A Definitive Guide on KYC for Crypto [Updated]

It’s an open secret that cryptocurrencies were introduced to tackle the problems of centralization and lack of authority in finance after the 2008 financial crisis. Though they have been used in illegal activities, they have ended up causing billions of dollars in damage. Read more.

KYC in the crypto industry

Governments classify blockchain and crypto service providers as Virtual Asset Service Providers (VASPs) and impose Anti-Money Laundering (AML) regulations. This requires crypto companies to implement thorough Know Your Customer (KYC) processes to scrutinize their clients. Additionally, they now have to stick to stricter requirements. 

One major example in this context is the Travel Rule, which imposed new obligations, including new thresholds or reporting requirements, among other nuances that aim to combat fraud in the crypto landscape. Additionally, crypto service providers must implement diligent identity verification procedures. 

But the ultimate question remains — how can we stay safe and conduct proper KYC checks to avoid hefty compliance fines? Get ready to stay ahead of the game in the crypto world with our ultimate guide to KYC! 

We’ll cover the following highlights:

  • What is KYC in blockchain?
  • How to implement KYC?
  • What is AML in blockchain?
  • Why do crypto startups need KYC?
  • How are crypto exchanges performing KYC? 
  • What are the benefits of KYC for crypto startups?
  • How to tackle the challenges of KYC checks?
  • What’s the future of crypto with KYC? 

What is KYC in Blockchain?

Crypto exchanges, NFT marketplaces, and digital finance involved in blockchain activities must follow the needs of the local governments for KYC requirements. However, KYC for crypto goes beyond mandatory regulatory requirements. It protects crypto users from fraud by safeguarding their transactions, especially if they’re new to the trading world and are more vulnerable to scams, which are getting more sophisticated by the minute. 

Key facts to remember about the KYC process:

  • KYC is the get-to-know-your-client procedure blockchain financial services conduct before allowing potential users to transact via the platform.
  • KYC is not a bypass procedure for blockchain financial services.
  • The use of KYC in blockchain fintech products poses a necessity for customer due diligence (CDD).

What is Customer Due Diligence?

CDD is used by crypto companies and other regulated institutions, such as banks, to verify users and assess their risk profiles. The main CDD measures include the verification and identification of customers, risk assessment, and ongoing monitoring. CDD makes it possible for companies to identify their customers. 

For example, confirming identities is done by comparing legal documents with government requirements. The standard information required usually includes: 

  • Full name
  • Date of Birth
  • E-mail
  • Phone number
  • Country and address of residence
  • Identification cards
  • OTP validation

Making this all a bit more binding, some jurisdictions have introduced more concrete requirements, such as the mentioned Travel Rule. This goes way back to 2019 when the Financial Crimes Enforcement Network (FinCEN) implemented regulations that demand that financial firms and VASPs obtain and share information on all originators and beneficiaries of economic transactions, and it also extends to crypto.

Before the Travel Rule: Companies that did wire transfers with regular money flow had to share certain information.

Today: This rule now requires financial companies and VASPs to gather and share information about who is sending and receiving funds in a transaction. This also refers to crypto transactions. 

Interesting fact: The Travel Rule is similar to regulations that already exist in other countries, such as the Bank Secrecy Act (BSA) in the US, which requires sharing data for transfers worth $3,000 or more. 

What are the Main KYC Processes?

KYC processes have various use cases and can be implemented through three main processes explained below:

  1. Customer Identification Program (CIP)

This is the very first process in KYC, where essential identification data is acquired from customers who have registered on the platform. These may include verification of legal documents, face recognition, address verification, or risk scoring. Larger companies are also likely to collect other regulatory documents before making sure full access is available and regional demands over KYC are met.  

Related: What is a Customer Identification Program (CIP)?

  1. Customer Due Diligence

Customer due diligence becomes more critical when users manifest evidence of being high-risk; for example, transaction size is too large, or the activity operates from high-risk jurisdictions. Additional verification must be done here for compliance, suspicious activity reporting, and fraud prevention on the platform. 

  1. Continuous Monitoring

Continuous monitoring is a huge part of ongoing KYC, forming an essential element in identifying customer risk profiles over time. For example, a user who was clear to onboard could later be flagged for sanctions or suspicious activity. Such regular monitoring will keep the crypto exchange updated with evolving compliance standards and ensure secure business operations. 

Related: What is Ongoing Monitoring?

What is AML in Blockchain?

AML in blockchain ensures legality in the transactions taking place over platforms. Blockchain provides users with a pseudonymous identity, which could be a web3 naming service or a native alphanumeric wallet address.

AML also requires means to track transaction paths and adopt a risk-based approach to AML in order to reduce illegal activities. 

Why Do Crypto Companies Need KYC?

To stay safe and build a safe tool in the crypto space, regulating bodies in Europe expect crypto and crypto service providers to comply with the Anti-Money Laundering Directives (AMLDs), such as the AMLD5 and AMLD6 legislation. Also, in the USA, FinCEN clarifies that virtual currencies and platforms that they trade are subject to anti-money laundering legislation.

And there’s a good reason for that. Companies involved in illicit activities or those that avoid sticking to compliance regulations risk can even end up being charged. Let’s look at some examples below. 

Non-compliance with KYC, as recent cases show, has serious consequences:

The Bitzlato Case

Bitzlato’s poor KYC practices are supposed to have permitted the processing of $700 million in illicit transactions. The main reason was the deficient KYC procedures that paved the way for criminals to launder money from drugs and ransomware easily.

The Tornado Cash Case

In 2022, Tornado Cash was fined by the US government for laundering an incredible $7 billion in virtual currencies, including funds that North Korean hackers had hacked. 

What are the Benefits of KYC for Crypto Companies?

Crypto companies that do implement KYC enjoy several security and trust-related benefits. Here’s how KYC benefits businesses: 

  • Enhances transparency and trust. KYC forms a trust bond between the users and the brand. Users are legitimately assured of data and funds safety. Illegitimate users won’t consider using brands that are KYC-oriented so as not to get caught.
  • Reduces risks of identity theft. Robust identification service providers, including iDenfy, help instantly detect fraudsters who use fake and stolen identities to take advantage of any platform and launder money.
  • Ensures money laundering prevention. KYC processes make every single user identifiable and traceable, meaning every transaction becomes traceable. When users bear this fact in mind, they take their fraudulent practices like money laundering to less secure platforms. 
  • Minimizes legal risks. When brands shy away from compliance and regulations, they become open to governmental risks and threats, which might lead them to pay outrageous fines. Consequently, identity verification helps ensure KYC compliance and prevents getting caught up in fraudulent activity.

Keep in mind that, like many digital spheres, cryptocurrency can be risky. People who own digital assets become victims of attackers who have the goal of stealing their money. This can also cause the prices of cryptocurrencies to change quickly, making the market unstable.

To be safe with crypto, it’s important to learn about it and take steps to protect your money. As for businesses, it’s vital to build a multi-step security system to prevent criminals from stealing funds. 

How Are Major Crypto Exchanges Performing KYC? 

In the world today, crypto exchanges are the easiest means by which users can buy or withdraw crypto. Regulations vary in different regions, and some exchanges have decided to get their brands registered with countries that do not enforce compliance laws.

So, what does that mean? 

This, in effect, will only pose the companies with illegitimate financial transactions with an increased rate of dishonest users.

Many exchanges differ regarding how they implement their KYC process. Here are a few examples from major exchanges: 

  • Coinbase allows users to make transactions with only a minimum document verification process, so if a user wants to buy or sell cryptocurrency, they have to complete full KYC. 
  • Binance, on the other hand, allows users to have only a withdrawal option if they do not have a complete KYC. 

Exchanges that operate in the US require users’ personally identifiable information (PII), government ID, and social security number (SSN) to go through KYC processes. 

Tackling Challenges in KYC Checks

Manual and automated KYC checks are the main identity verification types out there. The use of manual checks amasses a lot of challenges for the brands and the users. Some of them are listed below:

  • High costs. Manual KYC processes are highly expensive since abiding by regulations would require more hands to gather to verify and validate data relying on human speed. Small enterprises and medium-sized crypto companies that are not rich enough could run out of business if available funds become insufficient to pay staff.
  • Lack of speed. Relying on human efforts, before all KYC could be duly validated, customers would have to wait and abide by time frames provided by such crypto companies.
  • Human error. Malicious users could get so smart with legal documents or other means of identification which might be so difficult for humans to verify and authenticate. The use of human effort tends to point out a high rate of efficiency and thereby posing threats to such businesses.

Automated checks help to tackle all challenges amassed by manual methods. Through the use of automated KYC processes, financial institutions can foster onboarding, validating, and effortlessly making brands follow KYC and AML regulations without losing genuine customers and eliminating malicious users.

Related: Top 5 KYC Challenges and How You Can Overcome Them

The rise in high money laundering activity on both centralized and decentralized crypto platforms has only added up to the loss of customer funds and mistrust. All blockchain services that serve as financial instruments, stores of value, or are used on VASPs will be regulated for KYCs to curb malicious activities and make blockchain a safer tool. 

The FATF update to the AML Travel Rule does require not only customer identification at the KYC level but also the details of transactions and the users involved.

Besides stricter rules and updates, users think regulations would bring centralization to decentralization and then politicize crypto-centralized services. And, despite this narrative, they are only seen as conspiracies because innovations like ZK proofs will most likely redefine how crypto companies can efficiently follow compliance rules and still satisfy users’ decentralization needs.

Would you like to find out how iDenfy can assist in maintaining KYC compliance at your crypto platform? Let’s continue the conversation

TL;DR 

While cryptocurrencies are decentralized, governments often target them because of possible misuse. Many governments worldwide recognize crypto services as VASPsand place those under the radar to ensure the policies and procedures for KYC/AML are in place to avoid fraud and other criminal intentions. In general, KYC is customer identification through various customer identification programs. This use of KYC introduces a degree of trust and mitigates risks in a greater platform; it’s in the hands of shared cost and efficiency that automation can address. 

Frequently asked questions

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Why Do Crypto Companies Need to Implement KYC?

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Crypto companies must take up the work of KYC for regional regulation compliances such as AMLD5 and AMLD6 in Europe or FinCEN requirements in the US, where not abiding by them might amount to some legal consequence. A proper KYC would decrease fraud risks and increase user trust. 

2

What Happens if a User Fails KYC?

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Does KYC Allow Users to Remain Anonymous on Crypto Platforms?

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