. Since 1989, numerous countries worldwide have committed to recommendations introduced by the Financial Action Task Force. However, the KYC standard is not standardized. Different regions around the world have various versions of their KYC and AML regulations.
Overall, KYC aims to protect organizations from becoming a victim of criminals. That may be using their institution for laundering dirty cash, financing terrorism, or carrying out other illegal activities. With the implementation of KYC processes, businesses can accurately and efficiently verify the identity of their customers. Their financial activities, and can deny their services to applicants that appear suspicious. Thereby, organizations can easily monitor customer dealings and avoid risk.
KYC and Cryptocurrency Exchanges
2020 is known as the year of DeFi (Decentralized Finance), as more than 5,000 different cryptocurrencies were in circulation as of June 2020, and the market is projected to hit USD 1.7 billion by 2027. The concept of KYC is particularly new to the world of cryptocurrency. KYC requirements differ drastically between different cryptocurrency exchanges. This means that while some exchanges may require their users to provide an ID document and photograph, other exchanges consider KYC checks optional for identity verification.
With that said, common requirements for cryptocurrency KYC can include any (or all) of the following:
- An official ID document
- User’s full name
- Date of birth
- Phone number
- Physical address
- Copy of a utility bill
Evolving KYC/AML Regulations For Cryptocurrency
The cryptocurrency space is still largely unregulated worldwide, and AML and KYC regulations have only just begun affecting the industry. Back in 2019, the SEC (Securities and Exchange Commission), the CFC (Commodity Futures Trading Commission). The FinCEN (Financial Crimes Enforcement Network) was the first regulatory authority to issue a joint agreement. That declared cryptocurrency companies to be money service businesses (MSBs). Therefore making them liable to conform to KYC and AML regulations under the BSA (Bank Secrecy Act). This brought about new regulations at foreign exchanges for cryptocurrency holdings and wallets. Consequently, the cryptocurrency industry in the U.S. now faces a difficult choice: cause inconvenience to their existing customers is using an unregulated market by introducing KYC and AML checks, or dissolve their business from the U.S. altogether and potentially lose all customers.
Implementing KYC in the Cryptocurrency Industry
Cryptocurrency exchanges can be subdivided into two types for determining the implementation of KYC measures: Crypto-to-crypto and Fiat-to-Crypto. Let’s take a look at both of these categories to better grasp the concept.
As of 2019, KYC requirements for crypto-to-crypto transactions are more relaxed, with close to zero requirements for submitting documentation for ID checks. One company that can be discussed as an example here is Binance, which requires no KYC before opening accounts for their customers. Once the account has opened, customers can trade cryptocurrency without any verification requirement. However, in case more than two Bitcoins are withdrawn in a day, a photo ID is required for authentication.
Most cryptos to crypto exchanges have faced criticism due to their lack of KYC procedures as they do not actively monitor transactions, leading to undetected fraudulent behaviors and market manipulation.
Fiat-to-crypto transactions typically go through a certain level of KYC procedures since such exchanges deal with fiat currency that is considered as a legal tender by governments. These exchanges carry out business with traditional financial institutions like banks, most of whom perform internal KYC checks before conducting business with third parties.