Cryptocurrency
Frankfurt, Hesse, Germany - April 17, 2018: Many coins of various cryptocurrencies

Know Your Customer or KYC for short refers to the identity verification process that customers have to go through. According to this process:

  • Customers are required to validate their identity by providing their PII (Personally Identifiable Information)
  • Businesses gain a better understanding of their new or potential customer’s actions
  • They are also able to determine whether another business entity is legal
  • Judgment regarding the risk associated with each customer is made
  • Fraudsters are easily filtered out

KYC for Cryptocurrency

In terms of KYC for cryptocurrency, crypto exchanges require their customers to verify their identity before allowing cryptocurrency transactions. The KYC process is convenient and includes the following steps:

  1. In the initial stage of verification, customers are asked to provide their full name, a legitimate residential address, and their phone number.
  2. After this, they are asked to provide official ID documents, such as their government-issued ID card or a passport. To further enhance security, cryptocurrency exchanges require not only an image of the official document but also the customer’s selfie holding the ID document to verify that the document actually belongs to them.
  3. Finally, a few cryptocurrency exchanges might even ask for additional information for authentication, such as details about their occupation, a recent utility bill, or some other document as proof of address.

Why is KYC Mandatory for Most Exchanges?

The world of cryptocurrency is still largely unregulated worldwide, and AML and KYC regulations have only just begun affecting the industry. In 2019, the SEC (Securities and Exchange Commission), the CFC (Commodity Futures Trading Commission), and the FinCEN (Financial Crimes Enforcement Network) was the first regulatory authority to issue a joint agreement on this matter. According to new rules,  cryptocurrency companies were declared to be money service businesses (MSBs). This made them liable to conform to KYC and AML regulations under the BSA (Bank Secrecy Act) and brought about new regulations for cryptocurrency holdings and wallets.

These efforts serve two particular purposes:

1.      Eliminate the Illegal Use of Cryptocurrency

Cryptocurrency has long been used for numerous illegal activities due to its anonymity. By introducing new regulations, global authorities aim to have the ability to backtrack illicit financial transactions to the responsible party. For the same reason, it has become obligatory for cryptocurrency exchanges to request their customers to go through the KYC and AML screening process.

2.      Decreases Fraud

While AML methods deal with money launderers moving illegally obtain funds, CFT, short for Combating the Financing of Terrorism, focuses on preventing the money from being spent on terrorism. This includes analyzing and blocking suspicious transactions that facilitate any form of illegal religious, ideological, or political goals. Closely associated with money laundering, terrorism increases when criminal organizations fund decentralized blocks around the world. By imposing robust KYC and AML regulations, authorities have the opportunity to reduce terrorist acts that are committed through cryptocurrencies.

Consequences of Non-compliance

The U.S. government has been closely monitoring cryptocurrency exchanges that do not comply with KYC and AML regulations. In 2019, the FinCEN (Financial Crimes Enforcement Network) find a privately owned crypto exchange that violated the Bank Secrecy Act by neglecting to report approximately 150 transactions worth more than USD 10,000. The exchange had to pay a fine worth USD 35,000 and was banned from running a money service business. This sent a strong warning to other cryptocurrency exchanges about the outcome of non-compliance with AML and KYC with regulatory obligations.

The cryptocurrency market is therefore taking AML and KYC compliance more seriously, and are even utilizing services offered by third parties to help weed out potential fraudsters. Exchanges hoping to provide enhanced customer experiences, with high-level security, and avoid penalties from global authorities would do well by performing necessary KYC checks.

Key Takeaways

  • Cryptocurrency exchanges require their customers to verify their identity before allowing cryptocurrency transactions
  • Regulatory authorities declared cryptocurrency as MSBs, making them liable to perform KYC checks the same way as other financial institutions
  • KYC on cryptocurrency helps in the elimination of money laundering and other financial crimes
  • It also assists in decreasing the amount of money spent on terrorist activities

Failure to comply with these regulations leads to hefty fines and penalties