What is KYC for Crypto? KYC Compliance for Crypto Exchanges

The Know Your Customer (KYC) process is a set of identification processes and requirements that financial institutions employ while onboarding clients. These client onboarding procedures protect the financial institutes against fraud, corruption, money laundering, and terrorist financing. It essentially helps these institutes access their customers’ identities, allowing them to find the source of their funds and anticipate any risks associated with their financial activities.

In a time when fund transfers mostly happen online, it can be difficult for financial institutions to verify the identity of the party behind a financial transaction. The KYC process becomes a collaborative approach to addressing and stopping financial crime for all such institutions.

Why Is KYC Important?

KYC allows financial institutions to confirm the identity a customer has claimed is their own. Verifying customer identity allows organizations to prevent fraud and assess & monitor any risks based on customer financial profiles and past financial behavior. 

KYC verification is required by Anti-Money Laundering (AML) laws. AML laws are procedures and regulations that have been put in place to stop income generation through illegal activities and restrict access to funding and financial services for those who have been identified as terrorists, criminals, or suspicious actors by the government.

As part of KYC & AML compliance, customers must go through a process that involves ID card verification, document verification (proof of address, etc.), and biometric verification. These regulations help financial institutions detect suspicious activity indicative of money laundering, terrorism financing, and other illegal financial schemes.

Though KYC and AML are often used interchangeably, there is a distinct difference between the two. While AML is a framework containing the complete set of mechanisms used to fight money laundering and financial crime, KYC is one such mechanism that falls under AML.

KYC is used in various industries – financial services like banks, the healthcare sector, online gaming, and now even crypto exchanges. Noncompliance with these regulations can lead to heavy fines and penalties for companies, in addition to the loss of trust of customers.

What is KYC in Cryptocurrency?

By definition, cryptocurrencies are decentralized networks that are not reliant on any central authority to uphold or maintain them. This means that the confidentiality they provide is a crucial feature for many users. However, this also poses challenges when it comes to preventing money laundering because, for financial criminals, it’s the perfect way to launder their money. While there is a permanent record of each transaction conducted on the blockchain, the transactions cannot be tied back to an identity without properly implementing KYC processes.

As cryptocurrencies become more mainstream with more people investing in and using them, governing bodies around the world are pushing to impose KYC on crypto markets which would mean cryptocurrency platforms will have to verify the identity of their customers, much like traditional financial institutions. 

Unlike traditional financial institutions, which have strict, standardized KYC processes in place- when it comes to cryptocurrency platforms, the current situation is quite the opposite. Depending on the state or country, the regulations that apply to crypto trading are wildly different – while some have no regulations in place, others are pushing for stringent KYC enforcement.

While not ideal for crypto purists, stricter regulations seem to be around the corner with no way to avoid them. Many crypto platforms have already started implementing KYC processes in an effort to create trust among their users. In the long run, though, KYC processes will benefit both the financial institutions and the users as it brings more security, credibility, accountability, and transparency to the crypto space.

Understanding Cryptocurrency Risks

The things that make the cryptocurrency space exciting are also the ones that make it dangerous. This means that not only are normal users exploring this new evolving space but so are financial criminals in order to find new loopholes and ways to commit fraud.

To keep up, here are some risks and points that crypto companies should be aware of before implementing KYC solutions:

1. Anonymous transactions: Money launderers thrive in the anonymity that cryptocurrency exchange transactions give them. When building their KYC process, crypto companies should include steps that collect basic biometric information from every onboarded user (face, voice, and fingerprints) to mitigate the opportunity for money launderers to succeed.
2. Speed of transactions: Cryptocurrencies can be transferred between accounts in seconds, much faster than AML/CFT controls. When inserting the AML/CFT protocols into the product, crypto companies should ensure that these processes are completed before the funds can be transferred.
3. Structured transactions: A trick money launderers use is structuring their transactions into smaller amounts to avoid flagging off reporting requirements under the Bank Secrecy Act (BSA), which mandates financial institutions to report all transactions of $10,000 or more. Crypto companies can prevent this by not allowing users to create multiple accounts and keeping an open line of communication with financial institutions to detect and prevent such transactions in real-time.
4. Money muling: If all else fails, sometimes, instead of using their own accounts, money launderers also get other users to make crypto transactions on their behalf by incentivizing them. These third parties are known as money mules. Being able to detect users whose transactions don’t match their financial standing or behavior can help crypto exchanges flag and report such transactions immediately.
5. Customized user experiences: Keeping an updated and detailed risk profile on each user can help crypto companies provide a better experience to their users. Instead of putting everyone through stringent AML/CFT controls, they can flag the high-risk profiles and ensure only those get scrutinized, while the others can have a lighter KYC process.

What are the Benefits of KYC in Crypto?

KYC processes are still a dividing issue amongst crypto community members. While on the surface, it seems like it solely benefits crypto companies, that’s actually not true. Regulations like this also help the users in many ways.

Even for crypto companies, it’s worth it in the long run despite the implementation challenges that KYC processes pose.

1. Boosts customer trust: When users have to verify their identity when creating an account on a crypto exchange, it tells them that all the other users had to do the same. This builds confidence and trust in the crypto company.
2. Reduces instances of money laundering and scams: Identity verification doesn’t just make money launderers think twice, but it also reduces the chances of users getting scammed.
3. Reduced legal risk: With KYC policies looming on the horizon, implementing them now ensures that they meet regulations globally, and also, when regulatory bodies start requiring every crypto exchange to put KYC and AML processes in place, there will be no last-minute scramble to meet the regulations.
4. Higher confidence in crypto markets: Crypto markets are unpredictable and also known to be high risk. Increased adoption of KYC in the market will improve this reputation and lead to more stable crypto markets in the long run.

Automate Your Crypto KYC Process for Easier User Onboarding

Despite knowing the benefits of the KYC process, many crypto companies are reluctant to implement it because not only will they have to hire a KYC compliance team but manually verifying each customer’s details takes time and makes the onboarding process tedious for their users. They need a way to quickly verify the details without requiring extra effort from their potential customers.

Thankfully, there are many platforms that can make the KYC process easier. The Incode Omni is an end-to-end identity platform that offers a frictionless customer experience with a consistent level of security across multiple channels. Incode’s solution is fully automated, meaning it doesn’t use humans in call centers to identify clients. This gives crypto companies the flexibility to implement the processes they need without putting the burden on their bottom line or their users. To find out how Incode can help you streamline KYC for cryptocurrency exchanges, get in touch with the Incode Omni team.